There’s no doubt that commercial construction is big business. Despite the fact that construction suffered a worldwide correction in 2020 due to the COVID-19 pandemic, ReportLinker estimates that “global construction output will expand by 4.5% in 2021,” and Statista reported that the “construction industry grew to a spending value of close to 12 trillion U.S. dollars before the coronavirus pandemic.” But this doesn’t mean that the industry is without challenges. A 2015 report by KPMG discovered that more than two-thirds of owners blame contractors for underperforming construction projects and more than half had an underperforming project during the last year.
Such conflicts put owners and contractors at risk over contract disputes. In this post, we’ll discuss commercial construction contracts and why a standard construction contract is never a good idea. Additionally, we’ll talk about six different types of construction contracts and other common contract issues you should know about.
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What is a Construction Contract?
At its most basic, a construction contract serves as a legally binding agreement that does the following:
- Describes what will be built and who will build it
- Determines who will receive fiscal compensation
- States how and when that compensation will get divided
- Indicates when a job will be considered complete
This sounds simple enough, but failing to craft a contract that’s both comprehensive and appropriately detailed could land both parties in contract disputes. And as we’ve seen from the above statistics, there are plenty of opportunities for project-related conflicts to arise.
What is the content of a commercial construction contract?
No matter the types of commercial construction contracts you may be dealing with, every contract needs to contain certain kinds of detailed information in order to be legally effective. Some of this content should include:
- The project’s scope
- The project’s schedule
- A delivery date for project completion
- A total sum to be paid
- Provisions detailing how any changes will be handled
- Provisions detailing how any delays will be handled
- Any unique specifications requested by the owner
Such provisions seem cut and dried, and often they are. Sometimes, though, a whole host of issues can lurk below the surface of seemingly plain language. We’ll discuss potential problem areas in our last section.
What Are the Different Types of Contracts in Commercial Construction?
Discussing the different types of contracts in commercial construction can prove challenging because each sub-industry in the construction field has its own unique twist on its documents. You’ll find different types of contracts in architecture, in business, and different types of contracts in civil engineering. However, even if the specifics may vary, it’s wise to know the rough categories into which a commercial construction contract may fall. They include:
Lump Sum / Fixed Price Contracts
When you’re dealing with a clearly defined (and, typically, smaller scope) project, a lump sum or fixed price contract usually comes into play. It’s one of the simplest contracts to understand. Payment occurs at a single fixed price and in a single lump sum when the work has concluded. This price must cover all subcontractors and any unexpected developments.
Time and Materials Contracts
This type of contract works best with less structured projects. Highly flexible, time and materials contracts only charge for (appropriately enough) the contractor’s time and materials. If you need to account for scope creep or the need for potential future expansions, this is the contract for you.
Unit Price Contracts
Often employed by builders and governmental entities, unit price contracts specify standard costs for distinct “units,” such as inputs (e.g., labor, materials, equipment) or distinctly measurable metrics used in the final construction (e.g., square feet). While time consuming to prepare, unit price contracts work well with smaller projects.
Cost Plus Contracts
Cost plus contracts share some similarities with time and materials contracts. They also bill the owner for actual costs incurred during construction, but they also include additional charges (a “plus”), such as:
- A fixed fee
- A bonus contract for specific goals and guaranteed maximum price
- Fixed percentage
- A guaranteed maximum price
Design Build Contracts
In some instances, owners may not want to lengthen the construction process by finalizing designs before soliciting construction bids. Such cases require a design build contract, which sees construction begin even as the design process is still underway. (See the following section for more information.)
Integrated Project Delivery Contracts
This kind of contract is only used by those implementing an integrated project delivery (IPD) philosophy. Much like the vaunted lean manufacturing pioneered by Toyota, IPD seeks to improve construction efficiency. IPD contracts treat all parties as though they were members of a single firm and offer specific performance metrics.
Design Build and Building Contracts: What’s the Difference?
Most building contracts only proceed after the owner has finalized the design with a third party. This requires its own separate contract distinct from the one signed with the contractor and can sometimes create an adversarial atmosphere should something go wrong during construction. It’s not uncommon for the designer and the contractor to blame each other rather than seek to fix the problem.
Design build contracts seek to remedy this issue by bringing the design portion of the project under the auspices of the contractor. This means that the owner only needs to sign one contract. Additionally, sometimes construction may begin prior to the finalization of the design.
Common Commercial Construction Contract Issues
Despite the wide variety of specialized contracts, owners and contractors alike tend to run afoul of very specific issues in their contracts. This can turn a successful project into a painful one, and transform a struggling project into an outright failure. So before you sign a contract make sure you have addressed the following areas:
- The Scope of Work / Performance Duties Provision: Scope of work provisions detail what the contractor is supposed to do, and incomplete descriptions can lead to confusion (at best) or fraud (at worst).
- Securing the Parties’ Performance Provision: This provision lays out the fiscal details and the fiscal provisions of the deal, stating how far the contractor shall go and no farther. If this provision is too tight, it can lead to delays once the contractor reaches the limits of his “credit.” If it’s too loose, the contractor may perform additional, undesired work.
- Payment Provision: The biggest issue with payment provisions for a commercial construction contract is that many owners fail to specify how they will determine that a contractor has completed the work, which can lead to delays and conflict.
- Project Changes and Change Orders Provision: While these are two separate provisions explaining 1) how the owner can tell the contractor about any desired changes.; and 2) how the contractor will tell the owner about any desired changes, not all contracts include both of them. Any omission may lead to delayed work or legal action.
- Delays Provision: If a delay provision isn’t clearly written, contractors may be able to drag on the work while still getting paid.
- Indemnification Provision: This provision is intended to guard both the contractor and the owner against any third-party claims that may arise during construction. The greatest problem with these clauses occurs when the language fails to fully indemnify either party.
If you need a helping hand to aid you with your commercial construction contract, contact us here at GNP Realty. We have extensive experience regarding virtually every time of commercial construction project.