AACE International Chapter 23 Contracting for Capital Projects

TYPES OF
CONTRACTS

TYPES OF CONTRACTS
It would be simple if there was such a thing as a uniform standard contract regardless of what is being contracted between the
parties. For a whole host of reasons, this is impracticable. The primary underlying reason for the genesis of multiple contracting
forms is how the parties wish to deal with the issue of risk transfer. That is, a definition of which party agrees (not always willingly)
to undertake responsibility for some aspect of the work scope such that they now own the risk of performance or non-performance.
There are, generally, four basic types of contracts (with an almost unimaginable number of variations) used on capital projects. The
basic types of contracts are the following:

1. Fixed Price Lump Sum Contracts

risks are clearly identified, the price is fixed, and the time of performance is typically also fixed. The contractor is generally
free to select their own means and methods to perform the work provided that the final result conforms to the technical,
quality, schedule, and cost requirements of the contract. This results from the fact that under a fixed price contract, the
contractor assumes risk for the fixed price. That is, if the bidding documents are accurate but the fixed price too low, it is
the contractor who suffers the penalty. To balance this out somewhat, contractors are most often allowed the freedom to
select their own means and method of performing the work. Some variations of lump sum, fixed price contracts include:

Fixed Price With Economic Adjustment

adjustable under certain conditions. For example, if the price of asphalt, copper tubing, computer chips,
electronic boards, etc. increases or decreases more than 15 percent from the bid price, payment for the
specified item(s) will be adjusted in accordance with the terms and conditions of the Economic Price
Adjustment (EPA) Clause of the contract.
Fixed Price With Incentives
incentive clauses may be inserted into the contract related to time, cost savings, project performance, etc. For
example, the contractor may be entitled to additional payment for every day the project is completed prior to
the contract completion date. Or, a contractor may be entitled to keep 50 percent of cost saved on a completed
project when the final cost is less than the original contract cost. The concept is to provide an economic
incentive for the contractor to meet or exceed certain baseline objectives.

2. Fixed Price - Unit Price Contracts The distinction between this contract
form and the lump sum form discussed above is that the price is fixed for each unit of work rather than the entire scope of
work thus, the name, unit price. The total value of the contract is a function of the number of units fabricated, delivered,
installed, etc. Similar to the lump sum form of contract, a unit price contract may also be incentivized. Unit priced
contracts generally also contain a Quantity Variation Clause to the effect that if any of the unit quantities vary by +/- 15
percent, say, from the estimated quantities, then the unit price is subject to adjustment on that portion of the work. The
risk of changes to units provided is, therefore, shared between the owner and the contractor under such a clause. Since
AACE International Chapter 23 Contracting for Capital Projects

the total quantity of units may not be known at the outset of the contract, the final cost of the contract is generally
t.

3. Cost Reimbursable Contracts Rather, the

essence of a cost reimbursable contract is the contractor is paid for their legitimate actual cost incurred in performing the
work, plus a stipulated amount for profit. Such a contract is often referred to as a Cost Plus Fixed Fee (CPFF) contract or a
Time and Material (T&M) contract. Costs are ordinarily classified as either direct or indirect costs under such contracts.

Direct Costs
directly with work scope items or activities under the contract (such as labor, materials, equipment,
subcontractors or sub-consultants, consumables, etc.).
Indirect Costs (Overhead Costs)
general conditions costs) which cannot be allocated to specific items of work or costs allocated by the
ies of corporate executives), as a cost of doing business
(home office overhead). Home office overhead costs are usually calculated as a percentage of direct costs.
Mark Up Costs secured by
performance and/or payment bonds.

example. Incentivizing, in capital projects, typically takes the form of the owner offering to pay additional money to the
contractor in the event of early delivery of the project, underruns on the budget, performance of the completed project above
specified standards, etc. Such contracts are often referred to as Cost Plus Incentive Fee (CPIF) contracts.

4. Target Contracts
completion of work at the lowest possible cost and least amount of time. Often, the contractor will perform the early part
of the work (i.e., planning and design) on a cost reimbursable basis. At some point, the contractor will prepare and
negotiate with the owner, a detailed estimate, with a not to exceed cost and time of performance. Once agreement on
time and cost is reached, these become the contractor (Such contracts are also referred to as Guaranteed
Maximum Price [GMP] contracts.)
underruns, if any, are shared between the owner and the contractor on the basis stipulated in the contract. Overruns,
unless caused by owner intervention or other excusable events set forth in the contract, are generally assessed to the
contractor. Similarly, a comparison of targeted versus actual schedule is made and early completion bonuses are often
paid to the contractor for completing the project earlier than the target schedule.