What is a construction contract?

A construction project may involve more than two parties depending on its scope, duration, security, and size. When a person plans to build a house, he needs a contractor, subcontractor, designer, manager, source of funds, and, most importantly, a contract attorney specializing in drafting and reviewing contracts.

Contract for construction is a legally binding agreement between parties involved in a construction project, typically the owner (or client) and the contractor. It falls into the category of service contracts, where one party pledges to provide services against wages or shares in profit.

Why construction contract is essential?

Architecture has become more complex than in the 18th century, when skyscraper towers were not built, and safety rules, building codes, and quality standards had not been introduced. Consequently, modern projects require more detailed planning and oversight. The house owner, Mason, did not have to get a permit to construct a home for himself. That’s why the owner and Mason’s relationship was less complex than today. Innovation in lifestyle and standards has led to the discovery of new modes of expression, as the infrastructure and design of a business’s headquarters demonstrate the goodwill and credibility of that business.

That’s how the construction industry flourished and discovered complexities that demanded more thorough construction project documentation. The 21st-century boost in the sector involved parties including banks, insurance companies, building designers, architects, investors, owners, and masons. To address the rights and responsibilities of concerned parties, the construction industry needs a contract attorney to draft a contract, a negotiator, and an arbitration counsel if there is an arbitration clause in the contract.

A duly signed and certified contract secures the owner/client of the project against the contractor’s malicious practices, sub-standard materials, safety concerns, and negligence on the part of a contractor or his team. These contracts benefit all parties, as a contractor can claim the contract price, profit, or remaining dues against the investor or owner. A well-drafted construction contract is a security in itself for involved parties. It plays its role in growing the construction business.

Types of construction contracts:

Investment, investor’s intention, project scope, duration, and contractor are the critical elements in selecting contract type. The specification and flexibility of each type are different from others. Contract attorneys must keep their clients aware of the pros and cons of every type. There are eight commonly used standard construction contract types:

• Subcontractor contracts
• Design-build contracts
• Guaranteed maximum price
• Unit price contracts
• Cost-plus contracts
• Time and materials contracts
• Lump sum contracts
• Fixed-price contracts

Subcontractor contracts

At the start of a project, contractors hire subcontractors to speed up completion or when they need an expert, like a boiler engineer. In such a scenario, the owner will require a separate contract between the contractor and subcontractor. The main contractor is liable for the work done by the subcontractor.

Design-build contracts

Business-themed infrastructure and interior design may require a separate team of designers. However, this may increase costs and affect the timeline. The design-build contract frames projects where contractors design and build simultaneously, saving time and money. Working in such a collaborative way can streamline the process. This scheme helps the owner and contractor better understand and compare the situation to the expected results. The flexibility of a design-build contract empowers the involved parties to make minor changes while comparing infrastructure and design.

Guaranteed maximum price (GMP)

A guaranteed maximum price contract (GMP), also known as a ‘not to exceed price’ or guaranteed fixed fee contract, is the most detailed contract among other construction contracts. In such a relationship, the contractor has to work out a maximum price for the client for the project. This sort of contract requires a highly detailed breakdown of all works to assess costs and profits accurately. Guaranteed maximum price contracts enable the client to budget successfully and manage expenses.

The cons of GMP are the same as in other construction contracts, such as unexpected costs and unavoidable delays, including inflation and price rises for materials or the availability of subcontractors and staff, which can be mitigated by flexibility and margin.

Unit price contracts

A unit price contract is one in which separate prices are set out for each work area, including profit for the contractor, such as building material, labor, and design. The pros of unit price contracts are transparent pricing for the client and more accurate payment for actual work for the contractor in case of unforeseen circumstances.

This contract is more convenient for projects with competitive work, such as interior design, hotel bathroom suites, and roofing. A unit price contract is not more feasible for varying materials and tasks because it may complicate the invoicing system and pre-agreed rates for units.

Cost-plus contracts

A cost-plus contract is ideal when the scope of work or costs cannot be precisely estimated. Also known as a cost-plus contract, pays the contractor for all of its expenses, along with an additional amount to allow for a profit. These contracts have application in construction, defense, and research projects, as they provide flexibility in managing project costs.

Benefits for contractors in cost-plus contracts may vary from fixed fees to incentives depending on the project’s performance, while Fixed fees cannot vary. Costs may include staff expenses, mileage, supplies, etc.

