Construction projects are a conglomeration of various parties that all need to work together. Working together requires that each of the team members know their roles and responsibilities and what they are required to deliver. A construction contract is a tool that you can use to help outline these requirements.
What exactly is a construction contract, how can it be used and what are the different types?
A construction contract is a document that outlines the roles and responsibilities between two or more parties on a project. It is a legally binding document that the groups agree to at the start of a project and are held accountable to throughout.
The contract can take many forms and formats. It can be complicated or simple and tailored to your project. No project is the same and no construction contract should be the same because of that. Whether it’s an industry template or your own there’s plenty of options for you.
A construction contract should include information such as:
- Names of Companies or Individuals Involved
- Project Description and Details
- Cost of Work
- Inclusions and Exclusions within the work
- Requirements and responsibilities of each party
- Timeframe that the work is required to be completed (construction schedule)
- Staffing requirements
- Insurance Requirements
- Billing And Payment Requirements
- Procedures for Changes to the Contract
- Warranty and Closeout
- Dispute Resolution Processes
Construction Contract Types
As not every project is the same, there are various types of contracts between the owner and contractor which depending upon which is chosen can change your responsibilities drastically.
The different types of construction projects include:
- Lump Sum
- Construction Management (Cost Plus / Guaranteed Maximum Price)
- Design Build
- Design Build Finance Maintain
Below I’m going to walk you through the details of each as well as provide some real world examples. When utilizing each of these contracts it’s important to have someone knowledgeable in contract law prepare them – a lawyer or accountant should help review the nuances.
Lump Sum Contracts
A lump sum contract is one of the oldest and simplest types of construction contracts. This type is often used by governments and in simple residential construction.
A construction lump sum contract is based on creating a defined scope of work to be performed by a contractor and assigning a dollar value to that scope of work. If the work that is required to be performed is outside of the “scope of work” it is considered to be an extra to the contract.
Under a lump sum contract the consultants are typically engaged by the owner and the contractor falls under a separate contract with the owner. The contract is typically governed by the prime consultant.
I would recommend a lump sum contract type if you’re looking to get moving quickly on a project and have a complete design. These are great for usage on simple residential and commercial construction projects.
Lump Sum Construction Contract Example
As we move through the various contract types I’m going to keep the example consistent. For the examples I’ll be using a 10 storey office tower as the example building.
Utilizing a lump sum contract the owner would likely have engaged all of the consultants in advance and have a relatively complete design. Each component of the building would be outlined either in the contract documents or the scope of work.
The contract would be solely based on those documents and the scope of work. Meaning each door, wall, foundation type, mechanical unit, exterior wall system would be outlined in detail. Any change to, deviation or omission on those documents would be the responsibility of the owner to cover the costs.
Pros and Cons of Lump Sum Contracts
While this contract type seems risky, it’s been in use for hundreds of years and only recently have alternative contract types started to be put in use in our industry. There are advantages and disadvantages to it which can include:
- Defined Project – the product that the owner is expecting to receive is defined in advance and known.
- Competitive Value – if the drawings are complete, having competitively tendered the project can create value as people try to beat each other for the project.
- Widely Adopted – there’s a familiarity within the industry. Contractors and owners are used to working under this type of agreement.
- Design Risk – if the contract documents aren’t perfect there’s an opportunity for the contractor to claim extras. This means missed details, changes in site conditions etc can all result in major cost changes.
- Transparency – the nature of a lump sum contract is that it is based on a whole and guaranteed number. The contractor is typically not required to provide as much information and cost breakdown.
- Changes – changes requested by the owner can have a bigger cost impact as the competitive nature of the tendering process can force contractors to try to make up money on these.
Construction Management Contracts
Construction Management contracts were introduced in the 1980s as a new way to manage construction contracts. Unlike their lump sum counterparts they encourage a more collaborative approach to construction.
A construction management contract is an agreement between an owner and a contractor that allows the contractor to take a leadership role on the project. The contractor typically provides a budget or estimate for the project that is based on a set of documents and fills in any blanks or risks with their experience. The contract typically includes things like coordination between documents (if one document doesn’t matches another the contractor is responsible).
Once the budget is provided the contractor engages subcontractors to perform the scopes and manages the owners money. Because the contractor has had to opportunity to build their own budget and the team is relying on their experience to fill in the gaps there can be less pressure on the contractor.
“Construction Management Contracts Encourage a More Collaborative Approach to Building”
Two Types of Construction Management
A cost plus contract type allows the contractor to provides a budget or estimate on the project. In the event that the overall project over runs the budget the owner is responsible. A guaranteed maximum price on the other hand provides cost certainty from the owner. In the event the project over-runs the budget the contractor is responsible.
As a former contractor a cost plus contract is really the holy grail of contract types with little risk!
Examples of Construction Management Contracts
Using the office building example we noted above, the construction management contract is more fluid. Unlike the lump sum contract a construction management contract can start on day one before documents are prepared.
An owner might provide a schematic design to a contractor and the construction management contract can be written up on it based on the contractors experience. In the case of the office tower the contractor may initially sign a contract for a 11 storey office tower for a budget of $10 million. The contractor charges the owner based on the actual costs of the project including rates for overhead agreed to as part of the contract.
As the design progresses the owner may opt to take the guaranteed maximum price option – locking in a number and providing themselves with cost certainty.
