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What Types of Construction Contracts Are There? A List of Different Types of Construction Contracts, Their Purposes, and More

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With the various types of construction contracts available, it may be difficult to know which one to use with a particular project.

Understanding the ins and outs of the types of construction contracts can help builders and owners know which one will best serve their interests given the type and scope of the project.

This article will discuss the purpose of construction contracts and outline the different types of contracts most commonly used.

Table of Contents

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Construction contracts can be extremely long and complex. They can range from 500-600 pages because of the plethora of forms that need to be attached.

Each cost must be accounted for — from materials costs to necessary parking fees for contractors.

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In the end, Flexbase’s job is to make sure you have everything you need in the easiest and most automated way possible — no more manual contracts.

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  • AIA forms
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What Is The Purpose of a Construction Contract?

A construction contract is designed to outline the various details of a construction project including:

  • Costs
  • How payments will be made
  • Obligations of each party involved
  • Risks and liabilities to be shared
  • Other stipulations

Many parties are often involved in construction projects:

  • Owners
  • Builders
  • Contractors
  • Sub-contractors
  • Designers
  • Materials suppliers

Contracts are necessary to outline expectations from the outset, thus protecting each individual involved in the project.

How Does a Construction Contract Work?

Construction contracts work by setting out all the terms and conditions of a specific construction project.

These contracts provide information about the risks, scope of the project, payments, and obligations to help manage risk for both the owner and the contractor.

What Are The Different Types of Construction Contracts?

Not only are construction contracts complex, but they are also varied.

Different types of construction contracts are available, and choosing the contract to use will be dependent on various factors like:

  • The scale of the project
  • Budget
  • Risk tolerance
  • Flexibility in design
  • Duration estimates

The four most common types of construction contracts are discussed below.

For each type of contract, we’ll:

  • Define the contract
  • Outline the typical situation in which each contract is used
  • Detail the pros and cons of each kind of contract

#1: Time and Materials Contracts

Time and materials contracts are agreements where the owner and contractor consent to an hourly or daily rate including reimbursement to contractors for the cost of materials or additional expenses.

All costs must be categorized in the contract as:

  • Direct
  • Indirect
  • Markup, or
  • Overhead.

There is risk involved in time and materials contracts because of the unpredictability of time and work estimations. The owner may end up paying more for the job if the project takes longer than expected or supplies cost more than anticipated.

For this reason, sometimes price and duration caps are set to protect the owner’s interests.

Time and materials contracts may be ideal for:

  • Small projects, or
  • Projects where the scope is not defined.

Pros and Cons of Time and Materials Contracts

Pros:

  • Time and materials contracts work well for smaller projects.
  • Unexpected costs and delays are paid for because the hourly/daily wage has already been agreed upon.
  • Negotiations are simple and straightforward.
  • There are fewer limitations for the builder based on the budget.

Cons:

  • Listing every hour worked and material used is time-consuming — and inadvertently omitting items can cut into profits.
  • Being paid by the hour or day gives no incentive to finish the project early.
  • It is difficult to estimate the final cost.

#2: Lump Sum Contracts

Lump sum contracts, also known as fixed-price or stipulated sum contracts, are the most basic type of construction contracts. This type of contract sets one price for all the work done on a project.

Though lump sum contracts seem clear cut, they may involve risk, particularly to the builder.

If unexpected setbacks occur, builders and contractors may end up making less money or even losing money because owners are not required to pay for costs above the agreed-upon price.

To combat this risk and protect their interests, builders may add allowances that will cover any unexpected costs.

Lump sum contracts may be preferred for smaller projects or those with a clear scope and an established timeline.

Pros and Cons of Lump Sum Contracts

Pros:

  • Bidding is simplified for contractors because they are not receiving multiple bids.
  • Finishing under budget means more profit.
  • Owners do not pay for unforeseen costs.
  • Builders have realistic expectations of the scope of the job.

Cons:

  • Many variables need to be taken into account, and miscalculations can be costly.
  • For big projects where multiple suppliers and subs are involved, there is little room for error.
  • Budget restrictions can inhibit final outcomes.