Time and materials contracts

Contractors use this type of contract when the scope needs to be clearly defined yet flexible enough to manage unforeseen changes. In a time & materials contract (T&M), the contractor receives payment based on the actual time spent on the project and materials used. In turn, the client agrees to pay a set price that covers the contractor’s costs and profit. It combines some aspects of a cost-plus contract and a lump-sum contract. This sort of contract can offer flexibility by clearly setting out hourly rates for labor and estimated prices for materials.

The benefit for the contractor is reducing the risk of loss from fluctuating staff and materials prices. For clients, it allows them to keep more on top of costs for budgeting.

Lump sum contracts

It is also known as a fixed-price contract, as the contractor agrees to complete the project for a pre-set price. Contractors often use it to provide certainty in budgeting and costs. It benefits clients by including all allowances and contingencies in the pre-agreed price. However, for contractors, it can present a risk of loss of profit if staff or supply costs increase, or additional work. Contractors usually prefer these contracts in low-risk projects with a defined scope of work, such as decorating and glazing.

Fixed-price contracts

Like lump sum contracts, fixed-price contracts have a pre-agreed price and usually do not fluctuate due to changing materials or labor costs. The pros and cons of lump sum and fixed-price contracts are the same. Both types of contracts are better for projects with fixed scope or straightforward jobs, as they involve less profit risk.

With the evolving industry and lifestyle standards, the complexity of the job to be done by the contractor has become multi-tasking. The roles assigned may change from project to project depending upon the client’s preference to determine which contractual relation suits his project more. Drafting construction contracts is not a rigid practice, as the pros and cons of different contracts may overlap.

What is the most commonly used construction contract?

Every contract has pros and cons, as a contract that is best for one situation can result in the worst for a different problem. That’s why every construction contract has benefits and drawbacks depending on the build or renovation’s size, scope, and scale. In my opinion and current trends in the market, lump sum contracts, also known as fixed price contracts, are the most popular choice among clients and contractors for building and engineering agreements as it is simple.

The simple reason behind the popularity of fixed-price contracts is that pre-agreed prices have obvious benefits for clients. They reduce the invoicing system, labor complexities, and provision of materials. On the other hand, they help contractors in budgeting by estimating the costs they will incur throughout the project. Being the most popular type of construction contract only makes it compatible with some projects. Contractors prefer them where the scope of work is defined and straightforward with fewer profit risks.

How is construction contract drafted?

Development or engineering contracts may involve many parties, including banks and insurance companies, and may result in various disputes. These disputes may arise from misunderstanding or misinterpretation of clauses or negligence in contract drafting, which can result in fatal consequences, making the whole contract void ab initio.

Client or contractor can only take advantage of a written contract when the contract is legally binding and covers all corners of a construction project, as a project may end in a common nature of dispute as quality of materials, safety, design, delay in completion, and maintenance. Depending on the contract, a conflict may arise with price changes, labor shortages, or subcontractors’ work.

Here is a list of prerequisites for client, contractor, & contract attorney:

For Client:

• Scope of work
• Investment
• Launch/Completion
• Consult with contract attorney

For contractor:

• Scope of work
• Costs
• Services charges/profits
• Consult with contract attorney

For contract attorney:

For a construction contract to be enforceable and legally binding, it must cover these five key areas:

• Intention – what will happen, when and how
• Capacity – if all parties can agree
• Agreement – details of the offer and acceptance by both parties
• Certainty of terms – which terms are being set out
• Consideration – who will provide the services and payment schedules

What are the critical elements of a construction contract?

Obvious and well-drafted clauses are bodyguards of the interests of all concerned parties. They continue to provide protection even after completing the project. The contract outlines the scope of work, specifies the terms and conditions for executing the construction, and defines the obligations and rights of each party. Critical elements of a construction contract generally include:

• Scope of Work

In this clause, the contract describes construction activities, including specifications, drawings, and materials, thereby signifying the purpose of the contract and the owner’s intentions.

• Contract Price

The meaning of contract price may vary with the type of contract as it depends on the skills of the contract attorney and negotiator in negotiating how to pay off the contract for services rendered, provision of materials either by owner/client or contractor, and adjustments or variations against changes in law, costs, and unavoidable circumstances. This clause also discusses the schedule of payments, including workers’ wages.

• Timeframe

The schedule for the commencement and completion of the project, including any deadlines or milestones. The parties interpret the timeframe clause when claiming damages for delayed completion of the project.

