Construction contract

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A construction contract is a mutual or legally binding agreement between two parties based on policies and conditions recorded in document form. The two parties involved are one or more property owners and one or more contractors. The owner, often referred to as the 'employer' or the 'client', [1] has full authority to decide what type of contract should be used for a specific development to be constructed and to set out the legally-binding terms and conditions in a contractual agreement. [2] A construction contract is an important document as it outlines the scope of work, risks, duration, duties, deliverables and legal rights of both the contractor and the owner.

Contents

Types

There are three main types of construction contract, identified according to the mechanism for calculating the sum due to be paid by the employer: lump sum contracts, re-measurement contracts and cost-reimbursable contracts. The different types vary primarily with regard to who takes the risks involved, which party has to pay for the cost over runs, and which party can keep the savings if the project costs are less than the estimated costs. [3]

Other types of contract and descriptions of contractual purpose include:

Lump sum contract

Under a lump sum contract, an owner agrees to pay a contractor a specified lump sum after the completion of work without a cost breakdown. [8] [9] After work is complete, no detailed measurement is required.

Lump sum and scheduled contract

In lump sum contract the complete work as per plan and specifications is carried out by contractor for certain fixed amount as per agreement. The owner provides required information and contractor charges certain amount. This contract is suitable when the number of items are limited or when it is possible to work out exact quantities of work to be executed. The detailed specifications of all items of work, plans and detail drawings, security deposit, penalty, progress and other condition of contract are included in agreement. Though it is lump sum and scheduled contract, contractor will be paid at regular interval of 2–3 months as per progress of work on the basis of certificate issued by engineer in charge. A scheduled of rate is included in agreement for making payment of extra items.

Under a lump sum contract, a “fixed price” for the work to be done is agreed upon by the client and contractor before the work begins. This contract can also be applied to both home building and commercial contracts. It can be more of a risk to the contractor as there are fewer mechanisms to allow them to vary their price.

Commercial contracts

A commercial contract is an agreement containing all the work that should be performed for the construction of a commercial building or non-residential building. A skillfully constructed commercial contract can protect both parties' interests, minimize risks, and increase profitability for the contractor.

Domestic construction contracts

A domestic building contract is an agreement containing all the work that should be performed for the construction of a commercial or residential building existing or occurring inside a particular country; not foreign or international.

Percentage rate contract

When the lowest rate and comparative position among the contractors are already specified prior to the opening of the tender, then the percentage rate contract is used. Percentage contract is a type of contract where there is no possibility of unbalanced tender.

Cost plus fixed fee contract

In cost plus fixed fee, the owner pays the contractor an agreed amount over and above the documented cost of work. [10]

This is a negotiated type of contract where actual and direct costs are paid for and additional fee is given for overhead and profit is normally negotiated among parties. The owner is in more control of the project; however, the risks are transferred to the owner. [11]

A cost plus contract states that a client agrees to reimburse a construction company for building expenses such as labor, materials, and other costs, plus additional payment usually stated as a percentage of the contract's full price.

This type of construction contract is an alternative to lump sum agreements. It allows flexibility and transparency for the homeowner, and reduces the risk for a contractor since a Cost Plus construction contract guarantees them a profit.

The difference between this type of contract which is a cost-based contract with lump-sum contract is that in guaranteed maximum price (GMP), if there is any savings resulted from cost under runs, then that would be stipulated price contract, and the contractors will keep the savings obtained from the cost under runs for themselves and there is no obligation for them to give them back to the owners. Nevertheless, this saving can be shared by both the contractor and the owner. [12] Another difference is about status of the plans. The lump-sum contract may be used when the owner does have a complete set of construction plans, specifications etc. available, otherwise, the guaranteed maximum price (GMP) is preferred to be included to compensate for this lacking. When the Cost-Plus is utilized, it is better for the owner to determine the guaranteed maximum price, to prevent any further cost and contractor needed to provide the primary input for owner about the project cost. [13]

