A Construction Contract is a warranty that the executed job will receive the specific amount of compensation (payment of money) or how the compensation will be distributed. There are many types of construction contracts used in the construction industry, but there are certain types of construction contracts preferred by construction professionals. The best and most direct way to understand these reasons behind the different types of construction contracts is by examining and analyzing the construction costs of these contracts
There are three pricing forms of competitive contracts:
- Lump-Sum Contracts
- Cost Plus Contracts
- Unit-Price Contracts
- Time & Materials Contracts
In this type of contracts the contractor bids a single fixed price for overall activities in the project scope. The contractor here is responsible for estimating project costs from drawings “DWG” then adds overhead & his profit to determine the price of the project.
All risks in the lump-sum contract are assigned to the contractor, there isn’t any risk carried by the owner. The contractor has an incentive in this contract as he is rewarded for an early finish & there is a penalty for a late finish.
The lump sum contract is ideal when the project scope is well defined at the design stage because there is limited flexibility for modifying the design during the construction period.
2-Cost Plus Contracts
This type of contract contains payment of the actual costs, purchases or other expenses generated directly from the construction works. Cost Plus contract types must contain specific information about a certain pre-negotiated amount (percentage “%” of the labor & material cost) covering contractor’s overhead & profit. Costs must be detailed & should be classified as direct or indirect costs. There are multiple types of Cost Plus contracts::
- Cost Plus Percentage of Cost (CPPC): In this type of contract, the contractor bears zero risks & the client accepts it all. This is the least desirable cost-reimbursement contract for the client since all costs incurred by the contractor are reimbursed plus a percentage of them. An unethical contractor might be tempted to not control costs, as they should, since their profit increases as the cost increases.
- Cost Plus Fixed Fee (CPFF): Here, the client still bears all risk, but the contractor’s profit does not increase as costs increase. The profit is set at the beginning of the project (typically a percentage of the estimated costs) and does not change unless the scope changes, regardless of contractor’s performance.
- Cost Plus Award Fee (CPAF): This contract shares the risk a little more with the contractor. In the CPAF, the buyer reimburses the contractor for the actual costs and then awards a fee based on the client’s satisfaction of performance standards outlined in the contract.
- Cost Plus Incentive Fee (CPIF): This contract shares the most risk between client & contractor of the cost-reimbursable contracts. In the CPIF, the client reimburses the seller for contractor costs & then pays an incentive fee that is predetermined and outlined in the contract based upon the contractor achieving certain objectives.
2-Unit Price Contract
It’s the total contract price is based upon the price of all the individual or units of the work. Under a unit price contract, the main contractor provides the client with a specific price for one or more activity or a partial “segment” or a “block” of the overall work that’s required on the construction project. The client then agrees to pay the contractor for the actual units done by the contractor expends to complete the project.
So, rather than taking a look at the construction project as a whole and setting a price based on that finished product, a unit price contract will determine the price based on the “units” that will be required to make up that job. Often, the number of units needed won’t really be specified at the start of work.
Public works projects.
Horizontal construction, such as roads.
3-Time and Materials Contracts
Time and materials (T & M) contracts are a hybrid of both fixed price and cost-reimbursable & are used when a clear statement of work cannot be generated. An example of this is using set professional hourly rates (for instance attorney fees) when the scope (number of hours the client will need) is unclear. It is always a good idea to establish a ceiling or a not-to-exceed price in this type of contract to avoid massive cost overruns.