The 6 Types of Construction Contracts

Construction projects are complex, as owners, contractors, vendors, and suppliers must all work together to get the job done on time.

As such, construction contracts are needed to enforce the roles and responsibilities assigned to each party. They are legally binding documents that everyone signs off on before beginning the construction project to ensure accountability.

That being said, there are several types of contracts in construction. Everyone, from insured contractors to project issuers, can benefit from knowing the ins and outs of each—which is exactly what we’re going to explain in this blog.

Keep reading to learn about six construction contract types!

1. Cost-Plus Contracts

This is one of the most common types of contracts in a construction project in which contractors are paid for all their construction-related expenses.

These costs can include direct expenses—such as materials, labour, and supplies—as well as insurance, mileage and overhead costs such as office rent. In these agreements, the profit is paid out to the contractor at an agreed-upon amount.

Benefits and Drawbacks

For contractors, here are the benefits of these types of construction contracts:

• Zero risk of losing money on materials
• A guarantee that you will make a profit and get paid
• Reduced work by minimizing the need for specific estimates

However, these benefits are not without their shortcomings. Contractors will need to track all their expenses, which can require considerable time and effort. Certain cost-plus contracts may also sometimes place restrictive caps on cost allowances.

2. Design-Build Contracts

A design-build agreement is one of the most forward-thinking types of contracts in construction, as it addresses design and project costs at once.

Rather than wait for a design to be finished to get started, this kind of contract gets the ball rolling while it’s in progress. In doing so, it eliminates the need for two lengthy contract procedures that can drag out the process.

Benefits and Drawbacks

These types of construction contracts are all about speed and efficiency, as observed by the following benefits they provide:

• Fewer construction disputes between the designer and contractor
• Quicker project delivery by streamlining progress
• Fewer revisions thanks to increased designer input

However, the lack of a competitive bidding phase can increase the final costs for the project owner. Another con is that it may be difficult to accurately determine costs given the need for more collaboration between the designer and builder.

3. Unit Price Contracts

This is one of the more interesting construction contract types, as it details expenses per unit—which could include the costs of materials, labour, and supplies, as well as overhead costs and profit—that are paid out by the owner at a set rate.

Note: A unit price contract won’t always include the number of units needed to complete the project, rather take into account the cost for each unit and then charge with the progress of these units. For example, a contractor employed to build a road may come up with a unit price for each kilometre.

Benefits and Drawbacks

For contracts that can be easily divided into units or feature repetitive tasks, a unit price contract can provide the following benefits:

• Simpler invoicing given the straightforward division of units
• Can accommodate projects where the scope or duration of work is yet to be decided

However, they’re not always a good idea for complex projects that often require complicated tasks and a variety of materials. There are also no incentives for contractors, which can lead to losses unless you legally guarantee performance.

4. Lump Sum Contracts

These are the types of construction contracts in which a project is delivered at a pre-set price rather than bidding on specific deliverables—hence it is also called a fixed price contract.

As such, these construction contract types are rather simple and work best when the project scope and deliverables are mutually agreed upon with no variables. They’re best suited for jobs that do not require extensive or intensely accurate estimates to move forward.

Benefits and Drawbacks

For these aforementioned simple projects, a lump sum contract can provide:

• Time and flexibility to focus on doing great work
• Freedom from overbearing owner approval and supervision
• More straightforward administration and cash flow estimates

However, as you might have gathered, this looser structure will not work effectively for large and/or complicated projects. For these, you need to be able to provide an accurate estimation of the schedules, materials, and labour costs.

5. Guaranteed Maximum Price Contracts

A guaranteed maximum price contract also known as guaranteed maximums, dictates how much an owner will have to pay a contractor.

This figure is known as a guaranteed maximum price (GMP). Any costs exceeding this pre-established figure will have to be covered by the contractor, which lowers the risk for the customer and makes budgeting on their end simpler.

Benefits and Drawbacks

While other types of contracts in construction certainly benefit the contractor more than these, they do still provide benefits such as:

• Potential for increased profits if the project is completed under budget
• An expedited lending process that benefits the contractor

With that being said, this construction contract type requires careful review and analysis of the expenses. This can be time-consuming, especially if you’re working on multiple phases of the project at once. Contractors also stand to lose money for going over budget.

6. Time and Materials Contracts

Last on our list of construction contracts is a time and materials contract. Also known as a T&M contract, this covers the cost of materials separately and pays out the labour cost on a fixed hourly or daily rate.

These agreements are simple like lump sum contracts, but allow for more flexibility by taking material costs and labor rates into consideration. With that in mind, they may include mark-ups when materials are purchased at wholesale prices.

Benefits and Drawbacks

These types of construction contracts certainly have their benefits:

• Reduced impact or concern for fluctuating labour or material costs
• No need to pursue cost-cutting methods because profit is guaranteed

With that being said, these construction contract types provide decreased transparency when it comes to final costs for owners. As such, it’s not uncommon for disputes to arise, especially if inaccurate estimates start cutting into profit potential.

Insure All Types of Construction Contracts With KASE

As you’ve learned, there are several different types of contracts in construction that all have their benefits and disadvantages. However, no matter which you sign, protecting yourself with insurance and bonds is essential as a contractor.

KASE Insurance is Toronto’s leading commercial insurance broker. We take pride in helping clients create risk-management strategies to secure their finances. Whether you’re working on a simple construction project with a lump sum contract or getting ahead with a design-build agreement, count on us to safeguard your business and assets.

Get in touch with us today to start insuring all construction contract types!