3. Construction Contracts
Contracts
Definition : What is a contract ?
Why use contracts in construction ?
Valid Contracts
Contents of Construction contract ?
Parties to a construction contract ?
Types of Construction contracts
Lump sum
Unit Price
Cost – Plus
4. What is a Contract? Definition
A Contract is a voluntary agreement, between two or more
competent parties representing a promise to be performed for
valid consideration.
Construction contract : is a binding agreement, enforceable by
law, containing the conditions under which the construction of
a facility will take place.
5. Construction Contracts
Why use contract in construction?
Describe scope of work.
Establish timeframe.
Establish cost and payment provisions
Set forth obligations & relationships.
Minimize disputes.
6. Contract to be Valid
The following elements are essential for a contract to be
valid:
Lawful object
Description of Agreement
Pledge to do work
Owner/Contractor agreement
Considerations
Payment for work done
Mutual consent of the parties (offer and acceptance)
Signature attached to contract
Legal capacity of the parties
7. Contents of Construction Contract
Identity of parties.
Promises and responsibilities.
Scope of work
Price & payment terms
Commercial terms & conditions
Project execution plan
8. Parties to a Construction Contract
Simplest from: Two parties
Owner & A/E
Owner & Contractor
Owner & CM (either as an agent or at risk)
More complex: multiple parties
Owner and several contractors simultaneously.
By trade: electrical, mechanical, plumbing, etc.
By task: site clearing, interior finishes, utilities, etc.
9. Type of Construction Contracts
For construction project the work may priced by several
method or combination of the pricing method. The method
selected depends on distribution of risk between the owner and
contractors.
Types of construction contracts are determined by the ways in
which the contractor is paid for the work carried out.
10. Type of Construction Contracts
Pricing:
Lump sum (stipulated sum, single fixed cost)
Used when quantity and quality are known
Unit price (Admeasurement contracts)
Used when quality is known but not quantity
Negotiated Cost-plus (cost reimbursement contracts)
Used when scope (plans & specs) cannot be defined
before the construction starts
Guaranteed maximum price (GMP)
12. Cost vs. Price
What is the difference between cost & price?
Price
Risk
allowance Direct
Cost
indirect
margins
profit
Labor
Material
Equipment
Job overhead
Operating
overhead
13. Lump Sum Contract
Lump sum used when quantity and quality are known.
In this contract, the contractor agrees to provide a specified
amount of work for a predetermined price that includes profit.
The advantage of this contracting method is that the owner
knows before the work begins what the final cost of the project
will be.
This negates the possibility of a fast-tracked project.
In the majority of construction contracts there is a
CONTRACT SUM or CONTRACT AMOUNT
CONTRACT SUM: is the amount which would be paid by the
owner to the contractor
14. Lump Sum Contract
We offer to perform all the work shown on the drawings and
described in the specifications (as defined in the agreement) for
the sum of ……..$.
By receiving several bids or offers, the owner mostly selects
the lowest price.
15. Lump Sum Contract
Requirements:
Good project definition (Fully developed plans and specs
required)
Much longer time to bid & award this type of project.
Minimal scope changes
Contractor free to use any means and methods to complete work,
but contractor responsible for proper work performance
Owner financial risk low and fixed at outset
16. Lump Sum Contract
The contractor should know the followings to be able to price
the contract:
Adequate information about the work
The specifications of the work
Site conditions (investigate)
The bidder is familiar with the work
If the contractor finds that he will encounter high financial risk
due to site conditions or any other reason, he will assign high
mark up for profit, therefore, he will not be able to offer
competitive price.
17. Lump Sum Contract
Advantages:
Historically supported with well-established legal and contractual
procedures.
Overall cost is determined before construction outset.
Minimal involvement by the owner.
Owner may benefit from price competition.
Incentive for contractors to reduce costs through early
completion, construction methods, etc.
Low financial risk to the owner whereas high financial risk to the
contractor
18. Lump Sum Contract
Disadvantages:
Long procedure. i.e. Early project start not possible because need
complete design prior to bidding.
The owner and designer is in adversarial position with the
general contractor
Does not benefit from highly qualified contractor on
technological advancements (contractor free to choose lowest
cost, means, methods, materials therefore meet only minimum
contract requirements)
Changes difficult and costly.
Contractor may include high contingency.
19. Unit Price Contract
More familiar in heavy construction and highway
construction
Why?!
Used when quality is known, but not quantity
Used where ever difficulties are encountered in estimating
actual quantities in the project.
20. Unit Price Contract
In a unit price contract the owner and the contractor agree as
to the price that will be charged per unit for the major elements
of the project.
The design consultants prepare a schedule of unit prices in the
contract documents containing the measured quantities of all
the work item.
The contractor just price the units and multiply them to the
quantity to get the cost
Contractor overhead, profit, and other project expenses must
be included within the unit prices that are provided. (i.e. the
overhead costs and profits added to each unit price)
21. Unit Price Contract
The contractor should be careful to include all the anticipated
costs in the unit price e.g. Concrete items unit cost mostly
include form cost.
