How to Write a Construction Contract

A contract is defined as an agreement between two or more parties that is written and enforceable by law. A loss control representative should be familiar with the types and combinations of construction contracts. This report addresses types of construction contracts, the basic elements of contractual relationships, contracting methods, and contract requirements.

Contracts should be made early in the life of a construction project. While every contract is unique, depending on the project’s size and complexity, they all have some basic, common elements. These include:

  • There must be an offer and acceptance.
  • The agreement must be mutual.
  • There must be some value of consideration.
  • The objective(s) of the contract must be clearly stated and lawful.
  • There must be a genuine intention on the part of the parties involved to fulfill the terms of the contract.
  • The parties to the agreement must be capable of performing the designated tasks.

The contracting process involves the following steps:

  • Execution Strategy: The decision-making process that determines how the project will be executed, including the owner’s internal management capabilities, as opposed to those available through contracting.
  • Contracting Strategy: The decision-making process to determine the type of contract(s) that are required to meet the owner’s objectives. The process would consider the advantages and disadvantages of each contract type.
  • Validation of Contractor Capability: The determination as to whether adequate contracting capability of the desired type exists.
  • Analysis and Selection of Incentives: Decisions about appropriate types and methods of establishing contract incentives.
  • Analysis of Cost Liabilities or Impacts of Risks: The determination of probable liability and cost impact to the contracting parties of the incidence of specific risks.
  • Contract Language: The preparation of contract language, which recognizes principles of risk sharing and makes proper allocation of risk.
  • Contractor Selection: The principles and procedures of contractor selection.
  • Contract Administration: The general rules of equitable contract management.

Contractual Relationships

The number of possible contractual relationships is based on the owner’s requirements. Variables that influence a contractual relationship include:

  • The project’s type and size.
  • The parties involved.
  • The pricing and payment methods to be used.
  • The contracts award procedure.
  • Time constraints.
  • The applicable legal requirements.

Types of Contracts

There are many types of construction contracts. The following are the most common types:

Unit price contract. A unit price contract is when a contractor agrees to perform specific portions of work for a predetermined unit price. This type of contract is suited for situations where the quantities involved may vary, the total project cost is not firm, or the scope of work may change.

Lump sum contract (single fixed-price). A lump sum contract binds the contractor to perform all the work in accordance with the plans, specifications, terms, and general conditions of a contract for a fixed lump sum price, based on the materials and equipment described in the contract documents. Usually the general contractor will perform most of the work and subcontract the remainder to specialty contractors (e.g., electricians, roofers, plumbers). The general contractor assumes full responsibility for all work done by his own crews or any subcontractors.

Fixed-price contract. The fixed-price contract is considered to be the best incentive for the contractor to control costs and enhance productivity. However, there are some significant owner considerations involved in its adoption and implementation. The owner must accept the responsibility for providing a complete contract, which includes the scope, the overall schedule, the desired quality of construction, and the adequacy of the site condition. The owner must also become significantly involved in the projects coordination and administration to insure no omissions or duplication of the required work.

Cost plus fixed fee contract. With a cost plus fixed fee contract, the contractor agrees to perform the required work and the owner agrees to pay the contractor for the direct field costs, plus a fee to cover the contractor’s office costs and profit. The fee is usually based on the size and /or complexity of the work and may be expressed as a flat dollar amount or as a percentage of the total estimated cost of the project. One disadvantage with this type of contract, to an owner, is that the total cost of the project is unknown until the project is completed.

Guaranteed maximum price contract. Guaranteed maximum price contracts are used primarily for negotiation contracts. The contractor agrees to perform all the projects requirements for a price that will not exceed a pre-established maximum price. The contractor absorbs any costs that exceed the guaranteed price. However, if the contractor completes the work below the guaranteed maximum price, the savings is passed on to the owner unless there is an agreement (in the contract) to share any savings with the contractor.

The contract type chosen will depend upon:

  • How complete the work plans and specifications are.
  • The owner’s willingness to assume the risks inherent in the contract.
  • The owner’s willingness and capability to oversee the project.
  • The relative values the owner places on quality, completion time, and cost.

Common Methods for Construction Contracts

It is not unusual in the construction industry to find numerous combinations of the main types of contracts. The contracting methods in which the different types of contracts are used are described as follows:

Traditional Method

Based upon a predetermined budget, the owner selects an architect/engineer to design the required project. Once the design is completed and approved by the owner, one general contractor is selected, through a competitive bid or negotiated process, for the project. The contractor reports directly to the owner.

