Construction contracts

Construction contracts

Construction contracts

Introduction

While construction contracts serve as a means of pricing construction, they also structure the allocation of risk to the various parties involved. The owner has the sole power to decide what type of contract should be used for a specific facility to be constructed and to set forth the terms in a contractual agreement. It is important to understand the risks of the contractors associated with different types of construction contracts. (UK Council for Construction Management, 2006, 45-66)

From of contracts

Lump Sum Contract

In a lump sum contract, the owner has essentially assigned all the risk to the contractor, who in turn can be expected to ask for a higher mark-up in order to take care of unforeseen contingencies. Beside the fixed lump sum price, other commitments are often made by the contractor in the form of submittals such as a specific schedule, the management reporting system or a quality control program. If the actual cost of the project is underestimated, the underestimated cost will reduce the contractor's profit by that amount. An overestimate has an opposite effect, but may reduce the chance of being a low bidder for the project. (UK Council for Construction Management, 2006, 45-66)

Unit Price Contract

In a unit price contract, the risk of inaccurate estimation of uncertain quantities for some key tasks has been removed from the contractor. However, some contractors may submit an “unbalanced bid” when it discovers large discrepancies between its estimates and the owner's estimates of these quantities. Depending on the confidence of the contractor on its own estimates and its propensity on risk, a contractor can slightly raise the unit prices on the underestimated tasks while lowering the unit prices on other tasks. If the contractor is correct in its assessment, it can increase its profit substantially since the payment is made on the actual quantities of tasks; and if the reverse is true, it can lose on this basis. Furthermore, the owner may disqualify a contractor if the bid appears to be heavily unbalanced. To the extent that an underestimate or overestimate is caused by changes in the quantities of work, neither error will affect the contractor's profit beyond the mark-up in the unit prices. (UK Council for Construction Management, 2006, 45-66)

Cost plus Fixed Percentage Contract

For certain types of construction involving new technology or extremely pressing needs, the owner is sometimes forced to assume all risks of cost overruns. The contractor will receive the actual direct job cost plus a fixed percentage, and have little incentive to reduce job cost. Furthermore, if there are pressing needs to complete the project, overtime payments to workers are common and will further increase the job cost. Unless there are compelling reasons, such as the urgency in the construction of military installations, the owner should not use this type of contract.

Cost plus Fixed Fee Contract

Under this type of contract, the contractor will receive the actual direct job cost plus a fixed fee, and will have some incentive to complete the job ...