Duke and Carmen stated "Cost-plus with GMP provides an upper limit on total construction costs and fees for which an owner is responsible. If the party providing the work under this pricing method runs over GMP, it is responsible for such overruns…Cost-plus with GMP and an agreement for sharing cost savings can incentivize both parties to a construction contract to work together as efficiently as possible.” [14]

In this type of contract, the owner has more authorities in monitoring, inspecting and auditing the project periodically before ultimate payment. Therefore, the risk will be transferred from owner to contractor and this would be an attraction for the customer. [12]

Cost plus a percentage of cost contract

In cost plus percentage, the owner pays greater than 100 percent of the documented cost, usually requiring detailed expense accounting. [15] In this type of contract, contractor is paid the actual cost of work plus certain percentage as profit. Various contract documents, drawing, specifications are not necessary at the time of signing the agreement. The contractor has to keep all records for cost of material and labour and contractor will be paid accordingly to engineer in charge. This type of contract is suitable for emergency work like difficulties in foundation conditions, construction of expensive structure etc. The U.S. Federal Acquisition Regulations specifically prohibit the use of this type for U.S. Federal Government contracting. [16]

Re-measurement contract

Under a re-measurement (or remeasurement) contract, the price to be paid for the whole work is to be ascertained by measurement in detail of the various parts of the work and the valuation of the work done by reference to a schedule of prices included in the contract. [3] The FIDIC Red Book 4th edition [17] (the predecessor of the 1999 Red Book) is used in some parts of the world as a re-measurement contract for civil engineering works. [18]

Subcontract agreement

A subcontractor agreement is a contract primarily between a builder or a principal contractor and subcontractor. It outlines the perimeters of specialist work to be done for the construction project. [6]

Unit Cost Contract

This contract is based on units put in place rather than a single price. The payment is calculated at a specific rate for each item such as cubic yard for concrete times quantity put in place. “The contractor quotes an owner a price for a particular task or scope of work, though at the time of contracting the parties may not know the actual number of the units of work to be completed.” [14] Consequently, the owner does not have an exact final price till the project is finished. [19] This type of contract is normally utilized where the quantity of work cannot be established such as civil engineering construction projects where excavation of soil and rock are involved. The contractor is paid based on the units that have been put in place and verified by the owner. [20]

Unit Cost contracts provide more flexibility in discrepancies in field quantities and because of this, it is always used on heavy and highway construction contracts. [19] Associated General Contractors of America (AGC) states that this type of contract is hardly used for the entire project and is mostly applied to when contracting with subcontractors which identification of different quantities are of matter of importance and they are commonly used for repair and maintenance work. For this reason, it is “not particularly useful for most private building projects, except as part of a lump sum or cost-plus contract, applied to select components of work items such as dirt removal or fill, finish hardware, etc.” [14]

Special contracts

Special contracts are further classified into five types:

Owner exerts governance over the contractor. Contractor exerts governance over internal units and sub suppliers.

Features of construction contracts

Base date

A "base date" is a reference date from which changes in conditions can be assessed. In a construction contract, the inclusion of a base date is generally used as a mechanism for the allocation of risk between the owner and contractor for changes which might occur in the period between the contractor pricing the tender and the signing of the contract. This period can potentially be very long and changes that occur may have a significant impact on the costs of the works. [22]

The base date sets the reference date from which the conditions under which the tender was prepared are considered to have been known by the contractor and so are properly reflected in their price. If specified conditions change before the contract is implemented, then the contract may be adjusted to reflect this.

In very small projects, where the time frame is short, this may not be considered necessary. On larger projects, the base date can be used to allow changes to the contract sum, or sometimes extensions of time, or even to determine which rules will apply to the contract (for example, which edition of the arbitration rules).

