If you work in real estate or the construction business, it’s essential to understand the types of contracts with which you may come into contact. These legal agreements protect both owners and builders by laying out the expectations each has of the other as clearly as possible. Not only can this avoid unnecessary confusion and headaches down the road, but it could avoid disputes and litigation as well.
No two contracts are ever entirely alike, but there are four basic types of contracts used to govern construction projects. These include fixed price also known as lump sum, unit price, cost plus, and time and materials contracts. We’ll discuss each of these contracts below to provide you with a clearer understanding of what they entail.
1. Fixed Price/Lump Sum Contracts
The simplest type of construction contract is one that assigns a fixed price for an entire project. This is also known as a “lump sum” contract. These contracts include all labor or materials. There may be incentives for the builder to complete the project ahead of schedule.
Likewise, there can also be penalties for failing to complete the project on time that are sometimes referred to as “liquidated damages.” These can penalize builders who don’t complete a project on time or adhere to an agreed-upon schedule. Because they have the ability to determine penalties, it’s not uncommon for owners to use a lump sum contract to avoid change orders that can increase costs or project duration.
Builders who agree to lump sum contracts often accept more risk than owners. Because there is a predetermined, fixed price associated with the project, a builder can put themselves in a tight spot. This is especially true if they have to pay more than they anticipated for materials and labor or if there are unforeseen delays, like those caused by weather or unanticipated governmental requirements.
Because of this, builders may be keen to overestimate the cost of materials and labor to widen their margins of error. This means owners can end up paying more for a project under a lump sum contract than it could have cost under a different agreement. However, California law requires any contracts for improvement of a residence to be fixed price contracts.
2. Unit Price Contracts
Unit price contracts offer are preferred when flexibility is needed to account for fluctuations in the scope and price of a project. For this reason, they aren’t typically used for major construction projects, but rather smaller types of work like maintenance and repair.
Unit price contracts are most commonly used to cover public works projects or work that occurs on a regular basis. A good example of a unit price contract would be a building maintenance agreement that assigns values to a variety of different tasks that might be required to keep the building in good operation.
3. Cost-Plus Contract
A cost-plus contract is one where the owner agrees to pay for all of a project’s expenses, which can include the cost of labor, materials, and other related expenses. Cost-plus contracts also include provisions where owners agree to pay a percentage that covers the builder’s overhead and profit. . However, California law prohibits any contracts for improvement of a residence to be cost-plus contracts.
Usually, the owner accepts more risk than the builder under a cost-[SL1] plus contract – especially because the owner could end up paying much more for a project than the originally estimated cost. There are, however, different kinds of cost- plus contracts that each provide different levels of risk to owners.
These types of cost plus contracts include the following:
- Cost Plus Fixed Fee: These contracts include a fixed fee to cover the builder’s profit and overhead in addition to coverage for variable costs such as materials and labor.
- Cost Plus Fixed Percentage: The owner is responsible for paying for the cost of materials and labor for a project in addition to a fixed percentage of this amount to account for the builder’s profit and overhead.
- Cost Plus with Guaranteed Maximum Price: Owners can generate savings through this type of contract because they pay for a project’s associated costs and a fixed fee up to a specified maximum amount. This incentivizes builders to keep their expenses within the margin created by the guaranteed maximum price to maximize their own profits.
Because builders have a little bit more liberty in terms of cost to complete a project, the likelihood is greater that it will be completed as envisioned by the owner.
4. Time & Materials
A time and materials contract establishes an hourly or daily rate for builders to work on a project. Owners also typically agree to pay for the cost of materials and other associated project expenses.
These contracts are usually useful for smaller projects. They are also useful when owners can’t accurately ascertain the scope of work necessary to complete a project, especially because owners can include price or project duration caps. These caps limit how long a project can go on or how much it can cost the owner to incentivize builders to complete the job within a specific timeframe or budget.
Do You Need Assistance with Your Construction Contracts?
At the Law Office of Steven R. Lovett, we know that even very experienced business owners in the construction and real estate industries can have a lot of questions when it comes to protecting their interests on an important project.
If you require any kind of legal assistance regarding one of these agreements – drafting, review, negotiation, or litigation – we can provide the legal representation you require. Our attorney has more than 40 years of experience protecting the interests of clients like you, so rest assured that you’ll be in good hands when you work with the Law Office of Steven R. Lovett.
For more information and to request a free telephonic consultation, please contact our firm online today.