Construction Contract Formations

Construction Contracts

When forming a contract, it is imperative that each party to the contract completely and fully understand the terms and provisions of the contract. Anytime you sign a contract, you should understand the consequences of each clause in the contract. This may sound like common sense, but many times a party does not fully understand the impact and effect of the contract they are signing. Contracts are not one size fit all. There are many different types of construction contracts, which can be tailored to minimize and protect a party’s interests.

Construction Contract

Types of Construction Contracts

In Texas, the two most common types of contract forms used are the “TAB” contract, which is a contract developed by the Texas Association of Builders, and the “AIA” contract, which is a contract developed by the American Institute of Architects. As you might imagine, the TAB contract is tailored to protect the interests of builders, while the AIA contract is tailored to protect the interests of architects and owners.

There are many differing versions of construction contracts depending on the parties’ situation and needs. Below are some of the basic types of construction contracts, along with their associated benefits and drawbacks.

Cost-Plus Contract

Cost plus contracts are often used when the scope has not been clearly defined, such as when the project design is still being finalized and the owner wants to begin construction. An owner agrees to pay the cost of the work, including all trade subcontractor work, labor, materials, and equipment, plus an amount for contractor’s overhead and profit. Since the contractor is reimbursed only for actual costs, plus a fee for overhead and profit, if actual costs are lower than estimated, the owner gets to keep the savings. If the actual costs are higher than estimated, the owner must pay the additional amount, unless the cost is capped at a guaranteed maximum price. The advantage of a cost plus contract is that the project will result in what was intended, even if costs run high. However, despite the lower amount of risk for the contractor, these contracts are harder to track and more supervision is needed. The most common cost plus contracts are:

  • Cost Plus Fixed Percentage – Contractor compensation for overhead and profit is based on a percentage of the actual cost.
  • Cost Plus Fixed Fee – Contractor compensation is based on a fixed sum independent of the final project cost. The customer agrees to reimburse the contractor’s actual costs, regardless of amount, and in addition pay a negotiated fee independent of the amount of the actual costs.
  • Cost Plus Fixed Fee with Guaranteed Maximum Price Contract – Compensation is based on a fixed sum of money. The total project cost to the owner will not exceed an agreed upper limit. 

Stipulated Sum Contract

A stipulated sum contract, also called a lump sum or fixed price contract, is the most basic form of agreement between a contractor and owner. This contract should be used if the scope and schedule of the project are appropriately defined to allow the contractor to fully estimate project costs.

A stipulated sum contract requires that the contractor agree to be responsible for the proper job execution at a set price. The owner has essentially assigned the risk of project costs to the contractor, who can be expected to ask for a higher markup to anticipate unforeseen problems.

If the actual costs of labor and materials are higher than estimated, the contractor’s profit will be reduced. If the actual costs are lower, the contractor’s profit increases. Either way, the cost to the owner is the same. 

Design-Build Contract

A design-build contract is appropriate when the owner wants one entity to be responsible for both design and construction. Design-build is usually the preferred contracting method under a tight schedule, and design-build contracts are often awarded through negotiation rather than through a bid process.

With a design-build contract, the owner hires a design-builder (typically a contractor) to handle the entirety of a project. The design-builder is responsible for all design and construction required to complete the project. Since the design-build entity is head of the whole project, it may need to hire architects, engineers, contractors, or subcontractors to carry out the project. 

Integrated Project Delivery Contract

Integrated Project Delivery (IPD) contracts are a project delivery approach that integrate people, systems, business structures, and practices into a process that collaboratively harnesses the talents and insights of all participants to optimize project results, increase value to the owner, reduce waste, and maximize efficiency through all phases of design, fabrication, and construction.

IPD principles can be applied to a variety of contractual arrangements, and IPD teams can include members well beyond the basic triad of owner, architect, and contractor. This contract type results in more transparency among all the parties involved on a construction project. Additionally, both risk and reward are shared by the parties who enter into this contract.

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