No two construction projects are alike, thus requiring different types of contracts to protect everyone’s interests. Utilizing standardized contracts brings ease to a project through familiarity within the industry and trust in the knowledge that it is fully vetted covering all potential issues. AIA Contract Documents has long become the industry standard for contracts and related documents for the evolving world of construction. The AIA Documents Committee brings together experts in contract law, design, construction, and insurance to ensure that each area within a construction project is covered within the contract document. As the construction industry evolves, contracts are reviewed and updated as necessary, taking the guesswork out of contracts for the construction industry.
Choosing the contract that best suits your project is the next step in the process. The most common contract types are Cost Plus, Cost Plus with GMP, and Lump/Stipulated Sum.
Cost Plus agreements between an Owner and General Contractor or Construction manager are often used when the full scope of work is not clearly defined at the start of construction. The Owner agrees to pay the cost of work including all subcontractor work, labor, materials, and equipment, plus a fee to the Contractor for overhead and profit. The work is typically bid out to multiple vendors or subcontractors through a buyout phase and awarded based on review and recommendations by the Contractor to Owner. Often referred to as “open book” the owner has every right to inspect the books at any time and conduct an audit of the project. The most common type of Cost Plus contracts are:
Cost Plus Fixed Fee – In this arrangement the Owner agrees to pay the Contractor a set fee, independent of the actual cost of work
Cost Plus Fixed Percentage – A predetermined percentage is and the Contractors fee is calculated by multiplying the actual cost of work by the agreed-upon percentage
The pros of a Cost Plus contract:
Projects can be “fast-tracked”, and work can begin before all construction documents and designs are complete
There are no hidden cost and Contractors are not incentivized to cut corners or sacrifice quality
Open book format promotes transparency
The risks of a Cost Plus contract:
Paying more than expected as the final cost is not known until completion
Contractors may be incentivized to “upsell” or select the higher costs options to increase their own fee
Additional administration and oversight are required to monitor the budget and ensure the contractor adheres to cost controls
Cost Plus with GMP
Cost plus with a GMP (Guaranteed Maximum Price) also known as CMAR (Construction Manager at Risk) is an agreement between Owner and General Contractor or Construction Manager where the cost of the project is equal to the actual costs incurred on the project, plus a fee, which is predetermined as either a fixed amount or a percentage of costs. The total cost of construction is then capped at the guaranteed maximum price.
It is important to understand that GMP contracts are not always as final as they sound. Contractors will include a contingency for unforeseen costs and often any unspent contingency at the end of a project will get split between the Owner and Contractor as an incentive. Any changes in scope or items that were not originally included in the SOV will cause the Contractor to modify the GMP by issuing a Change Order.
The pros of a GMP contract:
Construction can begin before all construction documents are 100% complete
Promotes transparency due to projects being run in an “open book” format.
Protects Owner from exceeding a top budget if no further changes are made
The risks of a GMP Contract:
Owners need to be construction-savvy to properly monitor costs and whether or not the SOV (schedule of values) numbers are reasonable.
Owners will need to monitor which costs are considered additional vs. contingency
Any changes in scope will incur a Change Order from the GC/CM that will adjust the GMP and it’s not uncommon to have dozens of changes throughout a project
Additional administration and oversight are required to monitor approved Change Orders and can lead to disagreements between Owner on Contractor on whether or not Change Orders are extra or should have been included in GMP.
Stipulated/ Lump Sum
This contract type is typically only used on Design-Bid-Build (DBB) projects with a fully defined scope and schedule. Once design and documentation are completed, the project will be bid out to multiple GC's. The Stipulated/Lump Sum contract would then be put in place with the selected contractor based on their approved proposal.
This contract type is the simplest and most straightforward construction contract available. In this contract scenario, the owner assigns all the risk during construction to the contractor by agreeing to a lump sum regardless of the final labor and material costs. The contractor's net profit is ultimately dependent on the final construction costs.
The pros of a Stipulated/Lump Sum contract:
Bidding contractors typically results in the lowest possible price for construction of the project.
The cost to the owner remains the same regardless of the final costs of construction.
The contractor holds the majority of the risk for the construction portion of the project.
The risks of a Stipulated/Lump Sum Contract:
Design has had no input by construction. If the drawings are incomplete or require any revisions during construction, it will most likely increase the budget.
Disputes could arise from change orders or design/scope changes. Which could also increase the overall budget.
Construction does not start until the documents are completed and approved. This is not the best choice if the project needs to be “fast-tracked.”
Dubrow Group Recommends
As mentioned above, contracts are dependent on the project. This being said, from our experience the most common contract we see used in the marketplace is the Cost Plus with GMP. This contract gives the owner the benefits of lump sum with the potential for coming in lower as part of the Cost Plus agreement.
If you are starting a construction project and would like to learn more, please contact us.