#3: Cost Plus Contracts

Also known as cost-reimbursement contracts, cost plus contracts are agreements where the owner pays the contractor for project expenses and an agreed-upon amount for the contractor’s overhead and profit.

The price for the contractor’s overhead and profit must be negotiated ahead of time. Costs must also be detailed and labeled as direct or indirect costs.

Direct costs include things like labor and materials, while indirect costs are those having to do with office, travel, and communication costs.

Most of the risk with cost plus contracts lands on the side of the owner since any unforeseen costs are the owner’s responsibility.

There are 3 different types of cost plus contracts. Each one is designed for different kinds of projects and also helps reduce the risk for the owner.

  1. Cost plus fixed percentage contracts - Payment in these contracts covers the builder’s overhead and profit along with the real costs of the project. The builder’s profit and overhead are determined from a fixed percentage of the project cost.
  2. Cost plus fixed fee contracts - These contracts also include payment for the costs of the project, but the builder’s overhead and profit is a fixed fee, rather than the percentage used in the previous contract.
  3. Cost plus with guaranteed maximum price (GMP) contracts - Payment covers the costs of the project, and the fee for the builder’s overhead and profit is paid up to a maximum cost. If the GMP is not reached, the difference is not paid, resulting in savings for the owner. Or the builder and owner may agree to divide the savings, which motivates the builder to keep the costs lower than the GMP.

Cost plus contracts are best for projects where the scope of the project has not been clearly defined and where more creative flexibility is necessary.

Pros and Cons of Cost Plus Contracts

Pros:

  • Owners have more flexibility to make changes along the way.
  • Contractors can be assured that they will be paid for any extra materials or time if changes occur.
  • Projects are more likely to be completed as planned.

Cons:

  • Some expenses might be difficult to justify, especially those that are indirect costs.
  • Since they need to wait for reimbursement, putting funds upfront can be difficult for contractors, especially if one part of the plan ends up costing more than anticipated.
  • Projects can be difficult to manage and track.

#4: Unit Price Contracts

Unit price contracts are used when contractors give prices for each part rather than the whole project. Simply put, the price for the project is divided into several units.

Unit price contracts may also be called:

  • Measurement contracts
  • Measure and pay contracts, and
  • Remeasurement contracts.

These types of contracts are dependent on costs of materials, but prices can be set during the bidding. And sometimes the scope of the work isn’t evident before the project is started.

Transparency is a huge benefit to the owner with unit price contracts because they can know if they are being charged inflated prices.

Additionally, if plans need to change during the project, owners and builders can make adjustments in unit prices that they can agree on.

Unit price contracts are common for projects where the work is repetitive or for public works projects like painting, testing insulation, etc.

These types of contracts are also used for small jobs and maintenance repairs.

Pros and Cons of Unit Plus Contracts

Pros:

  • Invoicing is simple and straightforward.
  • More transparency is provided resulting in fewer disputes.
  • Because extra work is added as another cost unit, it’s easier to make changes.

Cons:

  • Estimating a final price can be challenging.
  • Since it’s hard to know the final price upfront, the owner may end up paying more than planned.
  • With transparency may come delayed payment. If the owner wants to compare the prices of each unit with the total cost of the project, it may slow down the time before the builder gets paid.

What Are The Three Most Commonly Used Types of Construction Contracts?

The three most common types of construction contracts are:

  • Lump sum contracts
  • Cost plus contracts, and
  • Time and material contracts.

These contracts are used for a variety of projects and come with both benefits and risks to either the owner or the builder.

When choosing the right contract for a particular project, owners and contractors should consider all the factors involved in the project to make the best decision.

In general, if the project is small, lump sum or time and materials projects may be the best choice.

On the other hand, for large projects or ones that require more flexibility, cost plus contracts may be the way to go.

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We’ve learned about the different types of construction contracts, but you may still be feeling overwhelmed with the many other details that go along with construction projects.

Establishing the contract is only one part of the process. There’s still payment, legal documents, price estimates, among many other details, that need to be considered.

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