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5 Types of Contracts for Construction - Which Is Best for Your Project?
7
Min Read
Construction projects can be complex, pricey and prone to disagreements over cost, quality, timing of payments, or other difficulties. After you write a construction proposal, you'll need to get a contract signed. A solid construction contract offers direction and a clear road map for all parties, which helps avoid conflicts in the first place. Plus, without a good contract, you'll increase the risk of losing money.
The contract may be provided by any party, including the owner, architect, contractor, or attorney. However, since every contract favors one party over the other, it's worth identifying and creating a contract that safeguards your interests. But how do you choose the type of contract that best suits the project?
To help you choose, we'll go over 5 of the most common construction contracts to outline their general features and give you a better idea of what path to take. But first let's quickly go over the basic elements that a construction contract must cover.
Note: Instead of wasting time creating a contract from the start, use Bonsai's online contract creator to dive right into the finer points of contract building for each client. Our editable contract templates are legally backed and designed to meet your business needs.
What Must Be Included In a Construction Contract?
Your contract must specify the work's scope and the lump sum that will be paid. Additionally, it should outline any subcontracted work and state the legal obligations for any completed building. These are the must-have provisions in your agreement:
- Explanations of the work and parties engaged in detail including your tasks, responsibilities as well as those of each involved stakeholder.
- Project timeline and key turning points, including deadlines that you and your team are accountable for.
- The terms and conditions for payment.
- Obligations and rights of both the owner and the contractor establishing who owns what, insurance coverage, government inspections needed, and applicable laws to both parties.
- A contract cancellation clause in case your customer is no longer able to afford the services, or may be unable to proceed due to a complication.
- You may include other items such as the procedure for handling dangerous materials, details for contacting legal counsel, and other applicable laws that are relevant to your locality but weren't previously mentioned.
5 Common Types Of Construction Contracts
There are many different types of construction contracts available to meet the demands of all parties involved. After all, no two building projects are the same. Owners, contractors, and suppliers are able to control risk and make sure that the work as well as payment process runs as smoothly as possible by knowing which construction contract suits the project the best.
Let's go over some of the most common options.
Lump Sum Contracts
This is the most basic kind of construction contracts, also commonly referred to as a fixed price contract. Lump sum contracts are quite popular in the construction industry because they provide a single fixed price for every work completed under them. They make bidding simpler, allowing customers to name a set price as opposed to making numerous bids, giving contractors a chance for high profit margins when finishing on time or under budget.
However, you must take into consideration every possible circumstance when drafting a lump sum contract as unexpected delays or adjustments throughout a project directly reduce your profit margin.
When to Use
Because the potential for failure increases with project size, lump sum contracts are best for smaller projects with a defined timeline and known scopes of work. If these are not explicitly agreed upon, it may be challenging for builders to predict costs in advance and avoid over scoping.
Time and Materials Contracts
Time and materials contracts specify an hourly rate or daily cost. Your customer also agrees to pay any associated project costs, listed in the contract as direct, indirect, markup and overhead costs, in addition to this rate. This contract often includes a price or project duration restriction to reduce the customer's risk. They also entail less risk when working on small projects, where the customer can more accurately predict the project's scope and thus, the eventual cost.
When to Use
Time and materials contracts are frequently used in cases where the scope of the project is not clear. Because they are more flexible and the customer reimburses you for the cost of materials paying you an hourly salary, all unexpected delays, obstacles, and other modifications to the project are conveniently covered.
Cost-Plus Contracts
A cost-plus contract, covers the cost of the supplies, materials and labor, as well as an additional fee to cover the contractor's profit. The charge may be either a predetermined fixed amount or a percentage of the project's overall costs. It may potentially include overhead costs in addition to project costs such as travel costs and a percentage of the contractor's office and administrative costs.
Unlike a time and materials contract, with cost-plus contracts, the contractor will charge for all costs incurred plus a fixed fee, instead of an hourly labor rate. Keep in mind you will be required to keep meticulous records of your spending and may need to provide justification to clients. You may also need funding upfront to pay for materials for the project.
