Types of construction Contracts
Before signing on a construction contract, it is essential to know the types and choices of the contracts we have so as to protect ourselves. In any construction contract, the cost of the project consists of the costs labor materials as and as the builder’s profit and overhead. The different types of construction contracts vary primarily with regard to who takes the risks involved, which party has to pay for the cost over runs and who keeps the savings if the project costs are less than that of the estimate one.
Lump Sum Contracts
A lump sum, sometimes called stipulated sum, contract is the most basic form of construction contract. Keating defines a lump sum contract as a contract to complete the work for a lump sum, i.e. whereby the contract promises to build X project for Y dollars. In this type of contract, the supplier (contractor) agrees to provide specified services for a specific price. The receiver (employer) agrees to pay the price upon the completion of the work, or according to a negotiated payment schedule. Lump sum contracts require complete plans and specifications setting forth detailed directions to enable the contractor carry them out. In developing a lump sum bid, the builder estimates the costs of labor and materials and adds to it a standard amount for overhead and the desired amount of profit.
Most builders estimate profit and overhead to total about 12-16 percent of the project cost. This amount may be increased based on the builder's assessment of risks. If the actual costs of labor and materials are higher than the builder's estimate, the profit is be reduced. If the actual costs are lower, the builder gets more profit. Either way, the cost to the owner is the same. In practice, however, costs that exceed the estimates may lead to disputes over the scope of work or attempts to substitute less expensive materials for those specified.
Lump sum contract envisages an entire contract and a fixed price contract. It is an entire contract in that the contract, basically, is one where the contractor’s obligation to carry out the work is based on a condition precedent to the liability of the employer to pay. On another note, it is a fixed price contract in which where the contractor takes the risk of the work becoming more extensive than that of the estimated previously. Thus, a lump sum contract is an entire contract that implies that the contractor must finalize the work in accordance with the contract before he/she entitled to the payment agreed upon. Similarly, there is an implied obligation upon the employer to satisfy the specifications in all its aspects so that the contractor can properly and timely undertake his/her work.
Re-measurement contracts, in contrast to the lump sum contracts, are contracts in which the price to be paid for the whole work is to be ascertained by measurement in detail of the various parts of the work and the valuation thereof by reference to a schedule of prices included in the contract. Keating defines such type of contracts as one where the amount of work, when completed, is to be measured and valued according to a schedule, or formula, or at cost plus a fixed fee, or a percentage of the cost, or at a reasonable price.
This type of contract is usually entered into when the extent and scope of the work to be done is not known at the time of entering into the contract. Therefore, in this type of contract, it is usually immaterial whether any particular piece of work that the contractor is required to do is included in the contract or not. This is because the contractor is entitled to payment for the piece of work at a stipulated rate, whenever applicable, or at a reasonable market price whenever the stipulated rate is not applicable. However, where the schedule of rates incorporated in the contract specifies a piece of work and its rate, it raises a question of construction with regards to whether that particular piece of work is impliedly included in that item being incidental or contingent. If so, it would not be classified as extra work to be paid separately.
Re-measurement contracts imply that price is agreed for each piece of work and the quantities are counted or measured either as the work proceeds, or at the end of the completion of a particular item. Profit rate is included in the rate settled, or separately as a percentage agreed upon.
In a cost reimbursable contract the contractor's profit is set at a fixed amount. If actual costs are lower than that of the estimated, the owner keeps the savings. If actual costs are higher than that of the estimated, the owner must pay the additional amount. The great advantage of a cost reimbursable contract is that, generally speaking, the project will result in the building that was envisioned, even if costs run high. The contractor is less likely to cut corners, or argues, for less expensive materials since his profit is not in jeopardy. By the same token, the contractor has little incentive to keep the owner's costs down.
Under this arrangement, the contractor is reimbursed for the actual cost of labor and materials, plus charges 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 create a list of specifications and an estimated budget that matches to the 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 overspending. One way to prevent breaking the budget is to set a guaranteed maximum price. However, even the maximum price will not alleviate problems.
This type of contract is advantageous in the fact that, where the employer wants to have open reign to select materials and workmanship as the project proceeds, this arrangement can be extremely flexible and accommodating. This contract also typically requires the contractor to obtain competitive bids from subcontractors, and translating (in theory) it in to lower construction cost. It is disadvantageous since this type of contracts are usually used where the scope of work is uncertain, and the costs can quickly get way out of control. Even under the maximum price, poor control in materials selection and on-the-fly design modification can quickly consume budget, leaving line items on the project starved for capital. This, in turn, requires either a diminution in quality in certain aspects of the project, and /or the total elimination of aspects of the project, and /or the need for an additive change order to increase project funding.