The general contractor performs only those portions of the project that do not require a specialist (subcontractor). Most subcontractors are specialists in their area of work and usually can purchase material at a better price and do the work at a more productive rate. This method can be used with any. However, the owner has the option to limit the amount and type of work that may be subcontracted.

The general contractor is always responsible for coordinating any subcontractor’s work. One of the main advantages of the traditional method is that the owner deals with only the general contractor. One disadvantage of using this method is that an adversarial situation may arise, with the general contractor on one side, the architect/engineer on the other, and the owner in the middle.

Construction Management Method

A “team” consisting of the owner, architect/engineer, and a construction manager (see Construction Management Report CM-20-17, Construction Management [1]), usually runs this method. Usually, the construction manager represents the owner and is authorized to supervise the construction of the project. The construction manager is involved during the planning and design phases and provides the owner with independent information about probable costs, schedules, and safety requirements.

The owner contracts directly with several contractors/subcontractors, instead of one general contractor this method, the owner usually is responsible for the work performed by the subcontractors. However, the construction manager might be contractually responsible for on-site supervision of the actual project operations and job-site safety programs.

Turn-Key Method

A turn-key contract is often used when the owner has only general project specifications and requirements. Using this type contract; the contractor is responsible for the projects design and construction. A turn-key contract is most commonly used for a specialized project (e.g., chemical processing plant or refinery) and usually costs more than a general contract based on completed specifications. The owner pays for the project when he/she can “insert the key” and take possession, thus the term “turn-key.”

Design/Build Method

The design/build method is similar to the turnkey method in that the owner has only one contract for the design and construction of a project. The owner may provide the site, a schedule, and a proposed budget. The contractor and the owner agree upon the total sum and dates of progress payments in advance.

Construction Contract Requirements

There are three basic elements to a contract package.

  • The contract – owner and contractor agreement.
  • The specifications – included are the required specifications, general conditions, and any applicable special provisions.
  • The drawings – all completed plans with any revisions included.

All construction projects involve a high cash flow and a high degree of risk. Contracts must be in writing and legally binding. Each contract must define the practical and legal responsibilities, and the commitments of all parties involved.

A construction contract should include the following:

  • The date of the agreement.
  • The parties involved and their addresses.
  • A description or name of the project and its location.
  • The name of the architect/engineer and their address.
  • A list of contract documents to be attached (drawings, specifications, addenda, etc.).
  • A description of the scope of work to be performed.
  • The required starting date and completion date.
  • The amount of the contract.
  • The method and frequency of payments.
  • The rights and duties of all parties.
  • How changes in the work will be handled.
  • A provision for termination by either party.
  • Other special provisions as needed.

Summary

The construction industry is based on contract documents. All involved party’s liabilities and responsibilities are determined by the contract. Each party must fully understand the legal consequences of their action.

A loss control representative should be familiar with the basic types of construction contracts so that they can evaluate the insured contractor’s legal liabilities and responsibilities. They should also evaluate the areas of responsibility and liabilities contained in the contract to help establish communication channels and lines of responsibility required to effectively complete the project. This can minimize the uncertainties and confusion that could keep effective loss control programs from begin developed and implemented.

References

1. American Insurance Services Group. Engineering and Safety Services. Construction Management. Construction Management Report CM-20-17. New York, NY: AISG, 1998.

2. Engineering and Safety Services. The Project Manager. Construction Management Report CM-20-11. New York, NY: AISG, 1999.

3. Bentil, K.K. Fundamentals of the Construction Process. R. S. Means Company, Inc. Kingston, MA: 1998.

4. Deutsch, Kerrigan and Stiles. Construction Industry Insurance Handbook. John Wiley & Sons, Inc. New York, NY: 1991.

COPYRIGHT ©2000, ISO Services, Inc.

The information contained in this publication was obtained from sources believed to be reliable ISO Services, Inc., its companies and employees make no guarantee of results and assume no liability in connection with either the information herein contained or the safety suggestions herein made. Moreover, it cannot be assumed that every acceptable safety procedure is contained herein or that abnormal or unusual circumstances may not warrant or require further or additional procedure.


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