When to Use
Cost-plus contracts work best for projects with a hazy scope or lots of uncertain variables. Most cost-plus agreements do have a "not to exceed" cap that establishes certain financial restrictions, but most of the time, they entail a higher risk for the project owner because they are responsible for covering any unexpected costs.
Unit Price Contracts
Another sort of contract that is frequently utilized by builders and federal organizations is a unit price contract. Here, you break down the overall amount of work necessary to finish a project into smaller parts. Instead of giving the owner a price estimate for the entire project, the contractor gives the owner price estimates for each individual item of work. This is especially helpful if a certain element, like a special material needed for the project, is driving up the total cost and increases the customer's understanding of the contract's transparency.
Unit price contracts also make it simpler to manage change orders and other modifications to the scope of work when any additional work is simply tacked on as another pre-priced unit. Keep in mind, although we should all work to be more transparent, a re-measurement of construction projects, or the owner's capacity to contrast the actual cost of each unit with the project's overall cost, might cause a payment delay.
When to Use
Smaller projects like repair or maintenance work are better suited for unit price contracts, which can often be amended if the project's scope changes in some way. When the scope of the work changes, unit pricing contracts make it simpler to modify prices. Because the contractor and the owner split the risk, this type of contract is not suitable for intricate projects involving numerous unique components and materials.
Guaranteed Maximum Price (GMP) Contracts
A guaranteed maximum price contract sets a limit on the final budget of a construction project. Here, the contractor is responsible for any overages, whether they involve labor costs or materials, so even though the project owner's budgeting process is meant to be made simpler, some financial risk is transferred to the contractor. On the bright side, when a project is completed on time and within budget, you may incorporate a clause to split any project savings with the customer.
A GMP contract might be a separate agreement or it can simply include a guaranteed maximum price and other particular parameters in another kind of agreement. For instance, a clause that restricts total costs to a set maximum price could be included in a cost-plus agreement.
When to Use
Construction contracts frequently include guaranteed maximum prices, which work well for projects with minimal unknowns such as the development of a retail chain using tried-and-true plans. Since there is a set project cost threshold, these contracts are also an excellent choice for clients with limited funds.
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What Defines a Verbal Contract?
A verbal contract (formally called an oral contract) refers to an agreement between two parties that's made —you guessed it— verbally.
Formal contracts, like those between an employee and an employer, are typically written down. However, some professional transactions take place based on verbally agreed terms.
Freelancers are a good example of this. Often, freelancers will take on projects having agreed on the terms and payment via the phone, or an email. Unfortunately, sometimes clients don't pull through on their agreements, and hardworking freelancers can find themselves out of pocket and wondering whether a legal battle is worth all the hassle.
The main differences between written and oral contracts are that the former is signed and documented, whereas the latter is solely attributed to verbal communication.
Verbal contracts are a bit of a gray area for most people unfamiliar with contract law —which is most of us, right?— due to the fact that there's no physical evidence to support the claims made by the implemented parties.
When is a Verbal Agreement Legally Binding?
For any contract (written or verbal) to be binding, there are four major elements which need to be in place. The crucial elements of a contract are as follows:
- Offer and acceptance: An offer is made and accepted by another party involved in the agreement;
- Consideration: The involved parties must exchange something of value (money, a service, time, etc), this is known as consideration;
- Intention and certainty: All parties must fully understand the terms of the contract and intend to make a legally binding agreement freely; and
- Capacity: The parties must have the capacity to legally enter into the contract; they're above age and of a stable mindset.
Therefore, an oral agreement has legal validity if all of these elements are present. However, verbal contracts can be difficult to enforce in a court of law. In the next section, we take a look at how oral agreements hold up in court.
How strong is a verbal agreement in court?
Most business professionals are wary of entering into contracts orally because they can difficult to enforce in the face of the law.
If an oral contract is brought in front of a court of law, there is increased risk of one party (or both!) lying about the initial terms of the agreement. This is problematic for the court, as there's no unbiased way to conclude the case; often, this will result in the case being disregarded. Moreover, it can be difficult to outline contract defects if it's not in writing.
