Types of Construction Contracts

June 11, 2024 Roberto Magalhães

Construction contracts play a crucial role in the successful completion of construction projects. They establish the legal framework and define the rights and obligations of everyone involved. There are different types of construction contracts to suit different project requirements, risk allocations and payment structures. In this article, we will look at the most common types of construction contracts and discuss their main features, benefits, and considerations.

We will discuss the following types of construction contracts.

Fixed Rate Contracts
Cost-plus contracts
Time and material contracts
Unit Price Contracts
Design-Build Contracts
Turnkey contracts
Construction Management Contracts
Contracts with guaranteed maximum price

When it comes to construction projects, different scenarios require different types of contracts. The choice of contract depends on factors such as project complexity, scope of work, desired level of control, and risk distribution preferences. Here are some of the main types of construction contracts:

Fixed Rate Contracts

A fixed fee contract also called a fixed price contract, is a type of agreement in which the contractor agrees to perform specified work for a predetermined fixed price. This type of contract is often used when the scope of the project is well defined and the design and specifications are clear.

The contractor assumes the risk of any cost overruns and provides the owner with cost security. Lump sum contracts are popular in residential construction and small to medium-sized projects.

Given that the project price is fixed and the contractor does not have a mechanism to initiate changes, the tariffs provided for in this type of contract are higher to cover possible risks of changes in quantities and prices, lack of items in the cost calculation, etc.

However, due to changes requested by the employer, there is the possibility of variation in the contract price.

Cost-plus contracts

A cost-plus contract is a type of agreement in which the contractor is reimbursed for actual costs incurred during the project, as well as an additional fee or percentage of profits.

This type of contract is ideal when the scope of the project is uncertain or changes are expected during the construction phase.

The owner is more aware of costs, but assumes the risk of cost overruns. Cost-plus contracts are often used on large, complex projects where flexibility and transparency are crucial.

Time and materials contracts

A time and materials contract is a mixture of the cost-plus contract and the unit price contract.

In this type of agreement, the contractor is reimbursed for the time actually spent on the project, as well as the cost of materials and equipment used.

Time and materials contracts are often used for small projects or emergency repairs where the scope and duration are difficult to determine in advance. Although this type of contract offers flexibility, it presents the risk of possible cost overruns.

Unit Price Contracts

A single-price contract based on set prices for specific quantities of work. The contractor will be paid based on unit prices multiplied by completed quantities.

This type of contract is suitable if the project involves recurring work or if work quantities cannot be accurately determined in advance.

Unit price contracts provide transparency and are often used in infrastructure projects, such as building roads or installing utilities.

Design-Build Contracts

A design-build contract is a single agreement that combines the design and construction aspects of a project.

In this type of contract, the owner hires a single company, called a design and construction contractor, to handle the entire project, from conception to completion.

Design-build contracts are often used for projects where time is of the essence or when the owner wants to have a single point of contact. Given that the project is managed by a single body, there are no communication problems between the different consultants.

It is common practice to hire a consultant or employer representative to act on the employer's behalf and protect its interests.

Turnkey contracts

A turnkey contract is a type of commercial agreement under which a contractor or project supplier assumes full responsibility for the design, construction and delivery of a project to the client in an operational or ready-to-use condition.

Essentially, all the customer needs to do is turn the switch to begin using the finished plant, system or asset. This type of contract is commonly used across multiple industries, including construction, engineering, technology, and manufacturing.

For a turnkey contract:

Scope and responsibility: The project contractor or supplier is responsible for the entire life cycle of the project, from design and construction, through procurement, construction, testing and commissioning to final delivery.
Single point of contact: The customer interacts primarily with the general contractor. This simplifies communication and reduces the customer's need to coordinate multiple suppliers or subcontractors.
Risk Distribution: The general contractor assumes significant risk, including planning errors, construction delays, and budget overruns. He is responsible for ensuring that the project is completed as promised, within the agreed budget and deadline.
Expertise: General contractors are typically selected based on their experience completing specific types of projects. Clients rely on your expertise to ensure successful project delivery.
Time efficiency: Turnkey contracts often result in faster project delivery because the contractor is responsible for managing all aspects of the project, reducing delays caused by multi-party coordination.
Fixed price: The contract usually establishes a fixed price for the entire project. This offers the client security in estimating costs, as any excess costs will have to be borne by the contractor.
Project delivery: Upon completion of the project, the customer receives a fully functional and operational object that meets the specified requirements. The project can be used immediately.

Turnkey contracts are particularly useful when clients minimize their effort in project implementation and look for a comprehensive solution from a single source.

Examples of turnkey projects include the construction of industrial plants, power plants, data centers and infrastructure projects.

It is important that both parties establish clear terms and specifications in the contract to ensure that the end result meets the client's expectations.

Although turnkey contracts are more convenient for the customer and involve less risk, they also require careful selection of a reliable and experienced contractor who can successfully complete the project as promised.

Construction Management Contracts

A construction management contract involves hiring a construction manager to oversee the project on behalf of the owner.

The CM provides pre-construction services, such as cost estimating and scheduling, and serves as the owner's representative during construction.

Construction management contracts are often used on large, complex projects where the owner desires more control and involvement in the decision-making process.

Guaranteed maximum price contract

A Guaranteed Maximum Price (GMP) contract is a type of construction contract in which a contractor agrees to complete a project for a fixed price that represents the maximum amount the project will cost the owner. This maximum price will be agreed before works begin.

In a GMP contract, the contractor takes responsibility for project management and cost control to ensure that the final price does not exceed the agreed maximum price.

If the actual project costs are lower than the guaranteed maximum price, the builder benefits from the cost savings.

However, if actual costs exceed the guaranteed maximum price due to unforeseen circumstances or changes in scope, the contractor is normally responsible for covering the additional costs.

GMP contracts are often used in construction projects where the owner wishes to have a certain degree of cost predictability while allowing for possible adjustments during construction.

This type of contract requires clear communication, collaboration and trust between the owner and contractor to ensure successful completion of the project within the agreed budget.

Choosing the right type of construction contract is crucial to the success of a construction project. Each type of contract offers different benefits and considerations depending on project requirements, risk tolerance, and desired outcomes. Understanding the different types of construction contracts allows owners, contractors and stakeholders to make informed decisions and effectively mitigate potential risks.

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