A construction contract agreement is a written document containing every detail in managing construction projects agreed upon by the owner and the general contractor, sometimes even subcontractors. It meticulously outlines the terms and conditions of what was agreed upon, the legal rights of all parties involved, the total amount to be paid, the commencement date of the construction undertakings, and the target or expected date of completion of the project.
It is absolutely vital to have a well-written contract for any type of construction project, no matter how big or small, because of the following points:
- The House Building Act requires it for legal reasons.
- It protects the rights of both the owner and contractors involved in the construction project.
It ensures that the owner’s plans and specifications are laid out clearly between all parties involved.
- It guarantees that the owner and the contractor are all working towards the same goals and objectives.
To make negotiations more manageable, the construction contracts are narrowed down to four unique categories. Understanding these four types are critical, for they determine data that you will be liable for throughout the construction operations.
The Importance of a Written Construction Contract
A construction contract doesn’t have to be written on paper. The requirements for a contract are quite simple: an offer, acceptance, and intent. In short, if there is no written contract established at the start of the project management process, then it would be formed based on verbal agreements alone.
However, verbal contracts are known for being susceptible to a misunderstanding of the most critical terms, such as the following:
– Is there an established lump sum price, or even an agreed price at all? Additionally, are the prices subject to fluctuations and remeasure?
- Is the contractor legitimately allowed to ask for a higher price due to project delays, or when the building materials’ prices change?
- Is there an agreed flow of works? Who is one of the tasks or activity is delayed?
- Is there an agreed scope of work? Is it subject to revisions, and who is allowed to make the changes necessary?
- What are the established payment terms? How often will the payments be made? Are the deposits refundable or not?
- What if one of the stakeholders decided to walk away and terminates the contract abruptly? What process must be followed in this kind of situation?
In practice, these questions usually arise after the problem has come up on-site, creating unnecessary disputes between stakeholders pertaining to what was discussed in the verbal contract agreement. Without the written terms, one of the most significant dilemmas with the verbal contracts is, therefore, accurately detailing the content of those oral discussions to enact the party’s agreed rights and legal remedies. Over time, all the people involved will have their interpretations, leading to the relationship’s failure, and worse, the project itself.
The Content of A Construction Contract
All the issues discussed above can be easily avoided by only having a black and white document that formally records the agreement reached by both parties, including their respective obligations in the construction operations.
Apart from recording essential contract elements such as price, time, and scope, the contract should also set out the procedures on project management for construction to be followed by all parties, handle the change of works, payment terms provisions, and dispute resolution, and so on. A formal written contract in an industry-ready format will also include potential issues that may not have crossed the minds of the parties had they opted to a simple verbal agreement, for example:
- Who takes on the risk if ever the labor and material prices change,
- Who will shoulder the cost of the project is delayed,
- The level and type of insurance that each of the parties will hold,
- The warranties that will be provided by the general contractor and subcontractors, and
By having a proper record of such a matter, all the possible ambiguity and assumptions will be removed.
The Four Types of Construction Contracts
To help you get familiar with your projected options, we explained the differences between the four contract types and when you should consider using a specific one for your project.
1. Lump Sum Contract
Also known as “fixed price” or “stipulated sum” contracts, a lump sum contract sets a determined price for all the work that will be done in the project.
Incentives are sometimes included in these contracts to reward the contractor if the job is completed ahead of the scheduled timeline. These agreements can also be inclusive of penalties, aka “liquidated damages,” for a job that is finished later than scheduled. Owners generally use these contracts to steer clear of change orders in the project or otherwise undetermined work.
If an owner decides to implement a lump sum contract on a construction project, contractors typically charge a higher price to account for the additional risks they might encounter. Otherwise, these unforeseen costs can either eat up the contractor’s profit or result in a project that may not be finished the way it was envisioned.
- Owners avoid paying unforeseen costs.
- Contractors have a clear expectation of the project scope, and construction crew management is easier.
- Can result in losing profit if the project works to go over the established scope.
- Budget constraints may limit the outcome of the project.
2. Unit Price Contract
Unit price contracts generally highlight the types of tasks being carried out, together with the materials used to execute those tasks. This categorized pricing method makes it more convenient for owners to evaluate the respective costs and allows contractors to more accurately charge the owner for each of the given categories.
This type of construction contract is seldom used for major construction projects and is more often incorporated for smaller jobs like maintenance and repair works. With unit price contracts, it’s definitely easier to adjust the prices if the scope of work changes. Unit price contracts are more frequently used for repetitive projects and public or government works.
- Convenient in evaluating costs of different categories.
- Adjustable prices in cases where the scope changes.
- Difficult to estimate the project cost for more extensive projects.
- Final price is not established at the beginning.
3. Cost Plus Contract
For cost-plus contracts, the contractor typically requires the owner to pay for all the expenses that will be incurred in the project, such as the cost of materials, labor, and other project costs. Moreover, these types of contracts are also inclusive of the agreed-upon amount or percentage that will cover the contractor’s overhead costs and profit that the owner will also be complied to pay.
Depending on the type of cost-plus contract that will be adopted, the owner may pay more than the planned costs and take on more risk than the contractor.
There are three types of contract plus contracts that can be employed according to the different needs of a project. Additionally, each of the contract types also reduces levels of risks for the owner. Here are some of the examples:
- Cost-plus fixed percentage: Payment terms that cover both the project’s associated costs and the contractor’s profit and overhead. The amount paid for the contractor’s profit and overhead would depend on the project cost’s fixed price percentage.
- Cost-plus fixed fee: Payment that includes the coverage of the associated cost of the project as well as the fixed price that would cover the contractor’s profit and overhead.
- Cost-plus with guaranteed maximum price contract: Payment includes the coverage of the associated costs with the fixed fee that is paid up to maximum costs.
Cost-plus contracts are typically used when the scope of work, labor, material, and equipment is not clearly identified or difficult to estimate at the start of the project.
- Project has more odds of being completed as planned.
- Reduce risks for contractors.
- Projects can go over the scope if the caps are not strictly applied.
- Difficult to track and manage as it is complex.
4. Time and Materials Contract
The time and materials contracts are defined by an hourly or daily rate for contractors. In addition to paying this said rate, owners also agree to pay any project related incurred costs, which are specified in the contract as direct cost, indirect cost, markup costs, and overhead costs.
Time and materials contracts are generally applied when the work scope is unclear and carries fewer potential risks when used for smaller construction projects. Project duration or price caps are also nothing new for this kind of contract to mitigate the risks of the owner.
- Contractors are not limited by the budget.
- Easy to adopt for small construction projects.
- Projects can go over the scope if the caps are not strictly applied.
- Final cost estimate will be more challenging to estimate.
Understanding these types of construction contracts helps you decide what contract is fitting for you and your project. Each of the types of construction contracts is usually tailored to the project’s needs, but you need first to understand them. Choose a new contract type for your next project, experiment, and always expand your options.