Achieving an Optimized Construction Contract Lifecycle
Risk & Compliance
There are a host of consequences when a construction project doesn’t go as planned. A single delayed shipment of supplies can cause further work interruptions, resulting in cost overruns and other issues, while compliance failures can create a slew of other problems. But because all of the relationships within construction projects are guided by contracts, effective contract management can be an important tool for making sure everything happens the way it’s supposed to.
Contract management is an organized and systemic approach to ensuring that all aspects of a contract, from deliverables and delivery dates to part and supply specifications, are adhered to during the contract term. In construction, careful contract management can help to ensure that every aspect of a build goes according to plan, and also help to reveal potential problems before they run the risk of derailing a project altogether. It is also key to keeping costs in check.
Managing contracts typically requires navigating a number of essential stages that take you from planning your organization’s approach to handling all contracts and developing standard contract templates that address frequent business needs, through to the handling of individual deals. These must be drafted and negotiated, executed, and managed through to a project's conclusion and wrap up. To maximize the return on investment from any contract, it is important to take steps to optimize these stages, ensuring that contract management is both thoughtful and efficient.
Within construction, there are three common types of contracts that are frequently used, each of which carries specific risks – and its own opportunity to optimize in order to best preserve all parties' interests.
1. Lump Sum or Fixed Price Contracts
Lump sum or fixed price contracts provide a total fixed price on a construction project. These types of agreements should include a clear project scope and detailed timelines, and may include clauses such as incentives for finishing a project early or liquidated damages for delays.
Optimization Opportunity: With lump sum or fixed price contracts, you’ll know what you are paying or earning up front, and can budget accordingly based on the project scope. But one risk that can arise with these contracts is when a change to the defined scope occurs during a construction build. As such, the key to optimizing such agreements is to heed to the project specifications closely – and when the work changes from what is defined within the agreement, communicate clearly and quickly. When scope changes do occur, it is important to get sign-off on deviations to the plan as well as to pricing changes. These should be detailed in a secondary document called a rider. This must be signed by all parties and should be stored together with the original contract for easy reference.
2. Cost Plus Contracts
For cost plus contracts, pricing is based on the actual costs of a construction project plus an additional fee. The model for that fee can be a percentage of the actual costs or a fixed fee. The contract may specify a project cost minimum or fee cap.
Optimization Opportunity: With cost plus contracts, the project scope is usually not clearly defined – which means the final price tag of a project will depend on how the work goes. The lack of definition makes a strong contract even more important to protect both builders and owners – if a project turns out to be quicker than expected, the builder may not receive the anticipated returns; on the flip side, no one wants to receive a final invoice that skyrockets beyond expectations. This is where a well-crafted contract comes in.
Taking some time to optimize the drafting and negotiation processes by reviewing the contracts and results of past projects can help you to craft the best possible agreement to protect your interests when a project scope is not yet clearly defined. A well-organized contract repository is key to such reviews; if you’ve taken the time to tag archived agreements appropriately (and have them in a text-searchable format), then you’ll be able to quickly zero in on the relevant ones. Conducting regular contract post-mortems can also help you identify what worked and what didn’t for future reference.
3. Time and Materials Contracts
Like cost plus contracts, time and materials contracts are commonly used when the scope of a project is not well-defined. In these agreements, the price is simply based on the actual cost of construction materials and time spent by the builder and subcontractors. These agreements are more commonly used for short-term or small projects.
Optimization Opportunity: As with cost plus contracts, time and materials contracts do not operate based on a defined scope. They should, however, clearly spell out labor rates – including for any administrative work – maximum and minimum hours, material markups, and any caps. Because the project details will not be closely defined within these agreements, you can save time by developing standard time and materials contracts that detail pricing and other terms. Developing these up front means you won't have to reinvent the wheel or risk leaving an important clause out of a contract each time you sign on to such an arrangement - and it can reduce up-front administration so the work begins sooner.
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