Construction Contract Terms and Types of Contracts

This is not a sexy post. Should you read it anyhow? Yup.

Alright, folks. Last week, we covered how to find your builder and request bids. What follows is not comprehensive, but I want to cover some key terms in construction contracts and types of contracts.

Key Terms

1. General Conditions

General conditions form the framework within which all other contract operations are conducted. They detail how daily operations are to be managed and define standard procedures for reporting, compliance with local laws, safety regulations, and quality control measures. This ensures that both parties understand their boundaries and expectations. This includes contractor overhead for staff.

2. Fee

The fee is essentially the contractor's profit from the project. It’s predetermined in the contract as either a fixed amount or a percentage of the overall costs, providing an incentive for the contractor to manage the project efficiently while ensuring fair compensation for their services.

3. Contingency

Contingency funds are critical for handling unexpected costs without the need for renegotiating the overall project budget. This may include unforeseen obstacles like delays due to weather, the discovery of hazardous materials (you’re building on a former laundromat!), or price inflation for materials. Good management of contingency funds is crucial to prevent project overruns.

4. Change Orders

Change orders provide a formal process for documenting changes in the project scope, timing, or cost. They require client approval and budget and schedule adjustments, ensuring that all parties agree to the changes and understand their implications on the project.

Are change orders “bad”?

Not necessarily.

Change orders are a normal part of construction projects and can sometimes lead to better project outcomes. For example, if halfway through the construction of your new build, the original contract specifies standard double-pane windows, but a change in local building codes incentivizes the use of energy-efficient materials by offering tax rebates, that may be a change you welcome! Change orders provide a structured way to address unforeseen issues or changes in scope, ensuring the project meets the desired specifications.

5. Indemnification and Insurance

Indemnification protects against financial loss due to lawsuits or claims resulting from the construction process. Insurance reduces risk by covering accidents, injuries, and damage to property. Both are crucial for managing legal and financial risks during construction.

6. Lump Sum

A lump sum contract simplifies budgeting and financial oversight as it locks in most costs upfront. This is beneficial when project details are clear from the start and unlikely to change, providing certainty for both the developer and the contractor.

I have to address the myth, though, that “Lump Sum” contracts are always cheaper.

Folks assume that a lump sum contract will always be the least expensive option because it sets a fixed price. However, this is not always the case. Lump sum contracts may include a premium for risk that the contractor takes on. If the scope of the project is not clearly defined, cost overruns due to unforeseen changes can make this type of contract more expensive. In other words, if you don’t have a good handle on your numbers, your builder, under a lump sum contract, is going to find other ways to mitigate your..ahem…lack of clarity :-)

7. Unit Price

Unit price contracts are advantageous when project specifics are not fixed. They allow for adjustments based on the quantities needed for each unit of work, giving you the flexibility to adapt to changes without renegotiating the entire contract.

8. Time and Materials

This contract type is favored when project scopes are difficult to define beforehand. It offers flexibility and transparency, allowing clients to see exactly where their money is going. However, it also requires diligent oversight to keep track of costs and ensure they remain within budget.

9. Guaranteed Maximum Price (GMP)

GMP contracts are a compromise between flexibility and budget certainty. They protect the client from budget overruns while allowing some flexibility in execution. Any savings resulting from efficient management can be shared, incentivizing contractors to control costs.

10. Cost Plus

Cost-plus contracts ensure that the contractor is reimbursed for all legitimate project expenses plus an agreed-upon profit. This arrangement is useful when project scopes are fluid, but it demands meticulous documentation and supervision to ensure that only appropriate and agreed-upon costs are covered.

Common Types of Construction Contracts

1. Lump Sum or Fixed Price Contract

This contract type is ideal for projects with a well-defined scope and detailed specifications because it provides a clear financial framework and minimizes the risk of budget overruns.

2. Cost Plus Contract

Offering various forms to accommodate different project needs—from providing incentives for efficiency to capping the maximum price—cost-plus contracts can align contractor goals with client goals, promoting better outcomes. Folks often think that cost-plus contracts give contractors no incentive to keep costs down since they’re reimbursed for all expenses plus a margin. While it’s true that these contracts can potentially lead to higher costs if not carefully managed, they also encourage transparency and can be structured with incentives for efficiency and cost savings, such as a shared savings clause.

3. Time and Materials Contracts (T&M)

Suited for projects where defining the full scope upfront is challenging, T&M contracts require robust tracking systems to monitor labor hours and materials costs to ensure financial control.

4. Unit Price Contract

This type is common in sectors like civil construction, where the work volume can change dramatically as the project progresses. It allows for scalability and adaptability in project execution.

5. Design and Build Contract

By combining design and construction services, this contract simplifies project management for the client and can lead to faster project completion through integrated project streams.

Peace,