Common Construction Contract Types Explained

No two construction projects are alike, and there is a need to have different construction contracts to meet all the involved parties' needs. Having the ideal arrangement for a project helps contractors, clients, and project managers properly manage the risk and ensure that everything runs as smoothly as possible.

What is a construction contract?

A construction contract is a legally binding agreement between the owner and the contractor that states a given job will receive the proper compensation. The contract outlines the terms and conditions of the agreement, rights, and duties of all the involved parties, the commencement date of the work, and the expected completion date. The contract also denotes how the compensation will be distributed. Even if both parties "trust" each other, it is vital to have a construction contract, as we will see below.

Benefits of a construction contract

Construction projects, by their nature, are complicated. However, it is essential to enter a contract as there are significant economic transactions involved. Construction contracts are generally in written form as this ensures that the parties involved comply with the reasonable business procedures as spelled out in the contract. A well-written construction contract is essential because of the following reasons: -

It meets the default provisions of the law

The provisions of the law state that a contract, whether written or oral, should be in place to control the handling of issues in case conflict arises. Having well-defined contract terms ensures that unfavorable default terms are not imposed on projects in the case of a dispute.

Shifting risk

The provisions in a contract continually shift some identifiable risks from the owner to the project's builder. There are numerous significant risk issues apart from the price that both parties may allocate to a contract. However, the contract also does not need to shift the risk to one party entirely. Other risk issues include regulatory risks, design issues, time, funding, indemnities, and acts of God. The contract, therefore, protects the rights of the client and contractor.

A contract leads to a more complete and satisfactory structure

The contract method ensures that the construction plans are detailed and comprehensive. It prevents costly mistakes and ensures that the project meets the owner's goals accordingly. Construction contracts also ensure that the whole project team works in the same direction to attain the same goal.

The three critical types of construction contracts

The disbursement of funds usually defines construction contracts. However, the contract types also detail other specific terms like quality, duration, specifications, and other items. Having the best contract type for your project ensures the best delivery outcome, client satisfaction, and profits. There are three major construction contracts that every builder ought to know about.

Lump-sum contracts

Lump-sum contracts have a total fixed price for all the activities involved in the project. It may also include the benefits and incentives for the early termination of the project. Lump-sum contracts usually are used when the owner wants to shift all the risk to the contractor and avoid the change orders for unspecified tasks in the project. 

The contractor, therefore, takes on additional risk as the owner has no obligation to pay more when the project stretches beyond the scope. Some lumpsum contracts consider this in calculation by having separate allowances that have unforeseen costs and changes.

An excellent example of a lumpsum contract may be during constructing a residential tower where the client agrees to a fixed price contract.

There are high odds that most contractors have been in lumpsum contracts severally. As simple as lumpsum contracts seem, they have clear advantages and drawbacks.

Pros of lumpsum contracts

When the scope of a project is clearly defined, the contractor can estimate the contract prices accurately. Other advantages of lumpsum contracts are: -

  • It reduces the client's risk as the price is fixed.
  • The bidding and selection process is easy and straightforward as only one sum is submitted.
  • There are minimal change orders.
  • There is ease and certainty by a client when securing construction loans.
  • Finishing under budget assures higher profit margins by the contractor.

Cons of lumpsum contracts

Contractors carry most of the risk involved in lumpsum contracts. Some of the disadvantages of these contracts are: -

  • It gives greater risk to the contractor
  • Due to the additional risk, contractors increase their tender prices
  • The tendering process may be slower than in other contract forms as the contractor uses more time in preparing the tender.
  • Disputes can quickly arise on matters such as scope, design changes, and change orders.
types of construction contracts

Re-measurement contracts

A re-measurement contract is whereby work done is measured then valued against the agreed rates. Unlike in lumpsum contracts, there is no agreement to a lump sum, but the terms are based on the work done. These contracts are also known as unit price contracts or measure and pay contracts.

An example of a re-measurement contract may be in constructing a highway where the price is given per kilometer based on the length built and the final length of the project. This contract is applied in extensive infrastructure and public works projects where the resources are easy to quantify. Another example is in excavation work. It may not be easy to estimate the scope of work until actual excavation commences.

Pros of re-measurement contracts

Re-measurement contracts are advantageous for work where work depends on the default rates. These contracts are also used to have a flexible budget and may want to improve the design progressively. Other advantages include: -

  • Lower risks for the contractor
  • Easy and  quick bidding processes
  • Competitive unit prices
  • Reduced design costs

Cons of re-measurement contracts

Re-measurement contracts are not always a good fit for projects with a lot of materials and tasks. Other disadvantages include: -

  • They cannot predict the total cost of the project
  • The client's risk is usually high
  • Controlling and reporting usually is difficult in these projects
  • There typically are delays in contractor payments in this contract type

Reimbursement contracts

This contract type is where the project owner reimburses the contractor for the costs incurred after carrying out the work with an additional fee. This contract applies where the scope of work is unclear from the outset, and the associated risks are high. This contract is also called a cost-plus fee contract.

