Construction Contract – Types, Usage & Terms You Must Know

Establishing a new building – either residential or commercial is not a small task. Since there are so many aspects of a construction project, be it design, exteriors, interiors, electrical fitting, or plumbing, it requires some legally-binding agreement. All the terms related to a construction project should be included in it so that the involved parties can get their share. 

Whether it is the owner, main contractor, or subcontractors, all the stakeholders must give their consent to this agreement before they start working in their individual capacities. In technical terms, this is what we call a construction contract. 

Learn more about how a construction contract is defined and its importance.

What is a Construction Contract?

A construction contract, also known as a construction agreement, is a legal document that details the terms and scope of a construction project. It defines the work to be done and by whom. In other words, it is an agreement between the contractors and the person/company hiring them for the project.

In general, this contract must contain several sections that contain clauses related to the terms, scope, and other conditions of the project. These include:

• What kind of work will be done
• When it should start and end
• Who all should be involved in the construction process
• The total cost of materials and labor
• Procedures to change the scope of work or other parts of the contract if needed
• Ways to resolve disputes that may arise if any

Besides this, the payment provisions of the HGCRA 1996 (Housing Grants Construction & Regeneration Act) is applicable to all construction contracts. Failing to abide by these provisions can result in a party requiring to pay a certain amount irrespective of whether the payment is due or appropriate.

Therefore, as per HGCRA, a construction contract is an agreement to get the architectural, survey, and design work done in relation to construction operations.

How does a Construction Contract Work?

In most cases, construction companies or contractors use a contract template that outlines their SOPs (Standard Operating Procedures), rates, and other project-related terms. Depending on the specification, every construction project is different from others. This is why the corresponding construction contract is unique, in terms of the modification done to the SOPs, cost, materials, etc. 

However, most of these agreements include certain sections to protect parties involved on both sides. These include: 

• Project description

This section details the basic information about the project, including the most important idea around which the project revolves or the problem(s) being addressed.

• Contract price

It covers the total amount of money being contracted, the possible additions or deductions to the construction contract and how they will be released.

• Project schedule

It covers the total number of days over which the entire project will be scheduled or divided. It describes either the business days or calendar days and is mostly presented in the form of a bar chart or GANTT chart. 

• Payment details

It covers the amount to be paid to the hired contractor, either weekly, monthly, or on the basis of milestones achieved. It also specifies the due date for payments, penalty for late payments, and similar other payment/invoicing terms.

• Document list

As the name suggests, it covers the list of all contract documents like drawings, specifics, exhibits, and similar others that will define the entire construction project.

• Construction scope

The scope of work related to a project is defined in terms of all the construction activities that will be a part of the part as it proceeds towards completion.

• Contract laws

All the legal requirements, government laws pertaining to the project, claims procedures, or liquidated damages are detailed in this section. It also includes procedures to terminate the contract or suspend the work with the hired contractor.

Once the contract is finalized, both the parties – the owner and contractor need to sign it before they begin any work. In case it is broken in any of the parties, the disputes will be addressed as defined in its sections. 

8 Types of Construction Contracts

There are eight types of construction contracts you can use for a project. Knowing which type of contract to use when is critical to ensuring successful completion of a project. Here, we have compiled all these types of contracts to make it easier for you to select the right one.
1. Cost-plus Construction Contract
Under this type of contract, the hired contractors are paid for all of the construction-related expenses, be it direct costs such as labor, materials, and supplies or overhead costs such as insurance. In addition to this, they also receive an agreed-upon amount as a profit, which refers to the ‘plus’ in its name. 

It is highly preferred by most contractors as there is no risk of losing money on the materials. In addition, there is a profit element involved. It is highly useful in cases when you lack enough information to share a thorough estimate of the scope of work.

2. Guaranteed Maximum Price (GMP) Contract

Under these types of construction contracts, there is capping added to the maximum amount the owner will have to pay to the hired contractor. Since this limits the amount payable by the owner or any additional expenses that may be incurred, many owners think it to be financially beneficial and find it easier to set the budgets for the project.

Here, the GMP includes costs of materials, labor, overheads, and a profit percentage above all the other cost elements. Hence, it requires careful review and expense analysis at the contractors’ end who is at high risk. 

3. Design-build Contract

Design-build contract addresses both design and construction cost simultaneously. Under this type of contract, the construction process begins before the completion of the final design, which ultimately saves time and money. It also combines the design and construction delivery into one contract, unlike the traditional process that requires two separate contracts one each for design and construction.

Since the construction begins timely, it helps in speeding up the process and avoids various disputes that may arise between a designer and builder. Here, the designers need to emphasize the drawing process, thus reducing the need for changes later.

4. Incentive Construction Contract

Under this type of contract, the contractor receives the agreed-upon amount if he delivers the project by a certain date. In case the project is delivered at a cost lower than the expected amount till the due date or earlier, he will receive an extra payment as specified in the contract. In other words, these contracts incentivize the contractor for his ability to control costs and stay on schedule.

5. Lump-Sum Contract

Here, the contractor chooses to deliver the project at a total preset price rather than bidding on the deliverables. The agreement is quite basic and does not require detailed estimates, which ultimately makes the task of estimating cash flows easy.

This contract presents easy-to-plan-for details to the owner while it also streamlines business analysis for the contractor. However, they are not good for complicated projects for which it is important to factor in changes in site conditions, material costs, and similar other aspects.

6. Integrated Project Delivery (IPD) Contract

IPD is a multi-party agreement between the builder, owner, and the design firm that follows a shared risk/reward model. Here, the delivery of the construction project is based on a single contract that covers almost everything related to costs, liabilities, and ownership of tasks. 

This type of construction contract basically spreads the risk and reward among the designer, owner, and builder involved, depending on the financial result. The signatories of the contract agree to receive a certain amount if the project meets the performance requirements. 

7. Time and Materials (T&M) Contract

Under the T&M contract, the owner agrees to pay an amount based on the time spent for project completion, required materials, and included profit rate. It also allows for more flexibility in the material costs and labor rates. It also helps the owner in budgeting the overall project cost.

8. Unit Price Contract

These contracts detail the price on a per unit basis, be it for materials, overhead, labor, or supplies. The contractor receives the payment based on the units at pre-decided rates. It works well for projects that can be easily classified into units.

Key Points Included in Construction Contracts

All contracts should:

• Be in writing and not based on verbal communication 
• Contain detailed description of the services required
• Be easy to understand for both the parties
• Cover the services being contracted in clear terms
• Include a termination policy
• Cover payment-related terms in detail.

Key Takeaways

1. A construction contract clearly sets the scope and terms for a project.
2. It should contain several sections of clauses defining what work is to be done, schedule, payments, and similar other aspects.
3. It is meant to protect the financial interests of various stakeholders involved in a project.

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