A Full Guide to Construction Contract Types - ENGINEERING MANAGEMENT

Construction Contract Types What is the contract definition and  purpose? A contract is a voluntary agreement between two or mor...

A Full Guide to Construction Contract Types

Construction Contract Types
Construction Contract Types

What is the contract definition and purpose?

A contract is a voluntary agreement between two or more parties. The purpose of a contract is to set out the rights, responsibilities, and liabilities of the parties. The purpose of a contract can be described from a different perspective; it is to allocate risk between the parties (Samuels 1996). Conditions refer to contract documents used to define no technical construction contract terminology and procedures necessary for safe, orderly execution and management of the work. They establish rights, responsibilities, risks, and requirements of owners and contractors in fulfilling contract obligations and must provide fair and equitable levels of protection for both parties. Thus, when owners presenting onerous and poorly written conditions, slanted in their favor; then, they will find it increasingly difficult to attract qualified bidders (Charles 1999).

Construction Contract:

A construction contract sets forth the intentions and procedures to be employed in any building effort. Ideally, it should be an easily understandable, mutually agreed-upon document that provides the answer to every project contingency. More realistically, these intentions and procedures often represent the owner's interests to which the business-hungry contractor agrees, with the hope that enough ambiguity resides in the document to permit multiple interpretations. The purpose of a contract is to set out the rights, responsibilities, and liabilities, of the parties. Meanwhile, the purpose of a contract can be described as a means to allocate risk between parties (Samuels 1996).

A contract is an agreement, usually between two parties, that is enforceable by law. In some instances, there may be a third-party agreement in which the benefit of the contract goes to a third party. An example would be an insurance policy, particularly a life insurance policy, in which a third party is named as the beneficiary. In order to be valid, all contracts must meet certain criteria. These criteria include an offer and acceptance, a meeting of minds (agreement on contract basic aim and its related legal issues), consideration, lawful subject matter, and competent parties. Most construction agreements are drawn up between two parties for their mutual benefit (Hinze 2001).

Construction Contract Types:

Contracts between the owner and the contractor are frequently divided into several categories. Each of these categories has several variations, usually determined by the type of fee the contractor is to be paid (Samuels 1996). These categories are:
  • Lump-sum contract; 
  • Unit price contract; 
  • Cost-plus contract; 
  • Design-build contract; 
  • Management-oriented contract; 
  • Two-stage selective tendering; 
  • Negotiated contracting; 
  • Continuity contracting; 
  • Serial contract; 
  • Turnkey contract.
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1-Fixed price (lump sum) contracts:
A fixed-price contract means that the contractor is to receive a lump sum amount, which compensates the contractor for the cost of performing the work (Samuels 1996). A fixed price contracts quote a single, guaranteed price as compensation for all the labor, materials, equipment, and services stipulated to complete the facility described in the construction contract. Fixed price contracts provide owners with an exact sum (barring exceptions and changes) to budget for their construction projects. Owners still believe it is the most cost-effective means to deliver their completed construction projects (Charles 1999).

2-Unit price contracts:
Unit price contracts are used for those less-complicated projects that are based on readily identifiable units. Paving, for example, can be accurately quantified in units of area and thickness. Piling can be quantified in linear feet or number of piles, and mass concrete in cubic yards and pounds of reinforcing materials. Unit price contracts also require careful preparation to prevent disputes. 

Well-estimated guide quantities for each unit price item as well as clear instructions for their measurements are the key to successful unit price contracts. Actual quantity variances greater than 15% may cause legitimate claims for added or deductible costs. Clauses are usually included in unit price contracts that address this issue. 

They are expected to be fair and equitable to both owners and contractors (Charles, 1999). Although unit price contracts do not guarantee the final cost, they may be advantageous for different reasons. Where the quantity of work may vary, requiring a contractor to bid on a lump sum basis often results in a contingency within the price to protect against the risk of a quantity different from that estimated. Thus, under a fixed-price contract, the owner ends up paying a premium (Samuels 1996).

3-Cost plus contracts:
The cost-plus agreement usually requires that the contractor be compensated by the owner for the actual costs of construction, plus a fee that may be fixed or may vary with the cost of construction (Samuels 1996). Cost plus contracts may be the best choice in emergencies since ready owner access to the daily labor, materials, equipment, and services records written into the contract helps prevent disputes. Also, cost-plus contracts may be the best choice when the additional time and cost to scope and specify a project accurately are unacceptable. Variations of cost-plus contracts may or may not include a fee, which can be negotiated or fixed, and a "not to exceed price". The intent is to stipulate a fair cost for the contractor's fees, expenses, and profit. Cost-plus contracts, too, require precise wording to prevent spending overruns and claims. "Fixed" or "percentage" fees, markups, profit, services, and work limits must be clearly defined in the contract. (Charles 1999).

