A construction contract is a legal agreement between all parties involved. Construction projects have numerous people involved both on and off-site: the project manager, owner, designer, contractors, subcontractors, and more. To ensure all parties involved are protected, the contract must be clear and agreed upon by all.
Construction contracts clearly state project compensation, responsibilities of all involved, and risks assumed by all parties.
The following contract types are used in construction projects and are customized to meet the needs of each new build.
Lump Sum or Fixed Price Contract
A lump sum, or fixed price, contract includes a total fixed price for the entire project. The contractor estimates the total cost of the project, including costs associated with overhead and risk. With a lump sum contract, the contractor assumes all risk. Incentives or penalties can be included in the contract for timeline adjustments.
Cost Plus Contract
With a cost plus contract, the contractor is paid for actual purchases and labor costs. A pre-negotiated amount to cover the contractor’s overhead is also included. All expenses are classified as either direct or indirect.
In this type of contract, the owner assumes all risk and is involved in construction administration. In addition, there is no incentive to reduce labor costs by finishing ahead of schedule.
The most common variations for a cost plus contract are:
- Cost Plus Fixed Fee
- Cost Plus Fixed Percentage
- Cost Plus with Guaranteed Maximum Price Contract
- Cost Plus with Guaranteed Maximum Price and Bonus Contract
Time and Materials Contracts
With a time and materials contract, the owner and contractor agree on an hourly or daily rate. Similar to a cost plus contract, all fees must be included and classified as direct or indirect. Overhead and markup costs also need to be added, and owners can put a cap in place. Time and materials contracts are most often used for a small scope of work.
Unit Pricing Contracts
For larger scopes of work, builders and federal agencies will often use a unit pricing contract. This contract determines the payment for a specific task (i.e., the number of residential units), which is multiplied by the quantity of that task. With unit pricing, the exact price will not be known until the project is completed.
The type of project you are working on will determine what contract you will need. Always review your contract in full and discuss any questions with your builder or project manager.