A contract is a legal agreement between two or more parties. When this type of contract is made to execute a construction project we call them construction contracts.
A construction contract mainly contains some common types of documents which are called contract documents. Based on the terms, conditions, specification, and scope specified in the contract documents, the involved parties are legally agreed to complete the construction project.
But the problem is, there are many types of construction projects. Each project has a different scope of work. So, not a single type of construction contract is applicable to all types of project. Depending on the scope of a project, you need to choose a particular type of construction contracts.
But which types of construction contracts is applicable to which types of project? For this, you need to know what types of construction contracts are practiced in the industry.
In this post, I’ll discuss the different types of construction contracts, their pros and cons, and when you should select a particular type of contracts for a particular type of project.
4 Common Types Of Construction Contracts
There are many types of contracts are used in the construction industry. Each type of contracts has its own advantages and disadvantages. The purpose of making a contract is to complete a construction project on time without any dispute between the owner and the contractor. A contract also ensures the right and obligation of both parties. But selecting the right type of contracts is essential to complete a particular construction project.
Below are four common types of contracts used in the construction industry-
1. Lump Sum Or Fixed Price Contract
This is the traditional means of procuring construction and still the most common type of construction contract.
Under a lump sum contract, a fixed price is decided for all the works of a project. Before starting the work, both the owner and the contractor are agreed to complete the project with a fixed amount.
Normally, the contractor estimates the project’s cost from drawing and add the overhead and his profit to determine the amount.
When Should You Select This Type Of Contract For A Project?
When the project scope is clearly defined, you can select this type of construction contract. Normally, this contract is applicable for small sized projects where there is no possibility of design change.
Pros and cons of Lump sum contract
There are some advantages and disadvantages of this type of contract both for the owner and the contractor. I’ve listed them below.
- The contractor needs to take all types of risk. And obviously, the owner doesn’t need to take any risk.
- The contractor can be rewarded for an early finish and there is also a penalty for a late finish.
- There is limited flexibility of design change during construction.
- It doesn’t need to take any measurement for processing the contractor bill. Depending on the terms and conditions in the contract, you can pay the contractor upon finishing the construction up to a certain level.
2. Unit Price Construction Contract
This is also a commonly used type of construction contract. In this contract, a unit based price is set for every item of works in the project. While hiring contractors, we normally ask for unit rate of different items from various contractors.
After choosing a contractor, we normally discuss with the contractor to adjust the rate of some items and then finalize the rate.
Some contractors have their default rate for common work items.
The thing is, the unit price for all the work items is normally set after the discussion between the owner and the contractor.
After finalizing the unit price for all the work items, a list of rate is included with the contract documents.
When This Type Of Contract Is Applicable For A Project?
Unit price construction contract is normally applicable for all type of project where there is a possibility to take measurement of different items of a project.
Pros And Cons Of Unit Price Construction Contract
Although this type of contract is applicable for all type of project, it has several advantages and disadvantages both for the contractor and owner.
- The risk is shared with both the owner and contractor.
- This type of contract has more flexibility for design change during construction.
- One of the good things about this contract is, the construction of the project can be started before completing the design of the project.
- you need to take measurement of finished work items before paying any bill to the contractor. So, more workforce is needed and it can increase the project cost.
3. Cost Plus Contract
This type of contract is an agreement between the owner and contractor where the contractor is paid based on the actual construction cost. This actual construction cost can include material cost, labor cost and other costs which are needed to complete the job. The contractor’s profit is calculated based on these costs. This profit can be a fixed amount or percentage on the actual cost.
Based on the profit distribution, the cost-plus contract can be many types. Such as,
- Cost plus fixed fee
- Cost plus fixed percentage
When this type of contract is made?
- Cost plus contract is ideal when the project scope is uncertain.
Pros And Cons Of Cost Plus Contract
- All risks are assigned to the owner.
- The owner needs to get involved in project management with the contractor.
- The contractor is responsible for increasing the project cost. So he has a risk in this case.
- There is no incentive for the contractor for early finish.
- The work execution can be started even before finishing the project design.
- Knowing the total cost of the project isn’t possible before finishing the construction.
- More design flexibility.
4. Time Base Contract
In this type of contract, the owner and the contractor agreed on an hourly or daily rate, including additional expenses that could arise in the construction process.
When This Type Of Construction Contract Is Applicable?
This type of contract is mainly applicable when the project scope isn’t clear but the time to complete the project can be assumed.
Pros And Cons Of This Type Of Contract
- Project duration can be specified.
- This type of contract is useful for small scope.
- The owner needs to take full risk.
All these types of construction contracts, I’ve discussed here, are practiced in building construction industry.
It’s not that if you make a contract for a project, you can’t use another contract.
In fact, in a building construction project, we often use several types of contracts whenever needed.
Which types of construction contracts do you use most in your building construction project? Please share in the comments below…