The owner then compares the final prices and selects the low
bidder.
22. Item Unit Quantity
Unit price
$
Price of item
Q x unit price
Mobilization Each 1
Excavation for foundations; in any
kind of soil, to the dimensions and
levels shown in the drawings
m3 2000
Supply and Cast B 150 Plain
Concrete Blinding under
foundations
m3 40
Supply and Cast Reinforced
Concrete Grade 'B 250' with a
minimum cement content of 300
Kg. per cubic meter for
Reinforced Walls
m3 300
Total 70,000
10000 10000
20 40000
2000
50
60 18000
Unit Price Contract
24. Unit Price Contract
Required sufficient design definition to estimate quantities of
units
Contractors bid on units of work
Time and cost risk “shared”
Owner at risk for total quantities.
Contractor at risk for fixed unit price.
Large quantity changes (> 15 – 25%) can lead to increase or
decrease in unit prices.
25. Unit Price Contract
Requirements
Adequate definition of work item units.
Good quantity surveying.
Adequate drawings.
Experience in developing bill of quantities (BOQ).
Payment terms properly tied to measured work
completion.
Owner furnished materials must arrive on time
26. Unit Price Contract
Advantages
Complete design definition not required.
Suitable for competitive (open) bidding
Early project start possible.
Flexibility, where scope and quantities easily adjustable.
27. Unit Price Contract
Disadvantages
Final cost not known at outset. (bills of quantities at bid time
only estimates)
Additional site staff needed to measure, control and report on
units completed.
Unit price contract tends to draw unbalanced bidding.
28. Unit Price Contract
Balanced Vs. Unbalanced
Balanced bid: is the bid in which anticipated costs for the
various work items are accurately reflected in the unit prices.
(i.e. bid where each bid item has its fair share of cost and mark-
up)
Unbalanced bid: is the bid in which the unit prices of various
work items do not reflect true costs of those items. (i.e. a bid
where some or all bid items have more or less of their fair share
of cost and mark-up, while keeping the total bid price
unchanged)
29. Unbalance Bid
Purpose of unbalanced bid:
Contractor want to increase their profits while maintaining
their chance of winning the bid.
Contractor want to maximize early progress payments, to
improve their cash flow. This is called “front-end loading”
30. Balanced bid
Item Unit Quantity
Unit price
$
Cost of item
Q x unit price
Excavate sand m3 8,000 4 32,000
Excavate rock m3 2,000 20 40,000
Fill material Ton 4,000 12 48,000
Total 120,000
Unit prices of bid items reflect true costs
31. Balanced bid
Item Unit Quantity
Unit price
$
Cost of item
Q x unit price
Excavate sand m3 10,000 4 40,000
Excavate rock m3 1,500 20 30,000
Fill material Ton 4,000 12 48,000
Total 118,000
Unit prices of bid items reflect true costs
32. Unbalanced bid
Item Unit Quantity
Unit price
$
Cost of item
Q x unit price
Excavate sand m3 8,000 6 48,000
Excavate rock m3 2,000 16 32,000
Fill material Ton 4,000 10 40,000
Total 120,000
Unit prices of bid items don’t reflect true costs
33. Unbalanced bid
Item Unit Quantity
Unit price
$
Cost of item
Q x unit price
Excavate sand m3 10,000 6 60,000
Excavate rock m3 1,500 16 24,000
Fill material Ton 4,000 10 40,000
Total 124,000
Unit prices of bid items don’t reflect true costs
34. Unbalanced bid
Item Unit
Quantity
A/E Est.
Unit price
$
Bid item price
Duration
(months)
Excavation
m3
100,000 9 900,000 2
Base Course Tons 90,000 50 4,500,000 3
Pavement m3 100,000 100 10,000,000 2
Total 15,400,000
0.45 0.45
1.5 1.5 1.5
5.0 5.0
Total 0.45 1.95 1.5 6.5 5
35. Unbalanced bid
Item Unit
Quantity
A/E Est.
Unit price
$
Bid item price
Excavation
m3
100,000 12 1,200,000
Base Course Tons 90,000 80 7,200,000
Pavement m3 100,000 70 7,000,000
Total 15,400,000
0.6 0.6
2.4 2.4 2.4
3.5 3.5
Total 0.6 3.0 2.4 5.9 3.5
36. Negotiated Cost plus Fee Contract
Used when scope (plans & Specs) cannot be defined before the
construction starts.
In a cost-plus contract arrangement, also called a
reimbursable, the contractor works on the project and is
reimbursed by the owner for its costs, plus is paid either an
additional agreed-upon fee or is paid a fee that is a percentage
of those costs.
It is important for the owner to spell out clearly in advance
what costs will be reimbursed and which costs are to be
covered by the fee.
