What are Construction Contracts? Methods and Types of Construction Contracts

Construction contracts are the legal agreements made between the client and contractor outlining the terms and conditions of a construction project. These agreements specify the scope of work, the timeline for completion, the budget, and the resources required to complete the project.

Given the complexity of the construction industry, it involves diverse parties from builders, clients, contracts, engineers, and laborers. By establishing legally binding agreements, these parties can work together to complete the project efficiently and effectively, while minimizing disputes and misunderstandings.

In this article, we will explore the definition, key features, and various types of construction contracts in detail. By understanding the different types of contracts available, contractors and clients can choose the one that best meets their needs and ensures a successful project outcome.

Definition of Construction Contracts

The International Federation of Consulting Engineers (FIDIC) is widely recognized as a global standard for construction contracts. FIDIC defines a construction contract as a legal agreement between the employer (client) and the contractor that sets out terms and conditions for the design, execution, and completion of a construction project.

Contract documents in construction refer to written agreements that outline the scope of work the contractor has agreed to complete, the payment that the owner will provide, and the terms and conditions of the contract.

The terms and conditions of the contract are documented to specify the responsibilities and obligations of both parties. In any case of unforeseen issues, the “conditions of the contract” determine which party is in charge of delays and additional costs.

Importance of Construction Contracts

Given the diverse activities and complexity associated with construction projects, there are always chances for risks, disputes, non-compliance, disagreement, and uncertainty. Hence, we need construction contracts to establish a binding agreement between the parties involved in a construction project. By doing so, the contract helps to ensure that the project is completed with minimal loss and disputes.

The importance of construction contracts for the successful completion of a construction project is due to the following features it provides:

1. Clearly Defines the Scope of Work: The construction contract clearly defines the complete scope of work of the project. The contract document consists of all the work to perform, its details, materials, drawings, specifications, rules and regulations, mandatory rules, etc. This way the parties involved in the contract clearly understand their responsibilities.
2. Allocates Possible Risks: The risks associated with construction work are different based on the type of project. A well-defined contract specifies all possible risks like delays, cost overruns, and unforeseen circumstances. It also defines the party who is responsible for any possible delays or cost overruns.
3. Establish Payment Terms: The contract document evidently states all payment terms that need to be conducted during the project. It mentions the total contract price, the payment schedule, penalties, or bonuses for completing the work on time or within budget. This way construction contracts help to ensure all parties involved are fairly compensated for their work.
4. Provides Legal Protection: Having a contract protects all the parties involved in the contract. Disputes arising during the project are smoothly resolved with the assistance of a contract. The contract also enforces the terms of the agreement if any party fails to meet its obligations.
5. Ensure Compliance with Regulations: Contracts specify standards for materials used, workmanship, and safety to ensure compliance with regulations and building codes. Compliance with regulations and construction contracts helps to complete the project safely as per the required standard. 

5 Main Elements of a Legally Binding Contract

The 5 main elements necessary to enforce and bind a contract are:

1. Offer and acceptance
2. Mutual intent
3. Consideration
4. Capacity to contract
5. Legality

1. Offer and Acceptance

An offer is a promise made in a construction contract. It must be in writing and follow certain rules. If it's not accepted by the owner or client in a reasonable time, it becomes void. You can negotiate based on the offer and revise it with a counteroffer to the contractor or engineer.

The offer can be taken back before you agree to it unless there is a rule saying you can't. It's important to know the rules for the offer in a construction contract to make sure it's a valid agreement. 

An offer provided becomes a binding contract, only when it is accepted or in other words signed by the other party. The acceptance of an offer must be made clear or unambiguous and unconditional. The concept is clearly explained by an example below:

EXAMPLE

Let's say a property owner wants to build a new house and hires a contractor to do the work. The contractor provides a written proposal that outlines the scope of work, the timeline for completion, and the total cost of the project. This proposal is an offer, as the contractor is promising to do the work under specific terms and conditions.

The owner reviews the proposal and decides to make some changes. They want to add a new feature to the house and need it to be completed by a specific date. The owner sends a counteroffer to the contractor with the revised requirements.

The contractor reviews the counteroffer and decides to accept the changes. They sign the revised proposal, making it a binding contract between the owner and the contractor.

However, if the owner had not accepted the proposal or sent a counteroffer within a reasonable timeframe, the original offer from the contractor would have lapsed and become void. 