Federal government agencies, particularly defense agencies, use this kind of contract in construction. For instance, you may have a project where you want to extend your office space, but you don't know the scope of work involved. Therefore, you may get in a reimbursement contract with your contractor to assist you in monitoring the cost appropriately even with the uncertainty in scope.

Pros of reimbursement contracts

In this contract, the project owner compensates the builder for the working fees plus a fixed fee representative of the work. This contract type has several advantages as follows: -

  • Higher work quality as the contractor is free to use the best labor and materials at his disposal.
  • There is a lower chance of overbids on the project.
  • It is cheaper than fixed-price contracts because of the lower risks on the contractor's side.
  • It allows for project completion even when there are unknown situations at hand.
  • There is more flexibility in decision-making.

Cons of reimbursement contracts

Due to the uncertainty in the scope of work, cost-reimbursement contracts have some limitations. Some of the disadvantages are as discussed below: -

  • It is challenging to compute a final project estimate.
  • It needs more oversight for effectiveness.
  • There are restrictions on the scope of the projects under this contract. For instance, in 2006, Australia mandated that all domestic building projects be fixed-price contracts.
  • This contract forces owners to take up most of the risk.

Other construction contract types

Other than the main contract types mentioned above, we have other construction contracts for special conditions. One of them is a GMP contract.

GMP contracts

These are known as Guaranteed maximum price contracts. They establish a maximum price beyond which the owner won't be liable for the expenses incurred. Other contracts, such as reimbursement contracts, may also have GMP provisions to curtail the costs to a maximum. They are suitable for projects with undefined scope. An example is the construction of a retail chain that has plans used over and over.

Pros of GMP contracts

  • Having a final price accelerates projects because of a quicker bidding process.
  • Contractors can incentivize savings

Cons of GMP contracts

  • GMP contracts place a lot of risks on contractors.
  • They take longer to review by the contractors because of the risk exposure.
construction contract

What to include in a construction contract

When drafting a construction contract, the arrangement of work should be precise. A detailed and coherent construction contract minimizes the confusion and clarifies all the duties and responsibilities of the involved parties. A construction contract should address the following key points: -

Base date

The base date refers to a reference date from when changes in contract conditions can be evaluated. It is a risk allocation mechanism between the client and contractor. It caters to any contract changes from the pricing of the tender to the actual signing of the tender. This timeframe in small projects is minimal, and therefore the base date is considered unnecessary. Traditionally the base date was the tender date, but due to uncertainties in the tender process, it is now linked to the date of the return of tenders.

Practical completion

This is a contractual term that signifies the date the project is handed over to the client. It is the point the project is complete except for some minor defects that can be rectified without interference to the occupant. Some contracts do not define practical completion but leave it open to the professional judgment of the architect or contract administrator. The minor defects are dealt with by the architect or project administrator by issuing a snagging list.

Retention

Retention refers to a certified amount deducted from the contractor on the interim certificate but is retained by the client. The purpose of the retention is to ensure the contractor completes the contract activities correctly.

Sectional completion

This provision of construction contracts allows for different completion dates on various sections of the project. It is prevalent for large projects as it enables the client to occupy the completed parts as construction is ongoing. When required in a contract, it has to be stated expressly, and the extent and completion of each section are clearly stated.

Snagging

Snagging is a slang term used in construction to define the inspection necessary for compiling minor defects or omissions that the contractor needs to rectify in a project. Typically, the architect or contract administrator prepares a snagging list that is issued to the contractor. The list contains faults that need rectification before the issuance of the certificate of completion.

Construction contract templates

Creating a construction contract with every new project can be very tedious, and that is why it is essential to have a standardized template with standard project parameters. The templates can then further undergo modification to meet specific project requirements. ConsensusDocs, Autodesk, and the American Institute of Architects have standardized contract documents that come in many varieties to suit project needs. A good contract is beneficial to all the involved parties, and such standardized templates give you peace of mind that other construction parties adhere to the same provisions as you are.

Frequently asked questions

Construction contracts have severe implications for your liabilities and rights. Below are the frequently asked questions that help you properly understand what you need to know about construction constructs.

How do I get construction contracts?

Getting construction contracts is not the most exciting part of a business, but it is vital since it is the difference between one-off jobs and major contract jobs. You can get construction contracts through construction bidding sites that give you unique services to plan and cost jobs.

What other documents should be with the construction contract?

The construction contract is not limited to a single document. It includes schedules, specifications, drawings, and a value of schedules.

What happens if I make a mistake on the contract?

Mistakes can be very costly, depending on whether it is a mutual or a unilateral mistake. Some mistakes may be minor and easy to modify, but others may need the rescission of the entire contract.

Conclusion

Understanding the different construction types helps you determine the best construction type for you. Not only are there a variety of contracts to choose from, but there are also options within the contract. Always look out for problematic clauses and plausible risks before signing a contract.