Types of construction contracts/The Nature of Construction Contracts
A contract is an understanding made
between two or more persons, by which rights are acquired on the one side to
acts or forbearances on the other. To make an agreement which results in a
contract, there must be an offer and acceptance which leads to a binding force
of obligation.
Lump sum contract
A lump sum contract is an agreement pursuant to
which one party consents to pay another party a set dollar amount for
completing the work or providing the goods described in the agreement.
Typically, lump sum contracts do not require contractors to provide a detailed
breakdown of costs. Rather, the payment of the total contract price is linked to the contractor completing
all of the work specified in the contract.
Cost-Plus
Under this
arrangement the contractor is reimbursed for the actual cost of labor and
materials, plus charges a fee (typically an agreed-upon lump or percentage of
the total costs) for overhead and profit.
This arrangement seldom begins with a blank slate regarding
specifications and costs. Rather, the consumer and contractor will create a
list of specifications and an estimated budget to match to those
specifications. Although the contractor
under this arrangement will have to keep copious records of its costs, most residential
consumers in a cost-plus arrangement suffer from kid-in-a-candy storeitis and overspend.
One way to prevent breaking the budget is to set a guaranteed maximum
price. However, even a maximum price
will not alleviate problems.
Unit Price
Contract
In a unit
price contract, the risk of inaccurate estimation of uncertain quantities for
some key tasks has been removed from the contractor. However, some contractors
may submit an “unbalanced bid” when it discovers large discrepancies between
its estimates and the owner’s estimates of these quantities. Depending on the
confidence of the contractor on its own estimates and its propensity on risk, a
contractor can slightly raise the unit prices on the underestimated tasks while
lowering the unit prices on other tasks. If the contractor is correct in its
assessment, it can increase its profit substantially since the payment is made
on the actual quantities of tasks; and if the reverse is true, it can lose on
this basis. Furthermore, the owner may disqualify a contractor if the bid
appears to be heavily unbalanced. To the extent that an underestimate or
overestimate is caused by changes in the quantities of work, neither error will
effect the contractor’s profit beyond the markup in the unit prices.
Target
Estimate Contract
This is
another form of contract which specifies a penalty or reward to a contractor,
depending on whether the actual cost is greater than or less than the
contractor’s estimated direct job cost. Usually, the percentages of savings or
overrun to be shared by the owner and the contractor are predetermined and the
project duration is specified in the contract. Bonuses or penalties may be
stipulated for different project completion dates.
Guaranteed
Maximum Cost Contract
When the
project scope is well defined, an owner may choose to ask the contractor to
take all the risks, both in terms of actual project cost and project time. Any
work change orders from the owner must be extremely minor if at all, since
performance specifications are provided to the owner at the outset of
construction. The owner and the contractor agree to a project cost guaranteed
by the contractor as maximum. There may be or may not be additional provisions
to share any savings if any in the contract. This type of contract is
particularly suitable for turnkey operation.
