Like Baskin Robins, construction contracts come in a variety of different flavors although, thankfully, significantly fewer than 31. Here are four of the more common types of construction contracts between project owners and contractors:
Fixed price construction contracts, also commonly referred to as “lump sum” or “stipulated sum” contracts, are the most common types of construction contracts. As its name suggests, under a fixed price contract a contractor agrees to construct a project for a “fixed” or agreed upon price.
Benefits: Fixed price construction contracts provide price predictability for project owners because absent changes in the scope of work, unforeseen conditions, or other circumstances which might cause the “fixed” price of the contract to go up or down, the contractor is required to complete the work for the agreed upon price.
Drawbacks: Fixed price construction contracts can be more expensive for project owners than other types of construction contracts because contractors, knowing that they are going to be subject to a “fixed” price, will often build in a buffer to protect itself from cost overruns and other unanticipated cost increases which the contractor cannot receive compensation for. Moreover, because fixed price contracts work best when there are well-defined plans, fixed price contracts can add to the time and cost of the design phase of a project which can in turn affect the overall project timeframe. And, finally, fixed price contracts can result in lower quality of work because contractors, knowing that they need to complete the work for an agreed upon price, may adopt a “cheaper is better” approach knowing that any cost savings they can achieve will improve their profit margin.
Best Use: Fixed price construction contracts are best for construction projects with well-defined scopes of works where the project owner wants price certainty.
Under a cost plus construction contract, also known as a time and materials contract, a project owner agrees to pay a contractor for its costs plus a fee, which may either be a fixed fee or fee a calculated as a percentage of costs, to complete the work.
Benefits: Cost plus construction contracts offer the most design flexibility for project owners and best price predictability for contractors since owners can make design decisions or changes “on the fly” and contractors know they will be paid for their time and cost of materials no matter how long the project takes or the cost of materials used.
Drawbacks: Because project owners agree to pay a contractor for their time and cost of materials no matter how long the project takes or the cost of the materials used under a cost plus construction contract, cost plus contracts provide project owners with the least control over costs. Moreover, because of the uncertainty of overall project costs, cost plus contracts can make it difficult for project owners to obtain construction financing. And finally, cost plus contracts can make it difficult for contractors to schedule their work on the project and to schedule their work and manage their workforce and other resources for other projects.
Best Use: Cost plus construction contracts are best for smaller construction projects or specific scopes of work within larger construction projects where a project owner wants the most design flexibility or where the scope of work is difficult to determine.
Guaranteed Maximum Price
Under a guaranteed maximum price construction contract, project owners agree to pay contractors for their time and cost of materials plus a fee but only up to a “guaranteed maximum price.”
Benefits: Similar to a cost plus construction contract, under a guaranteed maximum price contract, contractors are provided a degree of price predictability because they will be paid for their time and cost of materials and project owners are provided some design flexibility. But similar to a fixed price contract, project costs are capped at a “guaranteed maximum price.” Guaranteed maximum price contracts can also include a shared savings provision to incentivize a contractor whereby the project owner and contractor agree to split any savings if the actual costs of construction are less than the guaranteed maximum price.
Drawbacks: Like fixed price construction contracts, contractors under a guaranteed maximum price contract will often build in a buffer to protect itself from cost overruns and other unanticipated cost increases which may cause the contractor to exceed the guaranteed maximum price. Moreover, if there is a shared savings provision, a contractor may try to increase the guaranteed maximum price in order to benefit from “more” shared savings. And finally, guaranteed maximum price contracts can take more time to negotiate and to administer.
Best Use: Guaranteed maximum price construction contracts are best for sophisticated project owners and contractors.
Unit price construction contracts are most common on public works projects with repetitive, well-defined tasks such as transportation and infrastructure projects. Under a unit price contract, contractors agree to perform certain identified work known as “units,” for an agreed upon price per “unit.”
Benefits: Unit price construction contracts are one of the simplest contracts to bid and administer since a contractor agrees to perform certain identified “units” of work multiplied by an agreed upon price per “unit.” Of course, because unit price contracts are most often used on public works projects there is also the panoply of federal, state, and/or local laws governing advertising, bidding, union labor and other issues.
Drawbacks: Unit price construction contracts are not well suited for complex construction projects where division of a project into “units” would be difficult to accomplish in a meaningful way which provides scope assurance for a contractor and price assurance for a project owner.
Best Use: Unit price construction contracts are best for simple, repetitive, well-defined construction projects.