Construction contract basics

By Michael L. Fortney


Tha basics

Construction projects involve several different parties – owners, designers, prime contractors, subcontractors, suppliers – with different interests.  Construction projects also have great risks.  The purpose of the construction contract is to (1) allocate the duties between the parties, (2) recognize and allocate the risk to the different parties, and (3) reduce the uncertainty surrounding the project and allow the parties to plan for the project and the future.   

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Is a verbal agreement enforceable?

Construction contracts may be verbal.  However, it is recommended that construction contracts be in writing.  A written contract presents a clear record of the parties’ agreement, whereas and oral agreement is subject to the parties’ recollection of the terms.  

When entering into a written contract, the parties should make certain that the writing accurately reflects the agreement between the parties.  The parole evidence rule may prohibit evidence of contract terms differing from those in the written agreement.  The integration clause of a contract also prohibits evidence of other terms or negotiations.

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Stipulated value or lump sum contracts?

This is the typical contract with a negotiated lump sum price.  This type of contract is preferred by owners for the following reasons:

owners can utilize a competitive bidding process

all risks are placed on the general contractor 

the general contractor must control costs and perform efficiently

Before entering into this type of contract, the owner must have detailed plans and specifications for the project, and the general contractor must have clear and specific instructions and scope of work. 

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What is a cost plus contracts with a management fee?

A cost plus contract is often used in the absence of detailed plans and specifications.  The general contractor is paid for all costs incurred.  The general contractor is also normally paid a fee for overhead and profit, plus a fee for general conditions.  The owner assumes all risks of excessive costs.  Frequently, an incentive provision is used to encourage cost savings by the general contractor.  

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What is a GMP?

Similar to a cost-plus contract, but with some protection for the owner, utilizing a GMP (guaranteed maximum price) as a cap for project.  The GMP is typically adjusted with each change order, just as a lump sum contract price is adjusted.  This type of contract is amenable to the design build situation, where the general contractor also serves as a designer.  The GMP is arrived at after the project has been completed to the design development stage.

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Can contracts be negotiated?

Negotiated contracts are used in the private sector.  Any contract for a private project is subject to negotiation.

Negotiated contracts are not used in the public sector where contracts must be competitively bid.

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What are the contract documents?

In most contracts, the contract documents are "incorporated by reference."  Contract documents usually include plans and specifications, the “prime contract” between the owner and all prime contractors, including the general contractor, addenda, building codes and regulations, and modifications to the plans and specifications after execution of the contract.

It is important for a contractor to review all contract documents incorporated by reference, as the terms of those documents may be binding on the contractor.  For instance, if a prime contract (between the owner and a general contractor) contains an arbitration provisions, courts will typically enforce the arbitration requirement against a subcontractor in contract with the general contractor. 

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What is the scope of work?

Disputes regarding scope of work are often the basis of construction claims.  Scope of work is defined as the extent of a contractor's responsibility to perform certain contract work.  To determine the scope of work, the contractor may have to look to other contract documents –  plans and specifications, contracts with others – and to industry standards (building codes, etc.)

The scope of work issues between the owner and the general contractor differ from the scope of work issues between the general contractor and subcontractors.  The general contractor must be sure that all of the scope of work is contracted to subcontractors, and that there are no overlapping scope of work issues.   

Questions regarding scope of work should be resolved in the written contract.  Scope of work references should be detailed in the contract.  If detailed specifications are available, refer to the specifications in designating scope of work.

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What is the contract sum?

The price in the contract will either be lump sum, unit price, or time and material.  The contract should include a definite price, or a definite method of determining price.  Absent price, an otherwise valid contract will be interpreted as requiring payment of a fair value (quantum meruit).

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What are the methods for payment of the contract sum?

Progress payments are periodic payments constituting partial payment of the contract sum.  The contract should include a specific provision for time and method of payment and calculation of amount.

A schedule of values should be prepared by the contractor and approved by the owner and architect.  The schedule should accurately break down the scope of work into component parts, and assign a value to each component part.

Applications for payment should be measured against the schedule of values.  The application typically includes the amount of work in place, the cost of materials stored on site, the costs of labor to date, less an amount for retainage and previous payments.  The application is usually certified by the architect or owner and the payment is due thereafter.

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