In this article, you will read about different types of contracts and the advantages and disadvantages of all contracts in construction, the different types of building contracts affect the cash flow of the contractor
Types of Contracts in Construction Project Management
1-Lump Sum Contract
In Lump sum contract, the engineer or/and contractor agrees to do the described & specified project for a fixed price. Also named “Fixed Fee Contract”. Often used in engineering contracts.
A Lump Sum or Fixed Fee Contract is appropriate if the scope & schedule of the project are sufficiently defined to allow the consulting engineer to estimate project costs.
Advantages of Lump Sum Contract
- Lower financial risk to Client.
- Higher financial risk to Contractor.
- Minimum Owner supervision related to the quality & schedule.
- The contractor has a higher incentive to achieve earlier completion & better performance.
- Contractor selection is relatively easy.
Disadvantages of Lump Sum Contract
- Changes difficult and costly. (but it usually is)
- Need to substantially complete design prior to bidding.
- The contractor is inclined to choose the lowest methods/materials to comply with the specification.
- Hard to build a relationship. Each project is unique.
- Bidding expensive and lengthy.
- Contractors sometimes add high contingency within each Schedule of Rate item
2-Unit Price Contract
Unit Price Contract is a construction contract type based on estimated quantities of items and unit prices (rates: hourly rates, the rate per unit work volume, etc.). In general, the contractor’s overhead and profit are included in the rate. The final price of the works is depending on the total quantities needed to carry out and complete the work. The Unit Price Contract is appropriate only for a project involving well-known resources but at the moment of the agreement unknown quantities which will be defined when the design & engineering or construction work is finished.
The unit price contract is based on the quantity of items included in the project and their unit prices initially estimated. The final cost of the project’s works depends on the quantity required to perform a task.
The unit price agreement is one of the best choices for construction or supplier projects where the contract documents can correctly identify the various kinds of items, but not their numbers.
It is not uncommon to combine a unit price contract with a Lump Sum contract or other types of agreements for parts of the project
Factors affecting unit price contracts:
- Permit and Inspection Costs
Advantages of Unit Price Contract
- It makes the selection of a contractor is easy (the person with the cheapest unit price is usually chosen)
- It increases the speed of the project as the contractor wants to finish as many units of work as soon as possible.
- It allows the client to relate the cost of his project to tangible & measurable results (which are the units of work).
Disadvantages of Unit Price Contract
– When using hours (or any other unit of measurable time, such as days) for unit pricing, the cost of the construction project may be limitless. That’s why in all these types of contracts, there is a maximum number of units that the vendor can charge the client with, and when this maximum number of units is exceeded, the cost of the unit is reduced. In any case, when an hour is used as a pricing unit, clients take all the risk in unit price contracts.
– The quality of the work may suffer. Let’s take the example of the painting above, the faster the contractor finishes the job, the faster he’ll get paid, and that may result in sub-standard quality because he just wants to complete the construction works for another square meter of paint as fast as possible. Strict quality standards must be applied in order to avoid this issue.
– Misleading bidding. Let’s say two contractors are bidding for a job, and each is using the same pricing units, and one of them is cheaper than the other. Instinctively, the client chooses the cheapest of the two. But the cheapest of these two appear to be slower or have a lower quality of work, etc..
3-Cost Plus Contract
A contract agreement wherein the purchaser agrees to pay the cost of all labor & materials plus an amount for contractor overhead & profit (usually as a percentage of the labor and material cost). The contracts in construction may be specified as:
- Cost Plus + Fixed Percentage Contract
- Cost Plus + Fixed Fee Contract
- Cost Plus + Fixed Fee of Guaranteed Maximum Price Contract
- Cost Plus + Fixed Fee + Bonus Contract
- Cost Plus + Fixed Fee Guaranteed Maximum Price and Bonus Contract
- Cost Plus + Fixed Fee Agreement for Sharing Any Cost Savings Contract
Cost plus contracts are preferred when the scope of the work is indeterminate or highly uncertain & the kinds of labor, material & equipment needed are also uncertain. Under this arrangement, complete records of all time & materials spent by the contractor on the work must be maintained.
Advantages of Cost-Plus Contracts
- They eliminate the risk for the contractor.
- They allowing the focus to shift from the overall cost to the quality of work being done.
- They cover all the expenses related to the project, so there are no surprises.
Disadvantages of Cost-Plus Contracts
- They may leave the final cost up in the air since they can’t be predetermined.
- They may lead to a longer timeline for the project.
4-Time and Materials Contracts
The contracts for time and materials (T&M) are a fixed and cost-reimbursing hybrid that is used in cases where there can be no clear statement of work. For example, if the size (the number of hours that the client needs) is not clear, set professional hourly rate is used (for instance fees and costs). In this kind of contract, a ceiling or a price that can not be exceeded is always a good idea to prevent overruns of heavy costs.
What are the FIDIC contracts and why should they be used in construction?
In the construction and installation fields, FIDIC contracts constitute agreements used as an international standard. This contract has been drawn up by a Fédération Internationale des Ingénieurs-Conseils, which was established in 1915 by three European nations (Belgium, France, and Switzerland) and is widely known as the FIDIC.
The main objective of FIDIC was to establish standard contracts for a variety of projects in terms of construction and installation, in view of the fact that the basis of construction a whole project around the world is based on the same primary values (apart from the technical and geographical features). These standard contracts evolve a decade of construction and installation project experience and represent records that take the interests of both sides into consideration in a balanced way.
FIDIC published in 1999, on the basis of the specific features of the proposal, a set of normal construction and installation contracts.
Types of FIDIC Contracts
Three of the most famous standard agreements are the “Red” FIDIC, “Yellow” FIDIC, and “Green” FIDIC, named for the color on the cover of the document under which the document is released.
Red FIDIC (Building and engineering construction contract conditions)
The first edition of which was drawn up in 1956 is used for work on which the design (almost completely) is done by the employer, the layout of which has been designed by the employer.
The risks of the parties are balanced and the payment for work is based on the BOQ or the lump sums for work items.
- Plant and design contract conditions, designed by the contractor, for electrical, mechanical, and building and engineering works
- The plant and design/ build contract
- This type of contract agreement is applied in construction projects in which the contractor, such an undertaking, ensures that the design simultaneously increases the risk levels. It is a lump-sum agreement for the payment of payments based on the engineer’s certification (the engineer manages the agreement like the’ red’ FIDIC).
Is generally used for low-value projects (for instance, less than $500,000) or created within a short period, regardless of whether the project is designed by the contractor or the employer (by instance, less than six months). No engineer is available and monthly payments are made.
EPC and Turnkey Contract
EPC Contracts is a contract comprising Engineering, Procurement, and Construction.
Turnkey Contract is a contract comprising Engineering, Procurement, and Construction.
When one looks at the definition, it is perhaps impossible to distinguish between two concepts, but two concepts differ as follows ;
- In the EPC the employer shall provide the contractor with fundamental engineering, which shall carry out a comprehensive design based on the basic design obtained.
- In turnkey, the employer shall provide only specifications for the project and it is the contractor’s responsibility to prepare the project’s basic and detailed design.
- In turnkey, it is the contractor’s duty to construct and commission, start-up and transform the plant into the employer, but another third party may be liable for commissioning and start-up in EPC.