What Is Construction Contract?
In the definition, we could infer the criteria required for a contract to be valid.
These criteria are:
- There must be a mutual agreement between the two parties.
- There must be an offer made by one party called the promisor.
- The other party, called the promisee, must accept the offer.
- There must be a consideration, which is usually payment in the form of money for doing an act or abstinence from doing a particular act by promisor for promisee.
- The offer and acceptance should relate to something that is not prohibited by law.
- The offer and acceptance constitute an agreement that, when enforceable by law, becomes a contract.
- The contracting parties entering into the agreement should be competent, i.e., not disqualify
- Fied by either infancy or insanity to make such an agreement.
List of Contract Document
A conctruction contract comprises the following documents essentially:
- The Contract Drawing
- The Specifications
- The General Conditions of Contract (GCC)
- The Special Conditions of Contract (SCC)
- The Agreement
- The Bill of Quantities (BOQ)
Categories of Contract
1. Separated Contracts
- Lump-Sum Contracts
- Measurement Contracts
- Item Rate Contracts
- Percentage Rate Contracts
- Cost Plus Percentage Contracts
2. Management Contracts
- Management Contracts
- Conctruction Management Contracts
- Design Management and Conctruction Contracts
3. Integrated Contracts
- Design-build Contracts
- Turkey Contracts
- Build Operate and Transfer
4. Discretionary Contracts
- Partnering Contracts
- Joint Venture Contracts
Types of Engineering Contracts
When considering types of contract costing and types of contracts in law, following are the different types of engineering contracts:
- Lump-Sum Contract
- Item-Rate & Unit Price Contract
- Percentage-Rate Contract
- Cost Plus Percentage Contract
- Cost Plus Fixed Fee Contract
- Cost Plus Variable Percentage Contract
- Labour Contract
- Target Contract
- Negotiated Contract
1. Lump-Sum Contract
Nature of Agreement In case of a lump-sum contract, the contractor agrees to carry out the entire work as shown in the drawings and described by specifications, by supplying labour and materials, all for a specified lump-sump.
Sometimes, the agreement makes a provision for adjusting the “fixed sum,” allowing for the cost of extras, variations, omissions, etc.
The major feature of the agreement is that the contractor agrees to accomplish all his/her contractual obligations and responsibilities for the stipulated payment, no matter what trouble or expense he/she comes across or incurs in doing so.
All the documents, except the “bill of quantities,” form the basis of the agreement. A schedule of rates is sometimes included to work out the cost of extras or omissions.
2. Item-Rate & Unit Price Contract
Nature of Agreement What is item rate contract? An item-rate contract is one in which the contractor agrees to carry out the work as per the drawings, bills of quantities, and specifications in consideration of a payment to be made entirely on measurements taken as the work proceeds, and at the unit-prices tendered by the contractor in the bill of quantities.
This method has its own item rate contract advantages and disadvantages. A bill of quantities is prepared, giving, as precisely as possible, the quantities of each item of work to be carried out, and the contractor enters the unit rate against each item of work.
The basis of the agreement is thus the unit rate of each item, certain practical and reason-able variations in the quantities being accepted by both parties. All the documents are invariably included in the agreement.
For example,
The bill of quantities includes an item of cement concrete, and the estimated quantity is 11,000 m3.
The contractor’s tendered rate represents the amount that he/she is to be paid for each cubic meter of concrete in the finished work, Whether the actual quantity is 10,000 m3 or 12,000 m3.
3. Percentage-Rate Contract
In this form of the contract, often referred to as difference between item rate contract and percentage rate contract, the department draws up the schedule of items according to the description of items sanctioned in the estimate with the quantities, units, rates, and amounts shown therein.
When a department fixes the rate of item it is known as “Item Rate Contract”. The percentage-rate contract is similar to the item-rate contract in almost all respects except for the method of tendering the unit rates.
The bills of quantities supplied to all the intending bidders include, in addition to the approximate quantities and detailed description, the unit rates as estimated by the engineer.
While tendering, the contractors do not have to write the rate or estimated cost of each item, but a percentage figure by which the estimate unit rates are to be increased or decreased, the same percentage figure being applicable to all the items.
Contract documents are the same as those included in an item-rate contract. At the time of making the payments to the contractor, the engineer works out the cost of the work done in a manner similar to an item-rate contract by multiplying the quantities by the rate in the bill of quantities.
But increases or decreases the final amount by the percentage figure above or below quoted by the contractor, respectively.
4. Cost Plus Percentage Contract
It is seen while discussing the above common forms of contracts that neither party is sure of the final cost of the project as will be built till the completion of the project.
In these days of increase price rise, especially when considering different types of contracts, and absence of a satisfactory explanation to determine and pay escalation in the cost on a mutually agreed basis, contracting can be reduced to gambling or betting.
If the contractor is likely to lose heavily, he/she abandons the work midway to the detriment of the employer.
If the employer has to pay in excess of the agreed contract sum, he/she runs the risk of financial difficulty. An alternative form of a contract, which does not throw much risk on either party, is the cost-plus type contract.
5. Cost Plus Fixed Fee Contract
The cost plus fixed fee contract differs from the cost-plus percentage type contract with respect to the determination of the fee to be paid to the contractor to cover overheads and profit.
The agreement specifies the fixed lump-sump to be paid to the contractor by the owner over and above the actual cost of the work.
