The Different Types of Construction Contracts

The world of construction is complex, where countless details and moving parts must align perfectly. Construction contracts serve as the essential framework guiding each project from concept to completion. Understanding a construction contract's intricacies is essential for owners and parties, such as contractors, subcontractors, and developers, to ensure that a given project transpires seamlessly.

What Are Construction Contracts?

Construction contracts are agreements between different players involved in a construction project, including the owner of the project, who contracts the work; the contractor, who performs the work; and, in some cases, subcontractors, who perform portions of the work.

The primary purpose of construction contracts is to clearly state the scope of work, the tentative schedules of the project, cost estimates, and payment timings. One example is a standard form contract, which is an agreement essential for guaranteeing uniformity, reducing risks, and expediting procedures. These are pre-prepared agreements with standardized terms and conditions that parties can utilize repeatedly for comparable transactions.

Construction contracts are vital in that they reduce risks involved when managing a project and ensure that it is a success. They avoid any possible dispute or misunderstanding since it is a written agreement. It will be used in the resolution of differences arising. This, therefore, safeguards the interests of all the parties involved. They are also used as critical tools for contractor and subcontractor management, as they specify all the terms and conditions of the relationship.

What Are The Different Types Of Construction Contracts?

Every kind of contract in construction has unique characteristics, advantages, and benefits tailored to the project's various needs, risk management strategies, and financial considerations. Below, we explore the different types of construction contracts by highlighting their features and benefits.

Design-Build Contracts

A design-build contract means that a single entity is responsible for the design and construction of a project. Such an approach to an undertaking facilitates integrated communication, promotes construction collaboration, and, more often than not, results in faster project delivery. These types of construction contracts may be most beneficial for complex projects where overlap in design and construction phases will be effective.

Pros:

• Faster completion
• Less administrative burden
• Improved team collaboration between the design and build teams

Cons:

• Greater potential for up-front costs
• Reduced owner control of design details

Guaranteed Maximum Price (GMP) Contracts

GMP contracts set the highest limit of a project's cost in that the owner will not pay a price exceeding this amount. Any costs over and above the GMP are therefore absorbed by the contractor. On the other hand, if all the project goes under budget, then the excess amount may be shared between the owner and the contractor, which provides an incentive for the contractor to perform cost-effectively.

Pros:

• Construction cost control is on the owner's side
• Incentive for the contractor to be competitive on costs

Cons:

• Risk of receiving high bids from contractors to cover their risks
• Requires unambiguous definitions of the project scope and the work involved

Unit Price Contracts

These types of construction contracts are those under which a unit price is applied. This is commonly used for projects that can quantify the scope of work into units, like road construction and installations for utilities. Payments are made according to the actual quantity of work done, not forgetting the agreed-on unit price beforehand.

Pros:

• Flexibility in making adjustments to project quantities quickly
• Better handling of variations in the work scope

Cons:

• Disputes related to the quantities of units
• Proper measurement and tracking of completed work need to be done

Cost-Plus Contracts

With these types of construction contracts, the client will pay for the actual costs incurred for the construction along with some extra fee or percentage amount for profit. This is the best contract to be used for projects that have scopes of work with uncertainties or possibly there might come changes during construction.

Pros:

• Allows for flexibility in making adjustments
• Cost tracking is transparent

Cons:

• The costs can rise if not carefully controlled
• Requires keeping extensive records

Time and Materials Contracts

Time and materials contracts resemble cost-plus contracts; however, they contain specific hourly labor rates and material prices. This form of contract is frequently used when the nature of the work is relatively small, or the scope of work is not clear. The owner pays for the actual labor and materials plus an agreed-upon percentage.

Pros:

• Flexibility concerning undefined scopes
• Easy mobilization of projects

Cons:

• Potential for cost overrun
• Meticulous tracking of labor and use of material

Lump Sum Contracts

These types of contracts in construction are also fixed price contracts, a one-time pre-determined amount for the entire project. They are used for projects where the scope of work and specifications are apparent. The contractor agrees to complete the project at the agreed-upon price, regardless of the actual completion cost.

Pros:

• Cost certainty to the owner
• Easier contract administration

Cons:

• Relatively inflexible to change
• Scope change disputes often arise

Incentive Construction Contracts

Incentive construction contracts tend to have a form of incentive payouts based on predetermined parameters such as early completion or cost savings. These construction contract types put owner and contractor interests at an affinity level and hence promote efficiency and performance.

Pros:

• Supports high performance and productivity
• Aligns the goals of the contractor with those of the owner.

Cons:

• It can be cumbersome to negotiate and administer
• Explicit measurable performance criteria are needed

Integrated Project Delivery (IPD)

Integrated project delivery is a project-specific delivery approach in which all stakeholders, from the client to the architect and constructor, collaborate from the initial stages of the project process.

Pros:

• Enhanced collaboration and communication in construction projects
• Shared risk and reward

Cons:

• Requires strong commitment from all parties
• Difficult contractual arrangements

How to Choose the Right Type of Construction Contract

The proper construction contract can be key to the success of a project. It's all about building the ground for a strong understanding between parties, reducing disputes, and making the project run smoothly. Key considerations will help you make the best choice for your construction project.

