TYPES OF CONSTRUCTION CONTRACTS
Although there are many different types of construction contracts, they generally may be grouped into two divisions. The first division include contracts obtained by competitive bidding. This means that general contractors received the plans and specifications and competitively bid on the project. Generally, the lowest bidder is awarded the work. Almost all public construction contracts, and many private contracts fall in this category. Competitive bid contracts are usually a fixed price basis and consist of two types, unit price and lump-sum. The second construction division is the negotiated contracts. Negotiated contracts are when an owner directly negotiates with one contractor to do the work. Although negotiated contracts can be on any mutually agreeable basis, such as, lump-sum, unit price, or cost plus fee, most negotiated contracts are on a cost plus fee basis. The following types of construction contracts are:
Lump Sum Contract
The lump sum contract is one where the contractor gives a lump sum bid to perform a specific amount of work in exchange for a specific amount of money. The contractor is obligated to complete the work for the specified, stated dollar amount regardless of difficulties and troubles that may be experienced in the course of construction. This type of contract is popular from the owner’s view point since the total cost of the contract is known in advance. If the work is of such a type that its nature and quantity cannot be accurately determined in advance, the lump sum type contract is not suitable.
Unit Price Contract
This type of contract is based on estimated quantities of certain well-defined items in a cost-per-unit amount for each of those work items is assigned in the contract. The units are then performed by the contractor who is carrying out the work and payment to the contractor is made on the basis of the number of units actually performed in the field. The owner does not know the final cost of the project until the completion of the contract.
Unit price contracts are most commonly used where the actual amount of quantities cannot be accurately determined at the time of bidding or the time of construction.
Cost Plus Contracts
Contracts that are cost-plus are usually awarded when a fixed sum contract is undesirable or inappropriate. Cost-plus contracts are normally negotiated between the owner and the contractor. Most cost-plus contracts are open-ended in the sense that the total construction costs to the owner cannot be known until the completion of the project.
The provisions regarding compensation of the contractor are the major differences between the various types of cost-plus contracts. The contractor’s fee can be designated as a fixed percentage of the cost of the work, a sliding scale percentage of the cost of the work, a fixed fee, a fixed fee with a guaranteed maximum price, a fixed fee with a bonus, or a fixed fee with an arrangement for sharing any cost savings.
Cost Plus Variable Percentage Contract
For this type of contract, the contractor agrees to a penalty if the actual cost exceeds the estimated job cost, or a reward if the actual cost is below the estimated job cost. In return for taking the risk on its own estimate, the contractor is allowed a variable percentage of the direct job-cost for its fee. Furthermore, the project duration is usually specified and the contractor must abide by the deadline for completion. This type of contract allocates considerable risk for cost overruns to the owner, but also provides incentives to contractors to reduce costs as much as possible.
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.