37. Negotiated Cost plus Fee Contract
In this contract, the contractor can start work before complete
design have been prepared (fast track), since all costs will be
reimbursed and a profit guaranteed..
Cost plus suited under the following cases:
If the owner needs to complete a project quickly i.e.
urgency of the project
Many changes are expected during construction or
Nature of the project (When the project is difficult to
define accurately upfront).
38. Negotiated Cost plus Fee Contract
“We offer to perform all the work for all costs (as defined in
the agreement) and a fixed fee of …….$, or a fee of X percent
of all costs.”
Only the amount of the fee is stipulated.
39. Cost plus Fee Type Combinations
Cost plus % of cost:
Used when project is poorly defined.
No incentive for contractor to be cost efficient.
Cost plus fixed fee:
Used when project is fairly defined (Cost can be roughly
estimated, thus fee can be determined.
Contractor is motivated to be cost efficient.
40. Cost plus Fee Type Combinations
Cost plus variable fee:
The fee = fixed fee + bonus
The bonus is base on the savings (target cost – actual
cost)
Project scope needs to be fairly defined (to establish
target cost)
Contractor is motivated to be cost efficient.
41. Negotiated Cost plus Fee Contract
Advantages:
The owner can take decisions and changes through work
execution.
The work can be started before complete design have been
prepared (fast track).
Minimal adversarial position.
Preferred for unknown technology
42. Negotiated Cost plus Fee Contract
Disadvantages:
unclear total cost (open ended)
Inefficient and non-economical contractor. (No incentive for
contractors to reduce cost)
Close control from the client. (Owner or designer involvement are
increased)
Risk to owner: cost can increase.
43. Guaranteed Maximum Price Contract
GMP: is made like a lump sum contract and administered like a
cost plus fee contract
In this type of contract the contractor agrees for a fixed fee and
profit at a cost not to exceed pre-established max. price.
Costs above the guarantee are absorbed by the contractor.
Savings may be reverted to the owner or in most cases shared
by the owner and the contractor.
An incentive clause, which specifies that the contractor will
receive additional profit for bringing the project in under the
GMP.
44. Guaranteed Maximum Price Contract
The sharing clause motivates the contractor to be economical
and efficient.
Worded : “ We offer to perform all the work shown on the
drawings and described in the specifications for a maximum
cost (as defined in the agreement) of …..$ and a fixed fee of
….$”
Worded as the stipulated sum contract except there are tow
sums ( maximum cost and fixed fee) instead of stipulated sum
The bidder need sufficient information but NOT full details to
estimate probable maximum cost and fixed fee
45. Guaranteed Maximum Price Contract
Advantages:
Guarantee maximum price.
Owner may pass some of the risk to the contractor.
Sharing the savings can reduce the cost.
46. Guaranteed Maximum Price Contract
Disadvantages:
Generate disputes in case of poor initial scope.
Change orders negate the advantage of guarantee
47. Lump-sum Contract
a = If final cost is $9,500, contractor profit is $800 (8.42%)
b = If final cost is $10,000 (as expected), contractor profit is $300 (3%)
c = If final cost is $10,500, contractor loss is $200 (-1.9%)
$ 10,300
b
c
a
$
10,000
$
9,500
$
10,500
Final
Price
Final Cost
(Price is fixed at $10,300)
48. Cost plus Fee Contract
a = If final cost is $9,500, contractor profit is $475 (5%)
b = If final cost is $10,000, contractor profit is $500 (5%)
c = If final cost is $10,500, contractor profit is $525 (5%)
$ 10,500
b
c
a
$
10,000
$
9,500
$
10,500
Final
Price
Final Cost
(Price = cost plus 5%)
$ 9,975
$ 11,025
49. Guaranteed Maximum Price Contract
a = If final cost is $9,500, contractor profit is $500 (5.26%)
b = If final cost is $10,000, contractor profit is $500 (5%)
c = If final cost is $10,500, contractor loss is $0 (0%)
$ 10,500
b
a
$
10,000
$
9,500
$
10,500
Final
Price
Final Cost
(Price = cost of work plus fixed fee of $500 with a maximum price of
$10,500)
$ 10,000
c
50. Degree of Risk for Owner & Contractor
RISK
RISK
RISK
RISK
RISK RISK
RISK
RISK
Contract
Contractor
Owner
Contract
(No Change
in Contract)
Contract
(Some
Changes
in
Contract)
Lump-sum
Contract
(many
changes) Unit Price
Agreement
Guaranteed
Max Cost
Contract
with
Sharing
Clause
(50/50)
Guaranteed
Max Cost
Contract
with
Sharing
Clause
(25/75)
Cost-Plus-
Fixed-Fee
Contract
Cost-Plus-
Percent-Fee
Contract
(or)
Cost-plus
with
guaranteed
max cost
51. How Asses Contract Types???
Complexity, uniqueness of project
Likelihood of changes or delays on project.
Amount of time to complete project.
Owner’s financial condition.
Owner tolerance for risk
Local marketplace factors.