Understanding Your Project Needs

Understanding your project needs is the first and foremost step in selecting the proper construction contract. The size and complexity of the project can be analyzed during the preconstruction planning phase, and a large and complex project will require a well-drawn contract to attend to every necessary detail.

Look closely at your budget and how well you manage the purse, then decide whether to have a fixed or a flexible budget. Find out who should bear the risk – the owner or the contractor – while anticipating challenges like cost overruns and delays.

The timing and scheduling of the project are also essential: the more rigid the due dates, the more the contracts will need to specify clear penalties and rewards; in contrast, looser arrangements are permitted when the timing is more flexible.

Finally, it needs to be defined what quality of work is expected and what level of performance standards must be set and determine whether you require contracts in construction that include some type of performance incentive or penalty. A complete understanding of these elements will help you pick an agreement that best matches the unique demands of your project, hence smooth and successful execution.

Essential Considerations in Picking the Right Construction Contract

Several significant factors must be considered in picking the proper construction contract to guarantee the success of the project.

Align the nature of the contract with your project's goals and priorities; that is, cost control, flexibility, time, or quality. Determine your risk tolerance and choose a contract that apportions the appropriate amount of risk between owner and contractor. Determine the experience and reliability of your contractor and project team, as these two can significantly affect the project result. Ensure that the contract considers and complies with local regulations and legal requirements to limit the possibility of later disputes.

Finally, expect changes to happen and select a contract that best manages the inevitable adjustments without great contention. By considering these factors, it becomes thoughtful for one to consider construction contracts that meet the needs of one's project and assure a smooth and effective construction process.

Contract Standards Around the World

The standards of contracts in construction play a vital role in setting out the terms and conditions under which the construction projects will be carried out, ensuring clarity, fairness, and consistency across the industry. These standards manage risks, allocate responsibilities, and provide a frame for dispute resolution. Therefore, they are crucial for the success of completing the project. This has been achieved around the world by several different organizations, all coming up with their standardized contracts to suit the requirements of their regions.

Probably one of the most critical and widespread sets of standards is provided by the International Federation of Consulting Engineers (FIDIC). FIDIC contracts, including the widely used in international construction Red, Yellow, and Silver Books known to everybody, are commonly used in international construction. The FIDIC forms are known to be well-balanced with respect to risk allocation; they help cooperation with different parties, which often act under various legal and regulatory regimes. FIDIC contracts have become the choice for many governments, developers, and contractors dealing with global construction projects by offering a common language and framework.

Contract standards in the UK

The standards in the UK are guided by two primary forms, namely the New Engineering Contract (NEC) and the Joint Contracts Tribunal (JCT). They are flexible and transparent, making collaborating easier for parties based on project management and sharing risks. These are primarily used for infrastructural and public sector projects.

JCT produces more standard forms of contracts, which are extensively used within the private sector. These kinds of contracts are more traditional, in which the roles and responsibilities are defined easily, hence suitable for any type of construction project.

Contract standards in the USA

In the United States, typical contract documents are those published by the American Institute of Architects (AIA) and ConsensusDocs Contracts. To the extent it is received, AIA publishes a library of contract documents that are broadly recognized and used as the standards in the profession for both architects and construction to encourage uniformity and reduce litigation.

ConsensusDocs is a product of industry organizations collaborating to provide contracts focusing on even-handed terms that foster collaboration. In addition, to ensure that most of the developed engineering contracts reach the best technical standards required, the American Society of Civil Engineers (ASCE) standards are often applied – which, in many respects, set the yardstick.

Construction standards in South Africa

The Joint Building Contracts Committee (JBCC), New Engineering Contract (NEC), and General Conditions of Contract for Construction Works (GCC) are among the standards subscribed to by South Africa's construction industry.

JBCC produces contract forms aimed at ensuring standardization of contract administration and thus minimizing disputes as much as possible. The NEC is used widely, even internationally, in South Africa to promote teamwork and flexibility in project management. The GCC is also a worldwide standard that gives broad guidance regarding the contractual relationship that applies to civil engineering and construction projects.

Construction contracts in the UAE

In the UAE, the contract of construction is mainly governed by the local standards of the Civil Code (Federal Law No. 5 of 1985) and the Federal Commercial Transactions Law (No. 18 of 1993). They outline a framework of the construction contract within issues concerning liability, warranties, and limitations.

Additionally, the UAE uses FIDIC contracts, which are universally acknowledged to be even and well-rounded in contract administration in the construction industry. This smoothens and lessens any potentially arising dispute.

Conclusion

As you learned from this post, contracts are fundamental to the success of complex construction projects. They set the terms and conditions to ensure the work is carried out as expected and in a way that benefits all parties. Choosing the best contract for your project is paramount as it will prevent risks and other issues that can affect the project.

At RIB Software, we provide diverse tools to support contract managers in this crucial aspect of their responsibilities. We have a range of construction contract management software tailored to meet your unique requirements and make your projects more efficient, organized, and productive. If you are ready to benefit from innovative construction solutions, get a demo of RIB’s toolkit today!