The 5 Types of Construction Contracts You Need to Know
A construction contract can be defined as a legal document that is can be entered into between all parties involved in the construction and details the scope and terms of the project or development.
There are 5 types of construction contracts. These are:
- Lump sum contract– This contract sets a fixed total price for the entire project rather than individual aspects. In most cases, it is set for straightforward projects with a clearly defined scope of work. For instance, a software installation company may enter into a lump sum contract for installing multiple data processing systems in a building. The installation company would receive a lump sum upon completion of the project. Lump sum contracts involve a fair amount of risk for contractors because they don’t take into consideration the unexpected costs or delays after the project is started.
The downside of lump sum contracts are that one may make less money, or, even worse, lose money on a construction project.
- Time and materials contract– This contract works best for projects in which the scope of work is not well-defined. It is entered into where contractors of a project are reimbursed for the cost, materials, and labor at an agreed pay rate; daily or hourly. This is often used for projects without a clearly defined scope of work. For example, where a client wishes to redo their veranda, the contractor is expected to look at the scope of the work/ project, the materials required and the expected time to complete the work.
- Cost-plus contract– This contract is also known as a cost- reimbursement contract. It is entered into where the owner pays the contractor for direct costs such as materials and labor, and indirect costs such as all overheads incurred during the project, travel and insurance expenses as well as a preset profit margin. The importance of this contract is that it offsets contractor risk for projects that involve design changes. The majority of the risk is borne by the owner/ developer. This is because the contractor gets to be paid for all costs incurred during the project and any unforeseen expenses are borne by the owner/ developer. For example, where a XYZ Limited, a construction company is hired to construct a property for a consideration of Kes 20 million, subject to it been completed within 12 months, if the project is completed within 11 months, they are subjected to a 5 % incentive of the total consideration of Kes. 20 million.
- Unit price contract– This contract is also known as measurement contracts, measure and pay contracts, or remeasurement contracts. It divides the work to be completed into separate units, which the contractor bills for individually. The importance of this contract is that it allows the construction work to start before the full extent of the project can be determined. This removes the risk of inaccurate estimation of the quantities. For example, the cost of constructing a road might have been laid out based on an approximate estimate of the distance required, and then the actual payment calculated based on the final length of the road.
- Guaranteed Maximum Price (GMP) contract– This contract seeks to establish an upper limit for construction costs and contractors absorb costs above this set point. This means that customers agree to reimburse the contractor for labor costs, cost of purchase of materials and the contractor’s fee that cover profits. This contract is best suited to projects with few unknowns, meaning that the building plans have been repetitively used and thus removing any uncertainty.
The key advantage of a GMP contract is that it shifts the risk to the contract since the owner does not pay for any cost overruns.
Conclusion
Every construction project requires properly drafted contracts that seek to protect the interests of the parties. At Netsheria International LLP, we offer various construction contracts that seek to protect the interests of the parties. For more information, visit our website at www.netsheria.com