Pros and Cons of Construction Management
The nice thing about a construction management contract is that you’re relying on the contractor to be competent at what they do. This can have it’s pluses and minuses:
- Flexibility – a construction management contract allows you to bring on a contractor early on and start projects at different phases. It allows you to start construction before the drawings are complete.
- Cost Certainty – The GMP (Guaranteed Maximum Price) option provides the owner with cost certainty by relying on the contractor to point out things wrong or missing in the design.
- Transparency – all invoices and costs from subcontractors and suppliers are submitted through to the owner and consultants allowing for a full review.
- Team Competency – the project requires that the teams performing on the project are competent and good. The contractor is only as good as their experience meaning your estimate may be completely wrong.
- Niche – not every contractor and construction team is familiar with this construction contract type. Therefore it can be a challenge for people unfamiliar with the concept.
Design Build Contracts
We all know that one contractor that complains about how bad designers are. The great thing about design build construction contracts is that it puts the contractors in charge of the designers and consultants.
A design build contract is similar in nature to a construction management contract where the contractor is required to take a leadership role in the project. The major difference however, is that the contractor engages the consultants and provides a complete proposal to an owner.
Unlike construction management contracts and lump sum contracts the owner typically issues a request for proposal at the start of a project. Contractors and consultants partner up to create proposals feature in different designs and prices for the owner. The owner then selects a team to design and construct the building.
The request for proposal will contain some high level variables that the project teams must stay within in, these can include price, design requirements, timeframes, etc.
Examples of Design Build Contract
Utilizing the office tower example, an owner may have a vision for an office tower. They would start the process by issuing an RFP to a prequalified list of contractors.
The RFP may outline things like – we want an office tower for $10 million dollars with 11 floors and 100,000SF. The project needs to be completed within 4 years. It may then go on to provide further detail on the usage of the spaces, requirements for consultants and services that are to be provided.
Contractors then assemble design teams and submit proposals to the owner. The owner performs a detailed analysis on the bids verifying that the proposals meet the requirements of the project and awards based on that.
The contractor and consultants then partner up to complete the design, documents, permitting processes and ultimately deliver the project.
Pros and Cons of Design Build Construction Contract
Creating a team is one of the defining characteristics of design build contracts. If the project goes badly both the consultants and contractors will lose money. Therefore it is in everyone’s best interest for the project to go as planned.
That being said there are some pros and cons to the design build contract:
- Teamwork – the project team is encouraged to work together to ensure the project is successful and profitable.
- Management – not every owner is experienced enough to run a project and make decisions early in the process. Having another team responsible for the details and pushing important decisions back to the owner can help an inexperienced owner.
- Control – this could be a pro or a con depending upon your role. As an owner you don’t control as much and especially with the design. As the contractor you can have more control which provides a benefit.
Public Private Partnerships – Design, Build Finance and Maintain
One of the new and more complex type of construction contracts is the Design Build Finance and Maintain model. Due to their complex nature these contracts are typically only reserved for some of the larges projects run by governments.
A Design Building Finance and Maintain type contract is very similar in nature to a design building contract with a few added complications. During the proposal process the contractor partners up with not just designers but a financial institution and a facility manager as well.
At the completion of construction the facility manager takes over the building and runs it for a set number of years defined in the RFP. The bank or financial institution offers lending to the owner. Essentially the owner has the length of the design and construction period as well as the maintenance period (which can be upwards of 25 years) to pay off the facility.
Examples of Design Building Finance Maintain Construction Constract
Utilizing the 11 storey office tower example, the process would work very similar to the design build construction contract example. The designers would be engaged by the contractor and they would collaborate to provide a design that works for the owner.
Because the construction team has a stake in the operation of the building often times the design process is much more involved. Owners create user groups which provide input throughout the design on how things like offices are laid out and spaces are used.
Once the construction team finishes building the office tower a facility manager takes over. They look after maintaining the building including janitorial staff and also maintain the building equipment (including mechanical and electrical equipment).
Finally during this whole process a bank is financing all of the work. They take care of paying all construction and design costs for the length of the project and then charges the owner a set amount per month.
Pros and Cons of Public Private Partnerships
This is a bit of a sensitive issue. There are plenty of articles online that criticize them. The challenge is that due to their size, when there are issues that the public sees they are usually large. As an example an over run on a two billion dollar project may be one hundred million dollars, however, in comparison to the size that’s only an over run of 5%.
Regardless, here’s a rundown:
- Comprehensive – due to the design process the detail that goes into developing the project is typically more than most other projects.
- Collaboration – most times trades are brought on as partners early on in the process. This creates collaboration between designers and the people building it creating a more well coordinated building.
- Usability – As I noted above – usergroups are often brought in during the design phase to comment on design. This creates a better space for the end user.
- Complex – due to their nature and size these projects are very complex. Only the biggest companies with the most resources can pursue them.
- Costly Pursuit – if you’re unsuccessful in your bidding you can lose a lot of money. Due to their size these often take millions of dollars and resources to pursue.
Construction Contracts Matter
During the start up phase it can often be daunting to have the conversation with your owner about a contract. It can seem intimidating and inexperienced owners may think you’re trying to take advantage.
For most industry veterans though a contract is a way to protect all of the people involved to ensure that if an issue arises there are rules and guidelines on how each party interacts. Having a contract on a construction project is one of the most fundamental requirements of any work.
What construction contract types have you worked under and what were their challenges? Feel free to share below in the comments.