Construction contracts 101

Written by LetsBuild

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Every construction project that a company takes on is a job that needs to be completed for their client.  While this may seem fairly straightforward, there are numerous details that need to be ironed out before the work begins, so that everyone is on the same page and knows what the results are supposed to be.

The only way to do this effectively and efficiently is to create a construction contract.  That contract is a legally binding agreement, for both parties, that states that at the end of all the listed work, one party will receive compensation from the other.

While there are plenty of construction contracts available, there are only a few that professionals prefer to use.  The contracts that everyone seems to like the most include the lump sum or fixed price contract, the cost-plus contract, the time and material contract for when the scope isn’t clear, and the unit pricing contract.

The lump sum or fixed price contract involves one price for all the activities for the project.  These contracts normally include benefits and other incentives for early termination, while a later termination will involve penalties.  These contracts are best when the scope of the entire project is clear, and the detailed schedule has been agreed upon by both parties.  Most people utilize this contract when the builder needs to deal with the risk and the owner doesn’t want to be bothered with numerous change orders for unknown work.  There are hidden costs placed in these contracts, as the contractors must cover their risks somewhere.

A cost-plus contract states that the payment will be made on the actual costs, purchases, and any other actual expense that was initiated during the project.  These contracts must contain detailed information about a specific pre-negotiated amount that will cover any overhead and any little profit that the contractor wants to make.

There are a few different cost-plus contracts available and they include cost-plus-fixed percentage, cost-plus-fixed fee, cost-plus with guaranteed maximum price, and cost-plus with guaranteed maximum price and bonus.  These contracts are usually used when the scope of the entire project is not entirely known, and the owner wants to make sure that they have some control of what the contractor is billing.  All these contracts are difficult to keep a handle on, as there is a lot of tracking necessary to keep up with all the variables.

A time and material contract is always used when the scope of the project is not clear.  In this type of contract, both parties will need to agree on an hourly or daily rate, as well as any additional expenses that will evidently come up during the project.  The costs in this type of contract are normally classified as indirect, direct, markup and overhead, and they all need to be included.  This contract is normally only used when the project is small, and it is known as to how long it will take to complete.

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A unit pricing contract is common, especially when the owner requested specific quantities with pricing during the bidding process.  The unit prices ensure the owner that they are not experiencing price gouging and instead are being charged the going rate for the item in question.

These unit prices can always be adjusted, in either direction, during a scope change, which makes it easier for both parties to agree when a change order comes into play.

It is not difficult to write construction contracts, but it can be time consuming.  Some companies think that numerous employees can write these with no issue at all, but that isn’t the case, because everyone sets them up differently, while also using different wording.  Any inconsistencies can void a contract if a major dispute occurs, or at least have an effect on the financial outcome.

There are certain guidelines that should be followed when writing construction contracts and they are as follows:

  • A logical layout and grouping of subjects. It is best if this is planned ahead of time.
  • The requirements for each subject should be stated clearly and all aspects should be covered.
  • Proper language should be used, as well as punctuation.
  • No legal terms or phrases should be used at any time.
  • The obligations should be listed as shall and must instead of should or is going to.
  • The quality of everything should be defined clearly, instead of stating that everything will be good.
  • Essential matters should be the focus to maintain brevity.

The goal of these guidelines is to ensure that the extent of the work is known, what is required and what will be delivered, and what methods will be used.

Long gone are the days of a simple handshake to confirm that everything is good for the project to begin.  Therefore, everyone needs to make sure that they use a construction contract, or they may walk away with a loss.