Types of construction contracts and their main differences
05 August , 2024 02:34 PM
A construction contract is a legally binding document that establishes the terms and conditions between a contractor, who is undertaking a project on behalf of the client, and the client, who is commissioning the work. Construction contracts are comprehensive and cover all aspects of the project. This encompasses the cost, payment terms, schedule, scope, relevant tasks, and any other contract terms required by one or more parties.
The contract also includes provisions for the handling and resolution of disputes. The specific terms of a contract are determined by the nature of the project in question. The complexity of construction contracts requires a high level of technical and legal expertise. However, AI tools have made it easier to understand and review all your contracts. With AI technology, you can create optimal contracts for your projects and identify potential risks.
This article will provide an overview of the types of construction contracts and their key differences.
6 Construction contracts and their main differences
The construction industry is characterised by a high level of complexity and risk. In order to protect their rights, contractors and clients enter into legally binding contracts. These contracts serve to safeguard both parties from major disputes and legal issues. In the absence of a contract, such disputes and legal troubles could threaten to halt a project entirely. Contracts of different kinds provide clarification on project specifics and financial details, which are necessary for the progression of work.
In light of the above, it is useful to examine the key differences between the various types of construction contracts.
1. Lump sum contract
The first type of construction contract is the lump sum contract. A lump sum contract is also referred to as a fixed-price contract. This type of contract is a common feature of the construction industry. As the name suggests, the contract documents specify the work to be carried out at a fixed cost, rather than incorporating variables into the project costing. A lump sum contract is an effective solution for smaller projects. This is because such projects are unlikely to involve significant scope or material cost variations.
It is important to understand the clauses of any contract you sign, as many people are unable to work out contract details themselves. AI can be a beneficial tool for making contracts easier to understand, as it provides simple, accessible language. You can contact a reputable AI construction contract management company to gain access to AI tools that can help you understand complex contracts.
2. Design-build contract
The second type of construction contract is the design-build contract. A design-build contract necessitates collaboration between the project designer and the builder. The project designer may be the architect or engineer, while the builder can be a contractor.
Traditionally, the project owner has had to make separate bids for the design and construction processes. However, a design-build contract incorporates both phases of the project into one contract, thereby saving the owner time and potentially money due to the collaborative approach. This is because they do not have to wait for the design process to be complete before moving forward.
3. Cost-plus contract
The third type of construction contract is the cost-plus design contract. A cost-plus contract for the contractor comprises two elements of payment. The first element of payment is the cost of materials and labour. It is possible to include the contractor's profit as a separate fee in the contract. The fee can be either fixed or calculated as a percentage of the final project costs.
In addition to covering project-related costs, this contract type can also include overhead expenses. Such costs may include travel fees, meals, a contractor's office, and administrative expenses. Cost-plus contracts are the optimal choice for projects that undergo frequent changes. The majority of cost-plus contracts include a "not to exceed" limit, which provides a framework for managing budgetary and financial constraints.
4. Guaranteed maximum price contract
The fourth type of construction contract is the guaranteed maximum price contract. A GMP, or guaranteed maximum price, contract allows you to set a limit on the final budget for a project. Any additional costs incurred are the responsibility of the contractor. These can be in the form of labour, bills, or materials. A guaranteed maximum-price contract can be a standalone contract.
Alternatively, a different type of GMP contract can be incorporated with a guaranteed maximum price along with other specific terms. A GMP contract allows the client to dictate how much they will have to pay the contractor. Any costs exceeding these pre-established figures will have to be covered by the contractor. This reduces risk for the client and simplifies budgeting.
5. Unit price contract
The fifth type of construction contract is the unit price contract. A unit price contract allows the contract to be divided into separate elements. This encompasses materials, labour, invoices and overhead or administrative costs. This facilitates greater transparency in the contract for all parties. Each section of the contract includes a unique estimate, which provides clarity for both the builder and the owner on what to expect from this contract.
This is particularly beneficial in situations where a specific component is driving up project costs, such as the use of special materials or design requirements. Unit price contracts are more suitable for smaller projects, as they allow for flexibility in case of changes to the scope. It is straightforward to identify the necessary adjustments to costs in the event of a change to the project scope.
6. Time and materials contract
The sixth and final type of construction contract is the time and materials contract. A time and materials contract is a bespoke approach to each project. This type of contract allows you to set prices for the amount of time a project takes, the cost of materials, and the construction company's profit margin. It is similar to a lump sum contract, but allows for the separation of materials and labour rates.
A time and materials contract allows you to set an hourly, daily, or weekly rate, making it an ideal option for projects with unclear scope or timelines. If materials are purchased at a wholesale price, your contractor can typically include a markup to account for the professional discount. AI tools can streamline the process of creating a suitable time and materials contract for your project. Alternatively, you can engage the services of a reliable construction contract management company to assist you in developing the optimal contract for your project.
Select the appropriate contract for your project
It is of the utmost importance to draw up a construction contract at the outset of any construction project. The contract selected should be appropriate to the project type and scope. A general contract, such as a lump sum or fixed price contract, is suitable for small to medium-sized projects with a clearly defined scope and specifications. A cost-plus contract is more suitable for projects with a changing or uncertain scope, as it allows for flexibility and flexibility in budgeting. The use of artificial intelligence (AI) can help to ensure that the right contract is chosen for the project and assist in managing the contract during its use on the project.