4-Design-build contracts:
Under a design-build contract, the owner retains a single party to perform both design and construction services. There is one great advantage to the owner: If anything goes wrong, the contractor cannot point to any other party as being at fault. One difficulty associated with design-build contracts is that the owner must determine in advance the design parameters. The contractor must be given guidelines; otherwise, the owner might end up with a finished 9 product that does not meet its needs. This is done by specifying the performance criteria (Samuels 1996).

Owners took the next step and assigned one firm the complete design-build responsibility. Proponents believe that design-build construction eliminates conflicts among the designer, contractor, and owner over poor design, specifications, and drawings. Owners with little or no design-build experience should know that the design-build construction is not a panacea, nor appropriate for every project. Before selecting this option, owners should discuss design-build results with others who have completed design-build projects. This method is sometimes, referred to as" competitive bids" (Charles 1999).

5-Management-oriented contracts:
Management contracting is a process whereby an organization, normally construction-based, is appointed to the professional team during the initial stages of a project to provide construction-management expertise under the direction of the contract administrator. The management contractor employs and manages works contractors who carry out the actual construction of the project and he/she is reimbursed by means of a fee for his/her management services and payment of the actual prime cost of the construction (Masterman 2002).

6-Two stage selective tendering:
In this approach, tenders are invited on the basis of limited project documentation, and the successful first-stage bidder(s) is/are asked during the second stage to collaborate with the client to produce a definitive design and agree with a final tender figure. Where more than one tenderer is involved in the second stage, the most appropriate bid is accepted and all of the involved organizations are usually reimbursed their second-stage costs. Two-stage selective tendering is a process whereby the client can be vulnerable to any change in the level of the contractor's pricing from that contained within the first-stage tender. In this process, the overruns are shorter than in any other conventional method. Saving time can be achieved when using this approach since the average time overrun incurred is usually shorter than when using other contracting methods (Masterman 2002). The client may need to appoint additional site supervision to ensure achieving the quality standard. 

The two stages are:
  • Stage 1: selecting a contractor on a competitive basis, 
  • Stage 2: negotiation to reach a fixed price and program.
7-Negotiated contracting:
It is possible when using this approach to appoint a contractor by assessing the experience, management expertise and competitiveness of a small number of appropriate organizations. More commonly, an appointment of a single contractor is made on the basis of past performance and competitiveness on an identical, similar or geographically adjacent project, preferably carried out for the same client. Negotiated contracting is a process of contracting whereby the project cost is nearly always higher than other contracting processes. A cost premium is paid by the client, but saving time can be achieved (Masterman 2002). With mutual trust and a commitment to excellence from both parties, this method is simpler, faster, and builds teamwork. In today's hurried markets, this method is quickly becoming the most prevalent (http://www.abuck.com/general/negotiated.htm).

8-Continuity contracting:
When using this approach, contractors bidding for a project on the basis of single-stage selective tendering are advised that the successful tenderer, subject to satisfactory performance, will be awarded a similar project to follow on from the completion of the first. The price for this subsequent project will be negotiated using, as a basis, the tendered rates included in the bill of quantities, or some other form of financial schedule, for the original project. It is, therefore, a prerequisite for the use of this system that there are at least two similar projects available within a defined geographical area that can be carried out sequentially and that is capable of being able to accommodate flexibility in the timing of the commencement and completion of the second project.

Opt-out clauses for both the contractor and the client are often included, even if all the criteria for success are met. Also, the criteria for measuring the success of the first project must be agreed by both parties to the contract, and procedures for negotiating the second contract must be established before the initial project islet. Continuity contracting has advantages, of having time overruns that are shorter than average, cost overruns are more predictable than average, very competitive rates can be obtained at tender stage, the value of variations is likely to be low in comparison with other methods and few variations were needed on the second or succeeding projects (Masterman 2002).
9-Turnkey Construction:
When the contractor is involved in the site selection process, and sometimes even the financing arrangements and the owner prefers to design and builds a delivery method, the contract is properly referred to as "turnkey". Literally, the owner is looking to the contractor to provide all services, down to turning over the key to the building. This method is the ultimate in trust and commitment; the owner and contractor are pursuing a common goal of a quality project, taking into account that "design and build" method is already included in "turnkey" contract.

The turnkey method was pioneered in the USA in the early 1900s, where it has been extensively used since that time, by the private sector, for the construction of process plants, oil refineries, power stations and other complex production facilities (Seale 2001). 

In a fixed price contract, by comparison, the contract sum is adjusted throughout the contract period. A true turnkey contract, therefore, is more akin to a purchase contract than to a construction contract. It has the principle that is said to simply hand over the cheque, turn the key and commence operation. The cost to the client of using the turnkey method can be higher than when using other more conventional procurement systems (Masterman 2002).

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