To ensure a smooth and fair experience for all parties in a building project, a construction contract is crucial.
But what is a construction contract?
This document is a legally binding agreement between a client and a contractor that specifies the terms and conditions of the project.
Without a construction contract, each party is vulnerable to disputes, such as quality of work, payment, timelines, and much more.
If you’re shopping around for a contractor, only choose one who is willing to sign a construction contract–a reluctance to do so is a major red flag.
Let’s make sure you understand the full scope of what a construction contract is, how it can be used, and important pitfalls to look out for.
Once the contract is squared away, the project can move along with everyone being on the same page, and that’s the formula for a successful endeavor.
1. What is a Construction Contract?
A construction contract is an agreement between two parties: the owner of the project site and the contractor.
The document typically breaks down the terms and conditions of the project and specifies details such as roles and responsibilities, cost, timelines, and types of materials.
Having a construction contract ensures each party has an understanding of what is expected, minimizes disputes, and provides legal protection for owners and contractors.
In most cases, the contractor is responsible for providing a construction contract that follows a standard template.
For larger and more complex projects where the owner is a large corporation or government agency, the owner may provide the construction contract.
Several municipalities have rules in place that dictate the content of a contract, no matter which party provides it.
The contract is the foundation of the project, and both parties need to carefully review the terms and conditions and negotiate any discrepancies before signing.
Failing to do so could result in disputes, delays, and legal battles.
2. How Does a Construction Contract Work?
A construction contract works like any other legally binding contract.
Each party has a say in the content of the contract and can request revisions to meet its desires.
If the content within the document cannot be agreed on, the owner and contractor have to decide whether they are comfortable continuing with the project.
Here is the typical process of establishing and using a construction contract:
Specifying terms and conditions: The owner and contractor will first discuss the details of the project, including what the project will entail, the payment structure, the materials to be used, and timelines.
During this process, there may be certain stipulations that have to be negotiated.
Drafting the contract: Once both parties have agreed on the terms and conditions, either the owner or contractor will draft the contract.
The contract should follow an industry-standard template and include all terms and conditions previously discussed.
Requesting revisions: The party who receives the contract then needs to review it.
Any last-minute discrepancies need to be ironed out.
If new terms and conditions are agreed upon, a new contract needs to be drafted.
Signing: After both parties have carefully read the contract and all revisions have been made, it’s time to sign the contract.
As soon as the signatures are on paper, the document becomes legally binding, and the owner and contractor must fulfill their responsibilities or risk potential legal action.
Requesting changes (optional): Occasionally, changes will need to be made during the project.
Aspects such as timeline, cost, or structural modifications will deem it necessary to update the contract.
In order to make adjustments, a contract amendment has to be signed off by both parties and attached to the original document.
Resolving disputes: If disputes arise during the project, the contract can be used to resolve them.
The ability to quickly and definitively resolve disputes is why it is so important for the contract to be specific and detailed.
The contract should provide the procedures to resolve disputes, such as through arbitration or mediation.
Closing the contract: At the completion of the project, when all obligations have been met, the contract will be considered closed.
Any final documents that verify the completion of the project and any information on future operation or maintenance should be signed off.
3. What Are the Essential Elements of a Construction Contract?
The more specific and detailed a construction contract is, the more protection it will provide owners and contractors.
Although each construction project is different, there are some essential elements that should be included in every contract.
If a contractor is unwilling to sign a contract that includes the following elements, owners should be wary of agreeing to work with them.
Remember, construction contracts are a form of legal and financial protection, and failing to include certain components puts parties at risk of expensive, time-consuming lawsuits.
Here are the essential elements a construction contract should include:
The construction contract needs to clearly identify the client and contractor.
If there are any other entities involved, such as subcontractors, architects, or engineers, they should also be clearly identified.
Detailed descriptions of the project need to be included in the construction contract.
Specifications such as blueprints, services to be performed, and materials are necessary elements to include.
Describing the scope of the project is especially important to qualify for insurance.
The construction contract should state agreed-upon deadlines, such as start and end dates.
Both parties may have also agreed on milestones deadlines, which also need to be added to the document.
In some cases, contractors may wish to include provisions that protect them from delays caused by circumstances out of their control, such as weather.
In the document, a payment structure, including prices and deadlines, should be specified.
Typically, construction projects are not paid for in one lump sum, and they are instead broken down into various stages.
If a retainer fee was agreed on (an amount of money paid upfront, typically to a third party), it needs to be included in the document.
Dispute Resolution Clauses
The contract should outline mechanisms to be used in the case of disputes.
These clauses help both parties to avoid court proceedings.
Common mechanisms include arbitration, mediation, and litigation.
Insurance and Liability
Insurance and liability provisions are essential elements of construction contracts that protect both parties in the event of accidents or damages.
Construction contractors are required to have certain liability and workers’ compensation insurance that need to be included in the contract.
Which party is responsible for acquiring permits and approvals that are necessary for completing the project should be stated in the contract.
Usually, the contractor will include acquiring permits as a part of their services and add it to the total price of the project.
Some contracts will include specifications of the contractor’s obligation to provide maintenance for a certain period of time.
These provisions are essential to assure the owners that future problems are covered within the agreement.
**Keep in mind that certain states and municipalities will require certain elements to be included in the contract.
For example, Florida requires a visible lien notice.