That being said, there are plenty of situations where enforceable contracts do not need to be written or spoken, they're simply implied. For instance, when you buy milk from a store, you give something in exchange for something else and enter into an implied contract, in this case - money is exchanged for goods.
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get started nowWhen are verbal agreements not enforceable?
There are some types of contracts which must be in writing.
The Statute of Frauds is a legal statute which states that certain kinds of contracts must be executed in writing and signed by the parties involved. The Statute of Frauds has been adopted in almost all U.S states, and requires a written contract for the following purposes:
- The sale of real estate or vehicles
- Real estate leases lasting longer than one year.
- Property transfer following the death of the owner.
- The case of a party agreeing to pay debt for someone else.
- Any contract that requires more than a year to fulfil.
- A contract involving and exceeding a specified amount of money (which varies by state).
Typically, a court of law won't enforce an oral agreement in any of these circumstances under the statute. Instead, a written document is required to make the contract enforceable.
Contract law is generally doesn't favor contracts agreed upon verbally. A verbal agreement is difficult to prove, and can be used by those intent on committing fraud. For that reason, it's always best to put any agreements in writing and ensure all parties have fully understood and consented to signing.
How are Verbal Contracts Enforced?
Verbal agreements can be proven with actions in the absence of physical documentation. Any oral promise to provide the sale of goods or perform a service that you agreed to counts as a valid contract. So, when facing a court of law, what evidence can you provide to enforce a verbal agreement?
How can you prove an oral contract?
Unfortunately, without solid proof, it may be difficult to convince a court of the legality of an oral contract. Without witnesses to testify to the oral agreement taking place or other forms of evidence, oral contracts won't stand up in court. Instead, it becomes a matter of "he-said-she-said" - which legal professionals definitely don't have time for!
If you were to enter into a verbal contract, it's recommended to follow up with an email or a letter confirming the offer, the terms of the agreement , and payment conditions. The more you can document the elements of a contract, the better your chances of legally enforcing a oral contract.
Another option is to make a recording of the conversation where the agreement is verbalized. This can be used to support your claims in the absence of a written agreement. However, it's always best to gain the permission of the other involved parties before hitting record.
Written vs Verbal Contracts: What's the Verdict?
Fundamentally, most verbal agreements are legally valid as long as they meet all the requirements for a contract. However, if you were to go to court over one party not fulfilling the terms of the contract, proving that the interaction took place can be extremely taxing.
So, ultimately, the question is: written or verbal agreements?
Any good lawyer, contract law firm, or legal professional would advise you to make sure you formalize any professional agreement with a written agreement. Written contracts provide a secure testament to the conditions that were agreed and signed by the two parties involved. If it comes to it, a physical contract is much easier to eviden in legal circumstances.
Freelancers, in particular, should be aware of the extra security that digital contracts may provide. Many people choose to stick to executing contracts verbally because they're not sure how to write a contract, or they think writing out the contract terms is too complicated or requires expensive legal advice. However, this is no longer the case.
Say hello to digital contracts
Today, we have a world of resources available at our fingertips. The internet is a treasure trove of invaluable information, platforms, and software that simplifies our lives. Creating, signing, and sending contracts has never been easier. What's more, you don't have to rely on a hiring a lawyer to explain all that legal jargon anymore.
There are plenty of tools available online for freelancers to use for guidance when drafting digital contracts. Tools like Bonsai provide a range of customizable, vetted contract templates for all kinds of freelance professionals. No matter what industry you're operating in, Bonsai has a professional template to offer.
Benefits of written contracts
A written contract makes the agreement much easier to prove the terms of the agreement in case something were to go awry. The two parties involved can rest assured that they're legal rights are protected, and the terms of the contract are sufficiently documented. Plus, it provides both parties with peace of mind to focus on the tasks at hand.
Create Professional Contracts with Bonsai
Bonsai's product suite for freelancers allows users to make contracts from scratch, or using professional templates, and sign them using an online signature maker.
With Bonsai, you can streamline and automate all of the boring back-office tasks that come with being a freelancer. From creating proposals that clients can't say no to, to sealing the deal with a professional contract - Bonsai will revolutionize the way you do business as a freelancer.
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