Additionally, if the contractor had revoked the offer before the owner accepted it, the contract would not have been formed. It's important for both parties to follow the rules and requirements of the offer to ensure a valid and enforceable contract.

2. Mutual Intent

Mutual intent means that everyone involved in a construction contract has to agree on what's in the contract. This is typically expressed in a letter of intent, which is an informal agreement to proceed with negotiations toward a contract.

However, a letter of intent does not make the contract binding until a formal letter of acceptance is issued. This means that all parties must have a clear understanding and agreement on the terms and conditions of the contract before it becomes legally binding.

3. Consideration

Consideration is when each party in a construction contract promises to give something valuable in return for what the other party is doing. This could be things like money, work, or goods. 

For example, a contractor promises to build a house in exchange for payment. It's important that both parties get something valuable in return for their promises, otherwise, the contract isn't valid. The things being exchanged should also be legal and not related to something that's already happened in the past.

4. Capacity to Contract

When making a construction contract, it's important that both parties are capable of doing what they promise to do. Not everyone is allowed to make a contract under the law. 

For example, someone who is mentally ill or drunk may not have the capacity to make a contract. Minors are also not bound by contracts, except for contracts for things they need like food and shelter. Corporations can't make contracts that are beyond their powers. So, when working with a corporation, the Engineer needs to be careful to check what the corporation can and can't do. If the contract is beyond the corporation's powers, it won't be legally enforceable.

5. Legality

A contract can only be enforced if its purpose is lawful. For example, a contract that violates municipal regulations is not enforceable in courts. A contract must also be made with the free consent of all parties involved. Consent is considered free if it is not caused by force or undue influence, fraud, or misrepresentation. If a contract is obtained through duress or fraud, it is considered void.

A contract will also be unenforceable if its terms are one-sided, heavily favoring one party. Unenforceable contracts are still valid, but a party seeking to enforce it will be denied a remedy due to a lack of required formalities.

To make a contract enforceable, it should not have an immoral or criminal purpose and should not contain clauses that are against public policy.

Standard Codes for Construction Contracts

The standard codes that are used all over the world are:

1. FIDIC (Fédération Internationale Des Ingénieurs-Conseils) : Europe, Middle East, Asia and Africa
2. NEC (New Engineering Contract): Australia, New Zealand, and South Africa
3. JCT (Joint Contracts Tribunal): Hong Kong
4. AIA (American Institute of Architects): The United States
5. ICE (Institution of Civil Engineers): Hong Kong and Singapore
6. GC Works (Government Construction Works Contracts): UK
7. SIA (Swiss Society of Engineers and Architects): Switzerland

Key Elements of a Construction Contracts

The 5 Key Elements Every Construction Contract Should Contain

1. Project description: A detailed description of the work to be performed, including the scope, materials, and specifications. It should also include the project's start and end dates. 
2. Payment terms: The payment terms should specify the total contract price, payment schedule, and method of payment. It should also include provisions for any additional costs, such as change orders, and how they will be handled. 
3. Contract documents: A list of all the contract documents, including plans, specifications, and any addenda or amendments. 
4. Warranties and guarantees: The contract should specify any warranties or guarantees provided by the contractor, including workmanship, materials, and equipment.
5. Insurance and bonding: The contract should require the contractor to carry insurance and bonding to protect against potential losses or damages.
6. Dispute resolution: The contract should include a dispute resolution process, such as mediation or arbitration, to resolve any disputes that may arise during the project. 
7. Termination: The contract should specify the conditions under which either party can terminate the contract, including default, breach, or termination for convenience. 
8. Safety requirements: The contract should specify any safety requirements or regulations that the contractor must comply with during the project. 
9. Indemnification: The contract should include provisions for indemnification, which is the obligation to compensate for any losses or damages that may arise from the contractor's work. 
10. Signatures: Finally, the contract should be signed by both parties to indicate their agreement to the terms and conditions of the contract.