The exact provisions will depend on the specific form of contract being is adopted. For example, in the Joint Contracts Tribunal (JCT) Design and Build Contract, the base date determines the allocation of risk in relation to changes in statutory regulations, changes to VAT exemptions and changes to definitions of dayworks. Under the JCT's Standard Building Contract, 2011 Edition, if there are changes to “Statutory Requirements” after the contract's base date, then the contractor must alter the scope of work to comply. The change will be deemed to be a variation for which the contractor is entitled to be paid, even if no formal instructions have been issued. [23]

Practical completion

Practical completion occurs when the contractor returns possession of the site to the owner, usually at the time when the work has been completed and accepted by the client. A certificate of practical completion usually confirms this acceptance. Typically half of the retention monies are released, the contractor's potential liability for liquidated damages ends and the defects rectification period begins. [24]

Retention

A retention is a sum of money withheld by the owner under the contract to act as security against incomplete or defective works. It can be a percentage of the work that has been completed, but cannot be unlawful. [25]

Sectional completion

Sectional completion refers to a provision within a construction contract which allows different completion dates for different sections of the works. This is common in larger projects which are completed in stages, allowing the client to take possession of the completed parts whilst construction continues on others. [26]

Snagging

Snagging refers to a process where the owner or the owner's agent checks for any defects, which the contractor needs to put right before the final payment is made. The UK consumer organisation Which? states that the most common issues picked up by snagging surveys for residential properties tend to be concerned with the completion of plastering, tiling, skirting boards and external brickwork. [27]

See also

Related Research Articles

<span class="mw-page-title-main">Architect</span> Person who designs buildings and oversees construction

An architect is a person who plans, designs and oversees the construction of buildings. To practice architecture means to provide services in connection with the design of buildings and the space within the site surrounding the buildings that have human occupancy or use as their principal purpose. Etymologically, the term architect derives from the Latin architectus, which derives from the Greek, i.e., chief builder.

A hire purchase (HP), also known as an installment plan, is an arrangement whereby a customer agrees to a contract to acquire an asset by paying an initial installment and repaying the balance of the price of the asset plus interest over a period of time. Other analogous practices are described as closed-end leasing or rent to own.

A performance bond, also known as a contract bond, is a surety bond issued by an insurance company or a bank to guarantee satisfactory completion of a project by a contractor. The term is also used to denote a collateral deposit of good faith money, intended to secure a futures contract, commonly known as margin.

Design–build, also known as alternative delivery, is a project delivery system used in the construction industry. It is a method to deliver a project in which the design and construction services are contracted by a single entity known as the design–builder or design–build contractor. It can be subdivided into architect-led design–build and contractor-led design–build.

Design–bid–build, also known as Design–tendertraditional method or hardbid, is a project delivery method in which the agency or owner contracts with separate entities for the design and construction of a project.

A general contractor, main contractor or prime contractor is responsible for the day-to-day oversight of a construction site, management of vendors and trades, and the communication of information to all involved parties throughout the course of a building project.

Construction management (CM) is a professional service that uses specialized, project management techniques and software to oversee the planning, design, construction and closeout of a project. The purpose of construction management is to control the quality of a project's scope, time / delivery and cost—sometimes referred to as a project management triangle or "triple constraints." CM is compatible with all project delivery systems, including design-bid-build, design-build, CM At-Risk and Public Private Partnerships. Professional construction managers may be hired for large to jumbo-scale, high budget undertakings, called capital projects.

<span class="mw-page-title-main">Revenue recognition</span>

The revenue recognition principle is a cornerstone of accrual accounting together with the matching principle. They both determine the accounting period in which revenues and expenses are recognized. According to the principle, revenues are recognized when they are realized or realizable, and are earned, no matter when cash is received. In cash accounting—in contrast—revenues are recognized when cash is received no matter when goods or services are sold.

