Contracts provide a legally-enforceable framework for guiding any and every type of business relationship, from employment agreements to orders for parts and supplies. While these agreements are key to guiding business relationships and ventures across all sectors, getting contracts right is especially important within construction, where the ability to complete a build on time, on budget and to code hinges upon all vendor arrangements going as expected. From the builder’s perspective, contracts are also important for preventing scope creep and to reducing the risk of cost overruns they may unexpectedly have to absorb.
Contracts, which detail everyone’s obligations and the consequences for failing to meet them, are key to making sure everything goes smoothly and that all parties fully understand their risks at the outset. This is especially important in construction given the vast expenditures associated with large-scale building projects and the potential for the unexpected: according to McKinsey, large construction projects typically take 20 percent longer than anticipated to complete and experience average cost overruns of 80 percent over budget. Contracts are extremely important for both preventing problems between parties that can delay or increase the costs associated with a build, as well as for determining who is on the hook should time and budget be exceeded. And should a build be less complicated than estimated, the contract may determine whether the purchaser is entitled to money back or whether the builder may keep the extra profits.
Construction management contracts encompass the work and/or materials required for a building project. Typically, they will address:
Labor and material requirements
Timelines for completion/delivery
Compensation formula and amounts
While construction management agreements will typically include the above, they can be structured differently, with numerous types of contracts that are designed to best meet the needs of all parties under all sorts of different scenarios. Familiarizing yourself with the types of contracts that are typically in play within building projects is an important first step to optimizing all contract-related processes within construction management.
Here is a complete list of the construction management contract types that are commonly utilized.
Unit Price Contract
A unit price contract defines the costs of a project based on rates – for example, hourly worker rates or rate per unit of work produced – but does not define the scope of work. The final price of such a contract will be dependent on the total quantities of contracted services and/or parts that are ultimately required for the project. Unit price contracts are commonly used when the design, engineering or other scoping have yet to be completed prior to the agreement and thus cannot be defined at the outset.
Lump Sum or Fixed Price Contracts
Unlike unit pricing, lump sum or fixed price contracts provide a clear total fee for a project, meaning the full scope of a build as well as timelines must be negotiated prior to the agreement. Under this type of agreement, much of the risk transfers to the builder as they cannot later adjust their billings to account for delays and other unexpected cost overruns. Lump sum or fixed price contracts may also include liquidated damages clauses in the case of building delays and/or incentives to the builder for completing construction early. Changes to the project scope and/or specifications may also result in increased costs for the purchaser.
Cost Plus Contract
When the scope of a construction project, and its full requirements and expenses, are unknown, cost plus contracts are often employed. These agreements specify a markup for the actual costs, both of labor and materials, that are incurred during a build. This markup is the builder’s profit. While the formula for the markup is agreed to within the contract – commonly in the form of either a percentage of actual costs or a fixed fee – the final costs are determined based on the actual work. Cost plus contracts may also specific a minimum spend or fee cap.
Time and Materials (T&M) Contract
Another type of contract used when the exact scope of a build is unknown at the outset is a time and materials (T&M) contract. Under this type of agreement the customer pays a defined hourly rate for the number of labor hours and pays cost for materials used. The builder’s costs associated with sourcing materials, transporting them, etc. are billed based on time spent. Like cost plus contracts, time and materials contracts may also include provisions for minimum and maximum total fees.
Guaranteed Maximum Price Contract
Under a guaranteed maximum price contract, the builder specifies an up-front maximum fee comprised of both actual costs incurred during the build and a fixed fee, which is subject to a ceiling. If the actual costs exceed the total fee specified within the contract, the builder absorbs the overage unless the changed is agreed to and amended within the contract. If the actual costs are lower than estimated, the excess fees are returned to the purchaser.