In other words, the fee does not fluctuate with the actual cost of the work. This factor overcomes the possible weaknesses of the cost plus percentage type of contract.
However, in this case, there is no incentive for the contractor to do the work efficiently and to affect the economy in the cost of construction of the work.
If the fixed fee is to include the salaries of the contractor’s staff, the contractor will try to complete the work as speedily as possible to make maximum profit.
Even if the salaries of his/her staff are to be classified as part of the general costs of the work, he/she will try to expedite the project so that his/her men can be available for another contract to make an additional profit therefrom.
In respect of all other points, this form of contract is similar to the cost-plus percentage type contract.
6. Cost Plus Variable Percentage Contract
By introducing an element of incentive for the contractor to carry out the work in the most economical way, an attempt is made in this form of contract to overcome the main drawbacks of the previous two types of cost-plus contracts.
This is achieved by suitably changing the nature of the agreement in respect of the fee payable to the contractor. The amount of fee is determined by reference to some form of a sliding scale.
Thus, the higher the actual cost, the lower is the value of the fee that the contractor receives and vice versa. From the owner’s point of view, this is one of the best “cost-plus” type contracts. The developed form of this contract is the target contract.
7. Labour Contract
The special feature of a labour contract is that the owner agrees to supply all the required materials to the contractor, and the latter agrees to supply all the labour and workmanship necessary to complete the work according to the drawings and specifications.
This form of contract is suitable for those cases where the owner is in a position to buy large quantities of materials at favorable rates and also deliver them to the site of work most economically.
For example, spreading and compacting metal and laying and fixing sleepers on the railway track.
8. Target Contract
This form of contract is comparatively of recent origin. It combines the best features of the cost plus percentage and the cost-plus fluctuating fee type contracts.
The contractor is paid on a cost-plus percentage basis for work performed under the contract plus or minus a certain amount, which is an agreed percentage of savings or excess affected against the target value.
The target value is arrived at by measuring the work on completion and valuing it at the rates agreed to earlier.
9. Negotiated Contract
The negotiated contract is a case where the contract is awarded on the basis of a direct agreement with a contractor, by not going through the process of competitive bidding. It is otherwise called negotiated agreement.
Hence, a negotiated contract is a kind of agreement where a specific firm is targeted, for a variety of causes, to carry out the contract, although there is more than one firm that can carry out the contract. Under usual conditions, a competitive tender or proposal would be issued.
This differs from an exclusive source situation, which takes place when: there is only one firm that is available and capable of carrying out and completing the contract, and/or the urgency of the situation dictates that the competitive procedure cannot be used.
A contract is a legally binding agreement between two or more parties to uphold terms in a relationship, as set forth by the contract.
The negotiated contract entails the process of discussing and compromising on contract terms and conditions in order to reach the final, approved draft of a contract. Some contracts are non-negotiable, in cases with leases and warranties extended by the manufacturers.
However, there are contracts business, real estate development, and finances that are negotiated in order to reach terms that are satisfactory to all parties involved.
Frequently Asked Questions (FAQ) about Construction Contracts
What is a construction contract?
A construction contract is a legally binding agreement between two or more parties to carry out construction work according to specified terms and conditions. It outlines the scope of work, payment terms, responsibilities of each party, and other relevant details.
What are the essential documents included in a construction contract?
The essential documents in a construction contract typically include:
- Contract drawings
- Specifications
- General Conditions of Contract (GCC)
- Special Conditions of Contract (SCC)
- The Agreement
- Bill of Quantities (BOQ)
What are the different categories of construction contracts?
Construction contracts can be categorized into:
- Separated Contracts (e.g., Lump-Sum, Measurement, Item Rate, Percentage Rate)
- Management Contracts (e.g., Construction Management)
- Integrated Contracts (e.g., Design-Build, Turnkey)
- Discretionary Contracts (e.g., Partnering, Joint Venture)
What are the common types of engineering contracts?
Common types of engineering contracts include:
- Lump-Sum Contract
- Item-Rate & Unit Price Contract
- Percentage-Rate Contract
- Cost Plus Percentage Contract
- Cost Plus Fixed Fee Contract
- Cost Plus Variable Percentage Contract
- Labour Contract
- Target Contract
- Negotiated Contract
What is a lump-sum contract?
A lump-sum contract is where the contractor agrees to complete the entire work for a specified lump sum, regardless of any additional expenses incurred during the project.
How does a percentage-rate contract differ from an item-rate contract?
In a percentage-rate contract, the contractor quotes a percentage figure by which the estimated unit rates are to be increased or decreased, whereas in an item-rate contract, the contractor provides unit rates for each item of work.
What is a cost-plus contract?
A cost-plus contract is where the contractor is reimbursed for all legitimate expenses incurred during the project, plus a predetermined percentage of the total costs as profit.
What is a negotiated contract?
A negotiated contract is awarded directly to a contractor without competitive bidding. Parties engage in discussions and compromise to reach mutually acceptable terms and conditions.
What are the advantages of a target contract?
A target contract combines features of cost-plus contracts with incentives for efficiency. Contractors are paid based on actual costs plus or minus an agreed percentage of savings or excess against the target value.
Are all construction contracts negotiable?
Not all construction contracts are negotiable. Some contracts, such as leases and manufacturer warranties, may have non-negotiable terms. However, contracts in business, real estate, and finance sectors are often negotiated to reach satisfactory terms for all parties involved.
