What Is a Construction Contract?

construction contracts are legally binding agreements that explain the work that a general
contractor will perform and the payment that a project owner will make. These contracts play
a key role in construction management.
However, construction projects vary greatly in terms of complexity and size, so there’s not a
one-size-fits-all approach when it comes to construction contracts. That’s why several types
of construction contracts have been developed.
Construction contracts protect both parties in the agreement. The construction
administration documents detail what work will be completed, when it’ll be completed and
how much it’ll cost. They also outline methods of communication and how disputes will be
handled if they arise.
By including information about communication and changes, construction contracts
streamline the decision-making process. Ideally, project risks have been anticipated and the
contract outlines how best to proceed. A construction contract is, first and foremost, an
agreement, but it serves as a roadmap of sorts as we
Who Is Involved in Construction Contracts?
Construction contracts involve two parties; owners and contractors. Owners need a job
outsourced and the contractor executes the job. The two parties work together to draw up a
contract and agree on the terms of completion and payment.
Owners contract builders when they need to execute a specialized job they cannot perform on
their own. They may also contract builders when the scale of the project is too large for them
alone. Construction projects, in particular, often require owners to hire several different
contractors. In this case, thorough construction contracts are crucial to successful project
management.

Types of Construction Contracts

Because construction projects take many forms, different projects require contracts with
different characteristics. All types of construction contracts define a timeline, budget, quality
requirements and other aspects that need to be defined in every construction project. The two
main differences between these types of construction contracts are how the disbursement will
be made and the risks and rewards that each party assumes.
Before creating a construction contract, it’s important to know the type of contract that best
suits your needs.
Lump-Sum Contract
A lump-sum contract (also called a fixed price contract) names a total price for the entire job.
This price accounts for all time and materials regardless of changes or issues. This type of
contract protects owners against unforeseen changes and setbacks.
contractors charge an additional percentage for signing lump sum contracts, as they’ll be
taking a higher risk. Additionally, incentive programs are often put in place by owners to
reward jobs being completed early.

Cost-Plus Contract
Cost-plus contracts are made of two parts: a predetermined fee and accumulated costs. This
fee is the agreed price owners will pay contractors. It can be an amount, a percentage of the
total project cost or another form of payment. The defining characteristic of a cost-plus
contract is it reports expenses as they occur rather than deducting costs from a set budget.
A cost-plus contract is used when construction project expenses are uncertain. While this can
seem like a liability, cost-plus contracts often include incentives for coming in under budget
and set caps on expenditures. This avoids conflict and ensures contractors are paid a fair
overhead.

Time and Materials Contract

Time and materials contracts are a fitting choice when the scope of a project is completely
unknown. In this case, contractors charge an hourly rate for labor and for materials as needed.
Because this leaves uncertainty, these contracts must be specific and prepare for almost
anything. An owner should include incentives for construction projects completed ahead
of schedule and/or under budget.
A time and materials contract is a good choice for small projects as they require close
supervision. For example, all costs must be carefully monitored and classified to document
them and ensure contracts are followed. The advantage of choosing a time and materials
contract is it protects owners from overpaying contractors.

Unit Price Contract

A unit pricing contract is used when an owner wishes to buy a large quantity of a certain
product. Each product is a unit and costs a set price. These items can also often be charged in
bulk quantities for a reduced price.
Unit pricing contracts are advantageous when an owner knows exactly how much of a
specific product they need, such as when a bill of quantities has been drafted or a material
takeoff has been done. Using this type of contract and buying all the units at once is also a
good way to protect against potential future inflation of material prices. By buying all of the
items at once, owners generally pay less than they would in the future and don’t have to
worry about drawing up future contracts.
Design-Build Contract
In most cases, project owners receive completed designs during the construction bidding
process. However, in a design-build contract, the design and construction are done
simultaneously and handled with one contract, as opposed to traditional construction
contracting methods.
This type of construction contract allows for increased communication between the designer
and the construction team and speeds up the bidding and construction process.
Guaranteed Maximum Price (GMP) Contract
A guaranteed maximum price (GMP) contract defines the maximum price that a project
owner has to pay for a construction project. If the costs exceed said guaranteed maximum
price, the general contractor will cover the additional expenses.
For that reason, this contract type requires that general contractors create the most accurate
construction estimate possible. General contractors create estimates. using construction
estimating software or hire a specialized construction estimator to create realistic and
profitable estimates.
Incentive Construction Contracts
Under an incentive construction contract, the project owner and contractor agree on an extra
payment fee that’s given to the contractor depending on whether the project is delivered on
time and under budget.
If the contractor misses the timeline or exceeds the budget, they still need to complete the
project and meet the owner’s requirements even without earning the extra payment fee.

Integrated Project Delivery Contract

This type of contract is mostly used for large, complex projects. Similar to the design-build
contract, it uses a single contract for design and construction, but it also involves a multi-
party agreement between the owner, builder and designer where they share risks, agree on
costs, set waivers and follow lean principles.
The main purpose of this construction contract is to provide a detailed framework that
spreads the risks and rewards evenly among the parties. For example, an IPD construction
contract involves a lump sum profit that’s divided among the owner, designer and builder if
the project achieves financial results.