Project finance is the long-term financing of infrastructure and industrial projects based upon the projected cash flows of the project rather than the balance sheets of its sponsors. Usually, a project financing structure involves a number of equity investors, known as 'sponsors', and a 'syndicate' of banks or other lending institutions that provide loans to the operation. They are most commonly non-recourse loans, which are secured by the project assets and paid entirely from project cash flow, rather than from the general assets or creditworthiness of the project sponsors, a decision in part supported by financial modeling; see Project finance model. The financing is typically secured by all of the project assets, including the revenue-producing contracts. Project lenders are given a lien on all of these assets and are able to assume control of a project if the project company has difficulties complying with the loan terms.

A cost-plus contract, also termed a cost plus contract, is a contract such that a contractor is paid for all of its allowed expenses, plus additional payment to allow for a profit. Cost-reimbursement contracts contrast with fixed-price contract, in which the contractor is paid a negotiated amount regardless of incurred expenses.

A Schedule of Values (SOV) is a detailed schedule apportioning the original contract sum and all change orders, among all cost code divisions or portions of the work. The Schedule of Values shall be based on the approved budget or the approved Fixed Price, or GMP, Cost-Plus Contract type as applicable. See the executed contract agreement for additional language regarding the Schedule of Values. Each Project/Job shall have a separate Schedule of Values. If multiple Projects/Jobs are included in one contract, then the Contractor/Vendor must create a separate Schedule of Values which clearly segregates costs among each Job for billing, reporting and audit purposes."

A guaranteed maximum price contract is a cost-type contract such that the contractor is compensated for actual costs incurred plus a fixed fee, limited to a maximum price. The contractor is responsible for cost overruns greater than the guaranteed maximum price, unless the GMP has been increased by a formal change order. Savings resulting from unexpectedly low costs are returned to the client.

Construction bidding is the process of submitting a proposal (tender) to undertake, or manage the undertaking of a construction project. The process starts with a cost estimate from blueprints and material take offs.

Integrated project delivery (IPD) is a construction project delivery method that seeks efficiency and involvement of all participants through all phases of design, fabrication, and construction. IPD combines ideas from integrated practice and lean construction. The objectives of IPD are to increase productivity, reduce waste, avoid time overruns, enhance final product quality, and reduce conflicts between owners, architects and contractors during construction. IPD emphasizes the use of technology to facilitate communication between these parties involved in a construction process.

Fast-track building construction is construction industry jargon for a project delivery strategy to start construction before the design is complete. The purpose is to shorten the time to completion.

Retainage is a portion of the agreed upon contract price deliberately withheld until the work is substantially complete to assure that contractor or subcontractor will satisfy its obligations and complete a construction project. A retention is money withheld by one party in a contract to act as security against incomplete or defective works. They have their origin in the British construction industry Railway Mania of the 1840s but are now common across the industry, featuring in the majority of construction contracts. A typical retention rate is 5% of which half is released at completion and half at the end of the defects liability period. There has been criticism of the practice for leading to uncertainty on payment dates, increasing tensions between parties and putting monies at risk in cases of insolvency. There have been several proposals to replace the practice with alternative systems.

A fixed-price contract is a type of contract such that the payment amount does not depend on resources used or time expended by the contractor. This is opposed to a cost-plus contract, which is intended to cover the costs incurred by the contractor plus an additional amount for profit. Such a scheme is often used by military and government contractors to require vendors to incur the risk of cost overruns, and to control costs. However, historically when such contracts are used for innovative new projects with untested or undeveloped technologies, it often results in failure if costs greatly exceed the ability of the contractor to absorb unexpected cost overruns.

The following is a glossary of terms relating to construction cost estimating.

Australian Construction Contracts govern how the parties to a construction contract behave and how the project manager and the contract manager administer the relationship between the parties. There are several popular standard forms of construction contracts that are currently used in Australia.

<span class="mw-page-title-main">Lump sum contract</span>

A lump sum contract in construction is one type of construction contract, sometimes referred to as stipulated-sum, where a single price is quoted for an entire project based on plans and specifications and covers the entire project and the owner knows exactly how much the work will cost in advance. This type of contract requires a full and complete set of plans and specifications and includes all the indirect costs plus the profit and the contractor will receive progress payments each month minus retention. The flexibility of this contract is very minimal and changes in design or deviation from the original plans would require a change order paid by the owner. In this contract the payment is made according to the percentage of work completed. The lump sum contract is different from guaranteed maximum price in a sense that the contractor is responsible for additional costs beyond the agreed price, however, if the final price is less than the agreed price then the contractor will gain and benefit from the savings.