Reputable contractors will be aware of these requirements, but owners can check online to ensure the contract checks all the boxes.
4. What Are the Different Types of Construction Contracts?
There are five main types of construction contracts, and which one is used depends on the scope of the project and the preferences of the owner and contractor.
It’s especially important for owners to understand the implications of the type of contract presented if they are unfamiliar with the different types.
So, let’s take a look at each one.
Here are the five main types of construction contracts:
A fixed price contract, also called a lump-sum contract, creates an agreement of a predetermined price of the project between the owner and contractor.
The contractor would be responsible for any cost overruns.
This type of contract provides the utmost price clarity for the client and motivates the contractor to be as efficient as possible to avoid additional costs.
In a cost-plus contract, the owner reimburses the contractor for all construction costs incurred and pays an agreed-upon markup fee.
The costs could include materials, labor, and equipment.
These types of contracts are great if the exact specifications of the project are uncertain.
However, owners will be unaware of the total price until the project is completed.
Time and Material Contracts
A time and material contract refers to an agreement that obliges the owner to pay the contractor based on the time spent working and materials used.
The contractor receives hourly pay and provides receipts of materials purchased to be reimbursed.
This type of contract is great for projects with specifications that may frequently change.
On the downside, it creates potential disagreements on time actually spent working.
Unit Price Contracts
In a unit price contract, the total cost of the project is based on a fixed price for each unit of work.
A unit of work refers to a repeatable aspect of the project.
For example, if a contractor is installing flooring, the price may be based on each square foot.
This contract is best for projects with repeatable tasks that are simple to quantity.
Guaranteed Maximum Price Contracts
In a guaranteed maximum price (GMP) contract, the contractor sets a maximum cost for the project.
If the project is completed below the set price, the client benefits.
If the price exceeds the maximum price, the contractor will see a cut in profits.
This type of contract motivates contractors to control expenses, but it potentially leads to disputes over costs incurred.
5. How Can You Negotiate Terms in a Construction Contract?
Negotiating a construction contract can be uncomfortable, but it’s an important step for both parties to protect their interests.
Negotiating the terms and conditions of a construction contract is just like anything else.
Each party needs to carefully read the content of the document, note discrepancies, and find a way to resolve them.
If certain aspects of the contract cannot be agreed upon, one party will have to accept what is being offered or choose not to continue with the project.
Here are some tips to help negotiate terms in a construction contract:
Read the entire contract.
Define clear goals.
Research industry standards.
Maintain a respectful relationship.
Be open to compromise.
Seek legal advice.
Include dispute resolution procedures.
Document and sign all agreements.
During the negotiating process, it’s important to stay level-headed and patient.
Rushing into an agreement that you are not happy with because you want to get the project started can lead to disputes in the future.
6. What Are the Common Pitfalls to Avoid?
Construction contracts are crucial for providing protection to all parties, but there are some key pitfalls to look out for to ensure the contract is valid and effective.
Here are the most common pitfalls to avoid in a construction contract:
The language used in a construction contract needs to be clear and exact.
Ambiguous language could lead to disputes, causing delays and unwanted disagreements or confrontations.
Everything from the scope of the project to payment structures to deadlines needs to be straightforward to ensure mutual understanding.
Unclear Payment Terms
Unclear payment terms are a major red flag.
Construction projects are costly, and the contract should specify the payment amount, how the payments will be made, and when the payments will be delivered.
If the payment terms aren’t specified, both contractors and property owners are vulnerable to being taken advantage of.
Lack of Change Order Clause
It’s not uncommon for changes to be made during the construction process.
So, the contract needs to outline change order procedures in case modifications are needed.
If the contract doesn’t include a change order clause, it can complicate the process of making modifications, causing delays, disputes, legal vulnerabilities, and contract breaches.
Lack of Insurance and Liability Provisions
Insurance and liability provisions are crucial to protect both parties and workers involved in the project.
A lack of these provisions will create a massive risk for both property owners and contractors if accidents or property damage occurs.
Often, insurance and liability provisions are required by the local government.
Lack of Delay and Extension Provisions
Unexpected delays are common in construction projects.
There are several factors that are out of both parties’ control, such as weather and material deliveries.
Failing to include delay and extension provisions could lead to parties being unfairly penalized for circumstances they did not cause.
So, it’s important to add these provisions to avoid disputes, ensure the quality of work is maintained, and help anticipate cost escalation due to delays.
Construction projects are exciting.
Property owners can look forward to new beginnings, and contractors can look forward to a money-making opportunity.
However, there is a lot on the line when it comes to these projects.
Property owners put in large chunks of money, and contractors put in countless hours of hard labor.
To ensure both parties’ interests are protected during the building process, a construction contract is vital.
When these documents are created correctly, they will help resolve disputes, verify payment terms, and specify the scope of the project.
Property owners and contractors put themselves at great financial and legal risk by agreeing to a project without a contract.
Always consult with a legal professional if there are any questions regarding the validity of the document.
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Disclaimer: we are not lawyers, accountants or financial advisors and the information in this article is for informational purposes only. This article is based on our own research and experience and we do our best to keep it accurate and up-to-date, but it may contain errors. Please be sure to consult a legal or financial professional before making any investment decisions.