Construction Contract should include:

 Contract Sum: Any construction contract should indicate the contract sum, which is
the total value that the project owner will pay the contractor for the execution of work.
The contract sum should cover all the project costs and expenses plus the contractor’s
profit margin.
 Retainage: The project owner and contractor must agree on a retainage rate, which is
a percentage of the payment that the project owner withholds until the contractor
completes the duties outlined in the contract.
 Scope of Work: The scope of work is a document that describes all the tasks and
deliverables of a project. In simple terms, it defines what will and won’t be done in a
construction project, which is important for estimating costs and making a budget.
Our scope of work template is a helpful tool that helps you define the tasks and
deliverables that make up the scope of your project.
 Responsibilities of Owner and Contractor: A construction contract should outline
responsibilities for both parties. For example, by signing a contract, the contractor
assumes responsibility for completing the scope of work while the owner agrees to
pay for that work. If either party fails to meet such obligations, the contract might be
terminated.
 Payment Terms: Construction contracts must define how payment will be made to
the contractor. There are several construction project management documents and
tools you can use for payroll management such as timesheets, schedules of values or
payment schedules.
 Change Management: Changes might be risky for your project, but they don’t have
to be if you establish a change management process and use tools and documents like
change requests, change orders and change logs.
 Construction Specifications: Construction specifications are the detailed description
of the materials, workmanship, tools and quality standards that the project owner and
contractor agree upon.
 Construction Timeline & Contract Duration: The contract should specify due dates
for the completion of construction deliverables and the duration of the contract.
 Terms and Conditions: Contracts contain terms and conditions such as
indemnification clauses whenever the contractor fails to meet the quality standards or
omits part of the scope of work due to negligence.
 Regulatory Compliance: Most contracts require the contractor to meet local
requirements, building codes and other regulations.
 Warranty: Some contracts require the contractor to offer a warranty, which requires
them to fix and repair any issues and defects that arise within a defined period.
 Construction Drawings: Some construction contracts involve the creation
of construction documents such as construction schedules, blueprints, drawings,
estimates and more.

Role of parties in the construction process

DISPUTE AVOIDANCE AND RESOLUTION

Most construction contracts provide for a dispute resolution mechanism, including the
procedure to be followed when a dispute arises between the parties to the contract. If
parties conclude a construction contract, it is recommended that the parties provide
for a dispute resolution clause and agree to a dispute resolution mechanism that will
be best suited considering the nature of construction project and disputes that may
arise between the parties.

For contractual claims, each of the standard forms of construction contract provides
for a specific procedure that the parties should follow if either one of the parties
believes it is entitled to claim relief. Generally, the party that believes an event entitles
it to relief under the contract will be required to deliver a notice to the opposing
contract party. The notice usually has to provide details of the event, the effect or
damage caused by the event, and the relief which the party seeks as a result of the
event. Often, for the contractor, such notice may have to be issued within a prescribed
period of time, failing which, the contractor may forfeit any entitlement to relief under
the contract. These types of time prescriptions often do not apply to an employer’s
claim.

Where the contractor has issued a notice of claim, they will be required to deliver
details of the claim within a specific period of time after delivery of the notice. The
particulars of claim need to show supporting evidence for the claim, including details
on the quantum of the claim and, often, a revised programme of works where the
claim is one for extension of time. The notice and particulars of claim are submitted to
the employer’s contracts manager (“Engineer”, “Project Manager” or “Principal
Agent”) for determination within a specified period of time.

Determination
The contracts manager will make a determination upon assessment of the particulars
of claim, which determination will be implemented upon determination. A
determination for money is, mostly, given effect to in the next payment certificate
through inclusion of an additional sum due to either the contractor or the employer. A
determination for additional time is, mostly, given effect to by extending the date for
completion and by acceptance of a revised programme of works. A claim for delay
damages by the employer may be implemented as soon as the completion date has
passed and the contractor has not yet completed the works. The contracts manager
may deduct the delay damages from any amount due to the contractor in the next
interim payment certificate. The determination will include a finding on the merits of
the claim and the relief sought by the claiming party. Some contracts provide that the
claim may be resolved by dispute resolution where the contracts manager does not
determine same within a prescribed period. The claim may, likewise, be referred to
dispute resolution where either party is dissatisfied with the determination, subject to
notice obligations. Some contracts provide that such notice of dissatisfaction be given
within a prescribed time period.
Dispute Subject to the provisions of the contract, the parties may resolve a dispute by
mediation, adjudication, arbitration, litigation or any other mechanism set out by the
contract. Certain contracts require the parties to first endeavour to reach amicable
settlement of the disagreement within a specified period of time (usually between
senior management representatives of the parties), failing which the parties may
proceed with formal dispute resolution procedures. Mostly, a contract would provide
for resolution of a dispute firstly by

adjudication (either by a single adjudicator or by a Dispute Adjudication Board), and

thereafter arbitration. Some contracts provide for an adjudicator or arbitrator to be
agreed between the parties at the time the contract is entered into. If this is not done,
the contract will provide a process for the parties to agree an adjudicator or arbitrator
when a dispute arises. Failing agreement, an adjudicator or arbitrator will be
appointed by a nominating body (which is agreed between the parties at the time of
contract conclusion).
The party who wishes to commence with a formal dispute resolution process, will be
required to make a referral to the adjudicator or arbitrator (once appointed). The
contracts often provide a time period within which a referral to adjudication or
arbitration should be made. The referral should set out the relevant background and
detail of the claim and set out the claim(s) required to be resolved. An adjudicator or
arbitrator may only make determinations on disputes referred by the parties.

Methods of Dispute Resolution in a Construction Contract