The Different Types of Construction Contracts Explained
As you might imagine, there are many different types of construction contracts. However, two of the most popular forms of construction contracts are “cost-plus” and “stipulated sum.”
Cost-Plus contracts are often used when the scope of the construction project has not been clearly defined, such as when the project design is still being finalized and the owner wants to begin construction. With this type of contract, an owner agrees to pay the cost of the work, including all 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 an additional amount, unless the cost is capped at a guaranteed maximum price. Generally, 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 can be harder to track, and more supervision may be needed.
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. Generally, this type of contract is 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. Conversely, if the actual costs are lower, the contractor’s profit increases. Either way, the cost to the owner is the same.
No matter the type of construction contract involved, it is imperative that each party to the contract completely and fully understand the terms and provisions of the contract. Construction 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.