In the world of contracts, there are many different types of legal agreements, most of which are intended to meet the needs of a specific business or personal arrangement. For example, a construction project is often governed by the guaranteed maximum price contract (GMP). This form of legal agreement sets a limit or ceiling price for which an individual or company must pay for a specific project. A contractor like a building contractor, subject to a maximum amount, is paid for actual costs incurred plus a fixed fee. The contractor is therefore responsible for all cost overruns and any savings arising from cost underruns are returned to the contractee (the client). Customers find the idea of GMP Contracts attractive.
How does ‘GMP’ Contract work?
Under the GMP (Guaranteed Maximum Pricing) contracts, the client has to pay the contractor for all of his costs plus a fee/remuneration above the cost, but this total compensation is limited to a predetermined amount.
Therefore, the total amount; including actual construction costs and fixed fees over and above that; is set in advance; well before the construction contract is awarded and the work starts. The amount that can be obtained by a contractor under this particular contract is limited to this GMP, i.e. Maximum price guaranteed.
Guaranteed Maximum Price (GMP) Contract Example
You are employed by a Client to build a Tower under a GMP contract. The terms of the agreement with respect to the price would seem to be something like this: the price would be the reimbursement of all costs plus a fixed fee of $50,000 above the cost of the guaranteed maximum price of $150,000.
Here, the maximum you can gain from this agreement is $150,000. But in order to receive your full $50,000; you, as a contractor, will have to limit your costs to $100,000 or risk losing your remuneration to that amount and paying out of your pocket.
If the total job costs are $80,000, the overall earnings will be $130,000 ($80,000+$50,000). $20,000 is going to save the client. You can receive a certain percentage of this on the basis of the terms of the agreement.
Advantages of Guaranteed Maximum Price (GMP) Contract For Contractors
- More customers find GMP an attractive choice, contractors opting for GMP would certainly have greater ease in getting contracts.
- Contractors can quickly raise funds for their working capital as well as long-term capital requirements from banks since their construction schedules are precise and comprehensive. It offers banks protection in terms of their ability to generate revenue.
- Contractors often have an incentive to complete the project before schedule and maintain expense under the budgeted estimates in order to prevent the risk of being penalized and to earn any percentage of savings if the contract allows. It thus is a win-win situation for both parties.
Advantages of Guaranteed Maximum Price (GMP) Contract For Clients
- This gives the client the certainty that he will not be penalized for the mistakes and carelessness of the contractor in carrying out the project.
- As there is no uncertainty about costs and an almost accurate, crystal-clear estimate of costs – there are no unexpected surprises.
- When the project specifics are worked out quite much in advance, the process is very smooth.
- With the GMP, the risk is transferred from the customer to you, the contractor. There are different ways to handle this additional risk. First of all, you might owe the customer more. Greater chance is expected to mean greater incentive. However, you need to be careful and compromise in unfair bidding situations.
Disadvantages of Guaranteed Maximum Price (GMP) Contract For Contractors
- The contractor will experience losses if he does not have a system to accurately estimate costs. It will miscalculate costs and will have to bear losses in the event of a cost overrun.
- Due to the risk of losses, the contractor may quote a higher price for a job and could lose the contract in a fair bid. It is therefore up to the contractor to figure out a balanced GMP.
Change Orders in GMP Contracts
Change orders are another way of preparing for uncertainty in a fixed GMP agreement. These are mutual agreements to increase the price of the contract or to extend the time of completion due to unforeseen conditions, unfinished plans, or changes to the owner which have a material impact on the scope of the project.
The GMP contract would establish the procedure for requesting and approving such change orders by the owner and/or contractors. Additionally, if a dispute occurs about price or work, a dispute resolution clause will be included in the contract to explain how disputes will be handled. A project could get stuck in limbo without the flexibility of incorporating change orders into the GMP.