References

  1. ↑ Bowman's, A Guide to Construction Contracts, p. 5, accessed 2 September 2020
  2. ↑ "Main types of contracts" . Retrieved 23 October 2014.
  3. 1 2 Hogos, T. and Shewangzaw, M. (2009), Construction Law: Teaching Material, sponsored by the Justice and Legal System Research Institute, accessed 29 August 2020
  4. ↑ "Building Contracts" . Retrieved 23 October 2014.[ permanent dead link ]
  5. ↑ "Common types of construction contracts". Archived from the original on 21 October 2014. Retrieved 23 October 2014.
  6. 1 2 "Construction contracts" . Retrieved 20 October 2014.
  7. ↑ Dr. B.C. Punmia (2014). A text book of Production Planning and Management.
  8. ↑ "Business dictionary". Archived from the original on October 17, 2014. Retrieved 17 October 2014.
  9. ↑ "Lump sum contract". Archived from the original on 21 October 2014. Retrieved 17 October 2014.
  10. ↑ "India study channel". by Owais Khursheed. Retrieved 17 October 2014.
  11. ↑ Barrie, Donald S. (1992). Professional construction management : including CM, design-construct, and general contracting. Paulson, Boyd C. Jr. (3rd ed.). New York: McGraw-Hill. ISBN   0070038899. OCLC   24219336.
  12. 1 2 Burger, Rachel. "What You Need to Know About Guaranteed Maximum Price (GMP) Contracts". The Balance Small Business. Retrieved 2019-07-04.
  13. ↑ "AIA". www.aia.org. Retrieved 2019-07-04.
  14. 1 2 3 "The Pros and Cons of Pricing Options in Construction Contracts". Bell Davis Pitt. 2017-06-20. Retrieved 2019-07-04.
  15. ↑ "Cost plus percentage of cost contract". by Owais Khursheed. Retrieved 20 October 2014.[ permanent dead link ]
  16. ↑ FAR Part 16.102
  17. ↑ FIDIC, Conditions of Contract for Works of Civil Engineering Construction, Fourth Edition, 1987
  18. ↑ Richards, G., UK: Procurement Methods in the Construction Industry, Pinsent Masons LLP, published 14 March 2006, accesses 1 September 2020
  19. 1 2 Halpin, Daniel W. (2006). Construction management (3rd ed.). Hoboken, NJ: Wiley. ISBN   0471661732. OCLC   61425134.
  20. ↑ The project resource manual : CSI manual of practice. Construction Specifications Institute. New York: McGraw-Hill. 2005. ISBN   0071370048. OCLC   56191871.{{cite book}}: CS1 maint: others (link)
  21. ↑ Dr. B.C. Punmia (17 October 2014). Production Planning and Management.
  22. ↑ Designing Buildings Wiki, Base date in construction contracts, updated 5 July 2019, accessed 24 August 2020
  23. ↑ JCT, Standard Building Contract, 2011 Edition (SBC/2011), referenced in Sergeant, M., Deemed variations under a construction contract, published 11 November 2015, accessed 24 August 2020
  24. ↑ Kempthorne, V., The meaning of ‘Practical Completion’, Clarks Legal, published 11 January 2019, accessed 3 September 2020
  25. ↑ AIA. "AIA 102-2017 contract Section 12.1.8" (PDF). aia.org. AIA. Retrieved 14 July 2021.
  26. ↑ Designing Buildings Wiki, Sectional completion in construction contracts, updated 14 January 2019, accessed 29 August 2020
  27. ↑ Which?, Snagging surveys, accessed 3 September 2020
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