Methods of Construction Contracts

The primary methods of construction contracts are:

• Design-Bid-Build
• Design-Build
• Construction Manager at Risk (CMAR)
• Integrated Project Delivery (IPD)

Construction Contract Method	Description	Advantages	Disadvantages	Application
Design-Bid-Build	The traditional method is where the owner contracts with a designer to create construction plans and then puts the project out for bid to contractors.	Clear separation of responsibilities between design and construction.	Limited collaboration between designer and contractor can lead to miscommunication and increased project duration.	Smaller projects with straightforward designs, government projects, and projects with a limited budget and schedule flexibility.
Design-Build	The owner contracts with a single entity to provide both design and construction services.	Single point of responsibility for design and construction, streamlined communication and collaboration between designer and contractor, and potentially faster project completion.	Limited owner involvement in the design and potentially higher costs due to lack of competition.	Large, complex projects with significant design challenges, projects with compressed schedules, and projects where cost savings are a priority.
Construction Manager at Risk (CMAR)	The owner hires a construction manager during the design phase to provide input on constructability and cost, and then the construction manager becomes the general contractor during construction.	Increased collaboration between owner, designer, and construction manager, the potential for cost savings through value engineering during the design phase, and the construction manager acts as a buffer between owner and contractor.	Potentially higher costs due to additional management and coordination fees, and increased risk for the construction manager.	Large, complex projects with significant design challenges and projects where the schedule is a priority.
Integrated Project Delivery (IPD)	The owner, designer, and contractor form a collaborative team and jointly share the risks and rewards of the project.	Increased collaboration and communication between all parties, shared risk and reward incentivize team members to work towards project success and potential for cost savings through value engineering and lean construction practices.	Requires a high level of trust and cooperation between all parties, potential for increased liability due to shared risk, and can be difficult to implement due to contractual and cultural barriers.	Large, complex projects with significant design challenges, projects with compressed schedules, and projects where sustainability is a p

Types of Construction Contracts

Here the main types of construction contracts are:

• Lump Sum Contract
• Cost-Plus Contract
• Time and Materials Contract
• Unit Price Contract
• Guaranteed Maximum Price (GMP) Contract

The definition of each contract along with suitable examples is provided for better understanding. 

1. Lump Sum Contract

Also known as a fixed-price contract, this is the most common type of contract. The owner agrees to pay the contractor a fixed price for completing a specific scope of work. This type of contract is ideal when the project requirements are well-defined, and the scope of work is clear.

EXAMPLE

A homeowner hires a contractor to build a new deck on their house for a fixed price of $10,000. The contract specifies the materials, design, and construction details required for the project.

2. Cost-Plus Contract

This type of contract requires the owner to pay the contractor for the actual cost of the project plus a fee for overhead and profit. This type of contract is useful when the project's scope is not well-defined or when changes are expected to occur.

EXAMPLE

A developer hires a contractor to build a new shopping center. The contract stipulates that the contractor will be reimbursed for all costs associated with the project, such as materials, labor, and equipment, plus a 10% fee for overhead and profit.

3. Time and Materials Contract

This type of contract requires the owner to pay the contractor for the actual time and materials used to complete the project. This type of contract is often used for smaller projects, where the scope of work is not well-defined, and there is a lot of uncertainty.

EXAMPLE

 A homeowner hires a contractor to repair their roof. The contract stipulates that the contractor will be paid $50 per hour for labor, plus the cost of materials used.

4. Unit Price Contract

This type of contract requires the owner to pay the contractor based on the number of units or items installed or constructed. This type of contract is often used for repetitive work, such as paving or landscaping.

EXAMPLE

A city hires a contractor to pave a new road. The contract specifies that the contractor will be paid $10 per square foot of pavement installed.

5. Guaranteed Maximum Price (GMP) Contract

This type of contract requires the contractor to complete the project for a fixed price, but the owner agrees to pay any additional costs that exceed the agreed-upon amount. This type of contract is useful when the project scope is not well-defined or when changes are expected to occur.

EXAMPLE

A university hires a contractor to build a new science building. The contract stipulates that the contractor will complete the project for a fixed price of $20 million. However, if the project costs exceed $20 million, the owner agrees to pay the additional costs.

Summary

In conclusion, construction contracts are essential to ensure the successful completion of a construction project. They provide a legally binding agreement between the client and contractor, clearly defining the scope of work, payment terms, and allocation of possible risks. 

By establishing these terms and conditions, construction contracts help minimize disputes, ensure compliance with regulations, and provide legal protection for all parties involved. It is important for contractors and clients to understand the different types of construction contracts available and choose the one that best meets their needs.

Read More On Construction Legals