If you are involved in a construction project, you may anticipate obtaining permits, coordinating materials, and battling weather conditions, but you may not think about paperwork. Every construction contract involves a contractual relationship, or several contractual relationships, depending on the demands and the complexity of the project. There are, however, a few types of contracts common to the construction industry:
Lump Sum Contract: Under the terms of a lump sum contract, a contractor promises to do the work outlined in the agreement for a fixed price. In a contract of this type, the contractor bids on the project as a whole, rather than bidding on individual terms. It requires the parties to plan ahead to envision the project as a whole and may present significant risks to the contractor (and significant advantages to the contract’s beneficiary) because it requires the contractor to complete the work for a fixed cost. A lump sum contract is probably the most common type of construction contract and is used most frequently in relatively small, defined projects – such agreements are common in ordinary residential construction.
Unit Price Contract: A unit price contract requires the parties to estimate the quantities of items to be used in the project and the price of each item or unit. The unit in question may be square footage (e.g., tile or paint) or the hourly rate for laborers, but the unit can be measured, and the work is based on that measurement. These contracts are beneficial if the parties know the types of items that will be needed but are not yet sure of how many of each unit the project will require. A unit price contract is most useful when projects are easily quantified, such as when a property owner wants to install a certain number of feet of fencing.
Cost-Plus Contract: Contracts of this type enable a purchaser to reimburse a contractor for its direct expenses in completing a project, its overhead (including communication costs, rental fees, and reproductions of plans and documents), plus a certain amount of profit. Typically, such contracts place a limit on how much the contractor can recover, so the contractor does not have an incentive to overspend. However, a cost-plus contract recognizes that a contractor may need to spend more than anticipated to complete a project and helps to insulate the contractor against unpleasant surprises. Cost-plus contracts are used in projects with limited budgets or where not all information about the project is available at the outset. Such contracts are often used in government work.
Incentive Contract: An incentive contract establishes a goal – such as a budget or a date of completion – for a contractor to meet. In other words, the contractor has an incentive to perform at a certain standard or certain speed. Typically, incentive contracts take one of two forms: fixed price contracts, when costs are stable and easy to anticipate, and cost reimbursement contracts, when the initial contract fee is altered based on the difference between target costs and allowable costs. An incentive contract is useful if you want to encourage creativity in a project.
The type of contract you enter into will depend on the practices in your industry and the requirements of your project. However, knowing the basics, their uses, and their various advantages may equip you as you embark on any contractual relationship.