Top 3 Most Common Types of Construction Contracts
- Lump sum contract – provides you certainty but you lose the possibility of saving money
- Cost Plus contract – all the savings enure to the benefit of the owner
- Cost Plus with a Guaranteed Maximum Price – a marriage of both the benefits of the cost plus and the benefits of a lump sum
Lump sum contract
It is also known as the stipulated sum. The contractor gives you the price to build your project. This type of contract gives you certainty. You know that, for a given scope of work, you are going to have a certain amount of construction work done. However, the problem with this type of construction contract is that any savings that may accrue during the course of the job will go to the contractor. Contractors have lots of different ways of finding savings, one of them is called a buyout. For example, the plumber gives the general contractor an estimate and that estimate is for a $100,000 worth of work. When the time comes to actually buy out the job, the contractor can tell the subcontractor or supplier, “you know what? You gave me a quote for $100,000 and I am ready to give you this contract, but I am only willing to pay $90,000”. That is called a buyout. Multiply that by various trades. All of those savings go to benefit the contractor and not you as the owner. But again, you have the benefit that if there is a bust on one of the scopes, you don’t have to pay for it, because you have a lump sum. You gain certainty but lose the possibility of saving.
Cost Plus with a Guaranteed Maximum price
The flip side of lump sum contract is a cost-plus contract. This comes in two versions. One type cost-plus is a cost-plus with a guaranteed maximum price. That means you are going to get the contractor actual costs plus a stated mark-up. Usually that ranges from 5% to 20% depending on the contractor. The mark-up could also be a flat fee. For instance, the contractor can tell you that his fee is going to be $100,000 divided by ten months of the job, so $10,000 a month. The contractor will also guarantee that, no matter what, the cost of the job will not be over that guaranteed maximum price. The benefit of cost-plus with a guaranteed price is that, if the contractor obtains a savings, that savings enures to your benefit. For example, when the contractor pays only $90,000 instead of $100,000 for that plumbing work, you get the benefit of that savings. This is because your cost of the job is the actual cost plus the already agreed on mark up fee.
Cost Plus with no Guaranteed Maximum Price
This is the second version of cost plus contract. In cost-plus with no guaranteed maximum price, the cost of the job plus the fee is not capped at all. The job could keep going on and on. If there are other instances of problems on the job, then those costs keep accumulating and you will have to pay.
In my opinion, the best hybrid version is cost-plus a fee with a guaranteed maximum price. This is a marriage of both the benefits of the cost plus, and the benefits of a lump sum. Cost-plus with a guaranteed maximum price ensures that your job is not going to cost more than that guaranteed maximum price. And you still have the benefit of having all of the savings of a cost-plus.