A construction contract is an agreement between two parties, contractor and contracted, which may be mutually or legally binding. There are mainly three types of construction contracts, fixed price contract, cost plus contract, and hybrid construction contract.
Construction fixed-price contracts, also known as” lump sum “or “stipulated sum” contracts, are considered the most common construction contracts. As the name suggests, a certain amount is fixed that the contractee has to pay the contractor for a construction project. The fixed-price construction contract gives the advantage of finishing projects under budget, resulting in a sustainable profit.
Fixed price contracts provide price predictability for the contractee as the contractor must complete the work for the agreed-upon price. It is budgeted as the price is fixed from the beginning.
As the amount is fixed, the contractor, sometimes, may use cheap quality products or may deteriorate the quality to minimize the profit.
As the name suggests whatever the cost is fixed, a certain amount or percentage is added along the cost. A cost-plus contract is also known as a time and material contract in which the contractee agrees to pay the contractor an agreed amount over and above the documented cost of work. Every bill needs to be shown to the contractee to get reimbursement.
Contractees can be assured and guaranteed good quality work because cost plus construction contract offers the most design flexibility for the project and the best price prediction for contractors as the contractors know that they will be paid for their time and material, no matter how long the project takes or the quality of material used.
Since every bill needs to be shown to the contractee, the contractor may use the wrong statements to increase his profit. As time and materials are variable, the contract provides the contractee with the least control over costs. Because of the certain uncertainty, it can be difficult for the contractee to obtain construction financing. However, cost-plus contracts can be used with smaller projects or specific scope of work within larger construction projects, where more flexibility is needed. Since the risk of cost overruns is shifted to the customer, contractors get benefitted.
Hybrid construction contract/guaranteed maximum price construction contract
A hybrid construction contract is the combination of fixed and cost-plus contract under a guaranteed maximum price, contractee agrees to pay the contractor for their time and cost of material plus a fee, but only up to a guaranteed ”maximum price.” Similar to fixed price contract, project cost are capped at a guaranteed maximum price in this contract.
Under this approach, contractors get a degree of price prediction as they will be paid for their time and material and contract retains more design flexibility. This type of contract can include a share-saving provision whereby the contractee agrees to split any savings if the actual cost of construction is less than the guaranteed maximum price. It can be used for positive results for sophisticated contractees and contractors. A share-sharing provision may increase the quality of the project. The result usually may come good as it gives the contractor its cost of material plus a certain amount whereas a contractee gets good quality assurance.
Contractors often build a buffer to protect them from the cost of overruns that causes the contractor to exceed the guaranteed maximum price. If there is a share saving provision, a contractor may try to increase the guaranteed maximum price to get more shared savings. This type of contract can take more time to negotiate and administer.