The ABCs of a Construction Contract

A construction contract is a legally binding document signed by the property owner and the contractor. Before you agree to any construction contract, make sure it’s protecting you.

A construction contract agreement is a legally binding document signed by the property owner and the builder or contractor. It specifies the date and the parties involved in the building process. The agreement should have the following section clauses:

  • A description of the project

  • Compensation price and terms of payment – monthly or weekly

  • Construction timeline

  • A list of documents: exhibits, drawings, etc.

  • The project scope

  • Terms, conditions, and the cancellation policy

  • Governing laws- claim procedures, liquidated damages, substantial completion requirements, etc.

The Significance of a Construction Contract

construction contract

A contract document defines the scope of work binding the owner to a contractor’s services. It’s very important for the two parties to agree on the payment terms and the schedule. This tool is needed to get the contractor paid. All contract agreements should fulfill 3 requirements:

The 4 Categories of Construction Contracts

There are a number of construction contracts used today, but they can be categorized into 4 basic groups. These are determined by the mode of disbursement, duration, and several other specifications.

1. Lump Sum Contract

It is also known as a fixed-price contract. The agreement states that the contractor will receive a fixed price upon job completion. The contractor takes a great risk since there is a possibility of problems happening.

To mitigate the risks, the contractor is given an allowance to go over the budget. An incentive can be provided for a contractor who manages a project below the estimated budget. The contract also states the penalties for overshooting a construction timeline.

The fixed price contract works best when the owner doesn’t want to deal with costs not specified initially. A clear scope of work and schedule must be reviewed and agreed upon.

2. Time and Material Contract

Here, the owner takes more risk. They pay for the materials used, and the time the contractor spends on a project. The contractor agrees on a certain pay rate as well as expenses that may come up.

The owner pays for overtime and any unexpected punch list costs. To mitigate the risk, a maximum-price clause is established. Time and material construction contracts make sense when the scope of the project is unclear or small.

3. Cost-Plus Contract

Sometimes, the scope of work is not clearly defined. It is the responsibility of the owner to determine the construction budget limits. This is called a cost-plus construction contract. The payments are made for the real price and expenses generated by building activities.

Specific costs on a pre-negotiated amount for labor and materials must be stated. These expenses cover the contractor’s profit and overhead. This is a very cost-detailed contract that contains both direct and indirect costs.

4. Unit Price Contract

Often, federal agencies prefer unit price construction contracts. The agreement is made during the process of bidding. The owner requests particular quantities and prices for unitized items. As such, the owner is assured of un-inflated costs. Unit prices are modified as the scope of work changes. This helps to avoid disputes in case the orders change. In essence, both parties assume a little risk. Upon successful completion of a project, the owner pays the price for the units offered by the contractor.

Choose a Construction Contract That Favors You

One of the benefits of construction management is protecting the interests of the stakeholders. Before you agree to any construction contract, make sure it’s protecting you. Do your research because there’s no going back once you sign those papers.