Construction contract

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, duties and legal rights of both the contractor and the
owner.

Contents
Types
Lump sum contract
Lump sum and scheduled contract
Commercial contracts
Domestic construction contracts
Percentage rate contract
Cost plus fixed fee contract
Cost plus a percentage of cost contract
Re-measurement contract
Subcontract agreement
Unit Cost Contract
Special contracts
Features of construction contracts
Base date
Practical completion
Retention
Sectional completion
Snagging
See also
References

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:

 Commercial contract
Domestic building contract[4]
Percentage rate contract
Item rate contract or Unit price contract
Lump sum and scheduled contract[5]
Cost plus fixed fee contract
Cost plus percentage of cost contract
Subcontract agreement [6]
Special contracts[7]

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:

Turn key contract

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

Negotiated contract
Package contract
Continuing contract
Running contract[21]

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
Australian Construction Contracts
Economics
Engineering, procurement and construction

References
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loads/2016/12/Guide-Construction-Contracts.pdf), p. 5, accessed 2 September 2020
2. "Main types of contracts" (http://civilengineerlink.com/common-types-construction-
contracts/). Retrieved 23 October 2014.
3. Hogos, T. and Shewangzaw, M. (2009), Construction Law: Teaching Material (https://chilot.fil
es.wordpress.com/2011/06/construction-law.pdf), sponsored by the Justice and Legal
System Research Institute, accessed 29 August 2020
4. "Building Contracts" (https://constructionlawyermelbourne.com.au/services/construction-cont
ract). Retrieved 23 October 2014.
5. "Common types of construction contracts" (http://construction.about.com/od/Construction-Ma
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6. "Construction contracts" (https://www.contractsspecialist.com.au/construction-contracts-sydn
ey/). Retrieved 20 October 2014.
7. Dr. B.C. Punmia (2014). A text book of Production Planning and Management.
8. "Business dictionary" (http://m.businessdictionary.com/definition/lump-sum-contract.html).
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What-Is-A-Lump-Sum.htm). Retrieved 17 October 2014.
10. "India study channel" (http://www.indiastudychannel.com/projects/2054-Various-types-of-Civ
il-Engineering-Contracts.aspx). 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 (https://www.worldcat.org/oclc/24219336).
12. Burger, Rachel. "What You Need to Know About Guaranteed Maximum Price (GMP)
Contracts" (https://www.thebalancesmb.com/guaranteed-maximum-price-contracts-845345).
The Balance Small Business. Retrieved 2019-07-04.
13. "AIA" (https://www.aia.org/articles/7196-how-gmp-contracts-keep-projects-from-endless-:46).
www.aia.org. Retrieved 2019-07-04.
14. "The Pros and Cons of Pricing Options in Construction Contracts" (https://www.belldavispitt.
com/blog/construction-and-design-law/pros-and-cons-pricing-options-construction-
contracts). Bell Davis Pitt. 2017-06-20. Retrieved 2019-07-04.
15. "Cost plus percentage of cost contract" (http://m.businessdictionary.com/definition/cost-plus-
percentage-contract.html.). by Owais Khursheed. Retrieved 20 October 2014.
16. FAR Part 16.102
17. FIDIC, Conditions of Contract for Works of Civil Engineering Construction, Fourth Edition,
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18. Richards, G., UK: Procurement Methods in the Construction Industry (https://www.mondaq.c
om/uk/real-estate/38356/procurement-methods-in-the-construction-industry), Pinsent
Masons LLP, published 14 March 2006, accesses 1 September 2020
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ISBN 0471661732. OCLC 61425134 (https://www.worldcat.org/oclc/61425134).
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22. Designing Buildings Wiki, Base date in construction contracts (https://www.designingbuildin
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23. JCT, Standard Building Contract, 2011 Edition (SBC/2011), referenced in Sergeant, M.,
Deemed variations under a construction contract (http://constructionblog.practicallaw.com/de
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24. Kempthorne, V., The meaning of ‘Practical Completion’ (https://www.clarkslegal.com/Blog/P
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25. AIA. "AIA 102-2017 contract Section 12.1.8" (https://content.aia.org/sites/default/files/2017-0
7/A102_2017.sample2.pdf) (PDF). aia.org. AIA. Retrieved 14 July 2021.
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27. Which?, Snagging surveys (https://www.which.co.uk/money/mortgages-and-property/new-bu
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