Construction Law: Choosing the Right Contract for the Job

Over the recent years as a result of the pandemic the construction industry has seen an unprecedented amount of inflation in the cost of construction. The national average cost to build a new home hit a drastic $443,200 in August 2021. In addition to inflation, there has been an extreme shortage of all resources needed to build. This has been driven by the number of consumers taking advantage of both the opportunity for new builds due to low mortgage interest rates and a current seller’s market. Because everyone wants their own ideal dream home, no two construction jobs will be the same, and as a result no single construction contract will work for every project. Construction contracts create legally binding agreement protecting the best interests of both parties so it’s important for the contractor to ensure it’s a good one that fits the needs of the specific project. As a potential contractor of a new construction or contractor to a current owner seeking renovations, it is important to understand the different types of construct contracts available for your specific project and the advantages and disadvantages of each. Here are four (4) commonly used construction contracts to keep in mind:

1. Lump Sum Contract (also known as fixed price contracts): A lump sum contract sets one determined price for all work done for the project. The contractor submits a total project price instead of bidding on each individual item. Advantages of a lump sum contract include advanced notice of the final price, the contractor having more incentives to reduce costs and increase profit, and incentive to complete the job as soon as possible. A disadvantage of a lump sum contract includes the large portion of assumed risk of the contractors which make contractors reluctant to bid on the contract.
2. Unit Price Contract: A unit price contract typically emphasizes the type of task being carried out in addition to the materials used. Under a unit price contract, the contract price is based upon the price of all individual units of the work. Advantages of a unit price contract include the ease of adjusting prices as the scope of the work changes. Disadvantages of a unit price contract include the final cost and deadlines of the project not being defined in the beginning and many times contractor face a delay in the payment that is due.
3. Cost Plus Contract: A cost plus contract generally require the owner to pay for all project expenses, like the cost of materials, labor, and any other projects costs. These contracts will also include an agreed-upon amount or percentage that covers the builder’s overhead costs and profit that the owner also pays. Advantages of a cost-plus contract include a greater chance of the project being completed as planned and the chance for additional performance incentives. Disadvantages of a cost-plus contract include the potential additional oversight by the client to ensure the contractor sticks to the budget.
4. Time and Materials Contract: A time and materials contract defines an hourly rate for builders. In addition to paying this rate, owners also agree to pay any related project costs, which are not noted in the contract as direct, indirect, markup and overhead costs. Advantages of a time and materials contract include the flexibility of change and the contractor being compensated for all work and materials needed for project completion. Disadvantages of a time and materials contract include the uncertainty of the timeline to complete the project and there is a chance the client could run out of money prior to the completion of the contract. Another disadvantage of a time and materials contract is that it may be outbid by a lump sum contract due to the lack of fixed price and timeline.

Any and all construction contracts, no matter the size should involve a written contract. The type of contract needed should be determined on a case-by-case basis and Contractor should take time to assess how to approach each bid efficiently. Contract types can also be blended to meet the needs of the project. To ensure you are choosing the right contract it is important to consider the type of project you are trying to accomplish. Attention should also be given to the provisions that frequently become the subject of disputes between the parties such as the scope of work, completion timeline, chain of command regarding changes, and terms of payment. In these unprecedented times, contractors should also be mindful of potential increases in the prices of materials and ensure the significant potential for unexpected costs are covered. To put yourself in the best bargaining position, Contractors need to understand the pros and cons of the different construction contracts. Failing to do so in advance could significantly impact the profitability of the construction project.

This article is a publication of MWH Law Group LLP and is intended to provide general information regarding legal issues and developments to our clients and other friends. It should not be construed as legal advice or a legal opinion on any specific facts or situations. For further information on your own situation, we encourage you to contact the author of the article or any other member of the firm.

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