• Quality Standards

These clauses specify the standards of artistry and materials to be used, ensuring compliance with relevant building codes and regulations.

• Responsibilities of Parties

The specific duties and obligations of the owner, contractor, and any other parties involved, such as subcontractors or suppliers.

• Change Orders

Depending on circumstances, such as mistakes, design changes, or quality issues, the project manager issues frequent orders to achieve the required results while maintaining the smooth running of the project. These change orders include addenda, change order request (COR), and field order (FO). The parties make these changes to the original scope of work, including approval processes and adjustments to the contract price or timeline.

• Dispute Resolution

Methods for resolving disputes may include negotiation, mediation, arbitration, or litigation. Construction companies and clients mostly prefer arbitration for its speedy resolution.

• Termination Clauses

Conditions under which either party can terminate the contract, including provisions for breach of contract or unforeseen circumstances.

• Insurance and Bonds

The parties require insurance coverage and performance bonds to protect against potential risks and liabilities.

• Warranties and Guarantees

The contract often specifies when the parties must rectify defects, assuring the work’s quality and durability.

The objective behind negotiations and formalizing those negotiated terms into construction contracts is to ensure that all parties have a clear understanding of their roles and responsibilities, thereby minimizing misunderstandings and disputes throughout the project’s duration.

Construction contracts in global legal framework:

Construction business holds a significant share of the market, as according to a survey in 2021, The market valued the global construction industry at USD 12,633.9 billion. Europe has the most significant presence of companies, with 40 groups in the Top 100, followed by Japan and the USA. With the boost in market size and innovation in engineering and technology, complexities in the construction industry also increased and necessitated the formulation of the legal framework for the smooth running of construction projects. Well-drafted construction contracts secure parties’ interests, build trust, and ensure sustainability, proving to be the cornerstone of the construction business.

Depending upon the sphere of projects and complexities, many international organizations manage and provide legal frameworks for construction contracts, enforcement of rights and obligations, and dispute resolution. There are critical global platforms designated for different aspects of the construction business:

• International Federation of Consulting Engineers (FIDIC)

FIDIC creates standard forms of contracts that the international construction industry widely uses. These contracts include provisions for the parties’ rights and obligations, dispute resolution mechanisms, and risk allocation.

• International Chamber of Commerce (ICC)

ICC provides various resources and services relevant to the construction industry, including the ICC International Court of Arbitration, a leading institution for resolving international construction disputes.

• United Nations Commission on International Trade Law (UNCITRAL)

UNCITRAL develops model laws and legal guides that provide frameworks for international commercial transactions, including construction contracts. Their work includes the UNCITRAL Arbitration Rules and the Model Law on International Commercial Arbitration.

• World Bank

World Bank issues guidelines and standards for procurement and contracts in projects it finances, often involving large-scale construction works. Many refer to the World Bank’s Standard Bidding Documents (SBDs) and Procurement Guidelines.

• American Institute of Architects (AIA)

AIA issues standardized contract documents that the United States construction industry widely uses. These documents cover various aspects of construction contracts, including design, construction, and project management.

• International Labour Organization (ILO)

ILO sets international labor standards, including those applicable to the construction industry. These standards cover working conditions, safety, and health regulations.

• International Organization for Standardization (ISO)

ISO develops and publishes international standards that impact the construction industry, such as those for quality management (ISO 9001), environmental management (ISO 14001), and occupational health and safety (ISO 45001).

• Joint Contracts Tribunal (JCT)

JCT issues standard forms of contract, guidance notes, and other documentation used in the UK construction industry. The industry widely uses these contracts for both public and private sector projects.

• European Committee for Standardization (CEN)

CEN develops European Standards (ENs), which cover various aspects of construction, including materials, design, and safety.

These organizations play critical roles in shaping the legal landscape of the construction industry by providing standardized contracts, guidelines, and dispute resolution mechanisms that ensure fair practices and efficient project management globally.

Technological development and convenient infrastructure are driving factors for this growth.

Haider Zia Kainth is an author at neutralslaw.com, a seasoned legal consultant and corporate expert specializing in contract drafting, reviewing, taxation, intellectual property rights, and corporate consulting. Legal research, global affairs, and international law are my passion/ cup of tea. I earned a certificate from UNCITRAL in International Commercial Arbitration and joined LCIA-YIAG London as a young member.

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