Construction Contract Types Explained

Construction projects involve various parties, and contracts play a crucial role in defining the terms and conditions of the project. Different contract types are used to accommodate the unique requirements and circumstances of each construction project. Let’s explore the most common construction contract types:

Lump Sum Contract:

A lump sum contract, also known as a stipulated sum contract, is the simplest form of agreement between a contractor and a customer. It requires the contractor to provide specified services for a fixed price. With this contract type, the owner transfers most of the project’s risks to the contractor. The contractor estimates labor and material costs, adds an amount to cover overhead and profit margin, and assumes responsibility for completing the work. If the actual costs exceed the estimate, the contractor’s profit decreases, while lower costs result in higher profits.

Lump sum contracts are suitable when the project’s scope and schedule are well-defined, allowing for accurate cost estimation.

Unit Price Contract:

A unit price contract breaks down the work into various parts based on anticipated quantities and their respective unit prices. For example, painting work may be priced per square foot. Unit price contracts are typically used with subcontractors or for maintenance and repair work, where accurate identification of items is crucial, but their quantities may not be known in advance.

Cost Plus Contract:

A cost plus contract involves the buyer’s agreement to pay the complete cost of labor and materials, along with an additional amount for contractor overhead and profit. This type of contract is favored when the scope of work and the types of labor, materials, and equipment are uncertain. The contractor’s profit is fixed, and if the actual costs are lower than estimated, the owner retains the savings. Conversely, if costs exceed the estimate, the owner covers the additional amount.

Three common types of cost-plus contracts are:

  • Cost + Fixed Percentage Contract: The contractor’s compensation is based on a percentage of the total cost.
  • Cost + Fixed Fee Contract: The contractor receives a fixed sum as a fee, independent of the final project cost.
  • Cost + Fixed Fee with Guaranteed Maximum Price Contract: The contractor’s compensation is based on a fixed sum, and the project cost cannot exceed an agreed upper limit.
Incentive Contracts:

Incentive contracts tie the compensation to the contractor’s performance, usually measured against specific targets related to budget, schedule, and quality. There are two main categories of incentive contracts:

  • Fixed Price Incentive Contracts: Preferred when contract costs and performance requirements are reasonably certain.
  • Cost Reimbursement Incentive Contracts: The contractor receives an initially negotiated fee, which is adjusted based on the relationship between total allowable costs and target costs.
Guaranteed Maximum Price (GMP) Contract:

A GMP contract is a cost-type contract where the contractor is compensated for actual costs incurred plus a fixed fee, subject to a ceiling price. The contractor bears the responsibility for cost overruns unless the GMP is increased through a formal change order resulting from additional scope. Cost savings resulting from underruns are returned to the owner. This contract type encourages cost control and can include cost-sharing incentives.

Design-Build Contract:

A design-build contract is appropriate when the project delivery method is design-build. Instead of the traditional design-bid-build system, where the owner hires an architect and later awards the project to a contractor, a design-build contract assigns the entire project to a single company. This allows for streamlined communication and coordination between the design and construction teams. The contractor assumes responsibility for both the design and construction aspects of the project.

Integrated Project Delivery (IPD) Contract:

IPD contracts promote a collaborative approach to construction projects by involving owners, designers, contractors, and key stakeholders from the early stages, often at the conceptual stage. This type of contract emphasizes transparency, risk sharing, and resource integration. By working closely together, the parties can maximize efficiency and improve project outcomes.

Understanding these construction contract types is essential for selecting the most appropriate agreement for your project. It’s advisable to consult with legal and industry professionals to ensure compliance with local laws and to address specific project requirements.