Contracts are vital regardless of the size of your construction business. These agreements will protect you from unforeseen risks and help your business succeed. They are also crucial to maintaining the validity of your license.
A construction contract sets out the client and contractor’s responsibilities, expectations, timelines, and prices. Unlike the bid, which is an estimate of the costs, a contract typically lays out costs clearly and assigns obligations to pay for any overages. It tells each party involved the essential details and plans for the project. If something vital is missed in a contract, it could strain your relationship with the client or, in a worst-case scenario, lead to litigation.
Many states also require the client and contractor to sign a contract before receiving a permit for the construction project. Even if this is not the case where you work, a contract is essential for payment guarantees, liability protection, and risk management.
Writing a contract when you have never done it before can be challenging. How can you be certain you’ve covered everything and avoided mistakes that could have financial and legal consequences?
Here are some of the most important points to understand when it comes to construction contracts.
Types of Construction Contracts
Every construction project is unique, and not all construction contracts are equal. There are at least four common types of agreements. While there are many more varieties, including some very specialized ones, these four are the most common. These are the ones you are most likely to encounter.
Fixed-price contracts are also known as lump-sum contracts and, as their name suggests, provide a set price for the entire project. The contractor assumes all of the risks. If there are extra costs, they have to cover them. However, they also stand to profit if they can set a reasonable price and keep their costs down.
Fixed-price contracts often include clauses to cover penalties or correct damages if the work is not up to par or the contractor completes it later than the agreed-upon date.
Cost-plus contracts are an agreement on the total costs of the project, including materials, labor, and overheads. The “plus” part of the name can either be a percentage of the total price or a fixed fee imposed on top of the total cost. They transfer most of the risk to the client because they have to foot the bill for the materials, subcontractors, and fees. They then pay the contractor on top of that.
This agreement protects the contractor from clients who don’t give all the details upfront or make additional demands when work is already underway. That said, cost-plus contracts often have a guaranteed maximum price, which puts a cap on the project fee.
Time and Material Contracts
A time and material contract, like a cost-plus contract, is meant to protect the contractor, especially if the project has a significant degree of uncertainty. The client agrees to pay a fixed hourly or daily rate. Note, however, that there can still be a clause in the contract for a guaranteed maximum price.
Such contracts are popular when the project’s scope is small enough that a contractor will likely finish it in a couple of weeks.
Unit pricing contracts are most common when contractors are bidding, especially for government projects or large developments.
A unit-pricing agreement involves a standard amount without a markup for a specific unit of work. A unit gets defined in the contract, as do the time frame and benchmarks. These agreements offer protection for both parties. The contractor knows what they will get paid for work completed, and the client only has to commit to smaller units rather than a larger, costlier project.
Sections of a Construction Contract
The first step you should take is to check local and state legal requirements to determine if certain disclosures, notices, or clauses are required in construction contracts. Some local and state permitting authorities have templates that you can use to ensure that you include all legal requirements.
With that in mind, below are the principal elements every construction contract should have:
- Title. This is the easiest step. The contract should have a title at the top that identifies the specific project.
- Preamble. There should also be a preamble to establish the names of the parties involved, the terms used to identify them, the start and end dates of the project, and the location.
- Project Overview. Next in line is an overview of the project. This section does not have to be detailed. You should only briefly talk about the purpose and goals of the project in a couple of sentences
- Description of Work. In this section, you will include a detailed description of the project, including the specific stages and the work required in each stage. You also include information about tools, equipment, and materials. Try to be as detailed as you can, down to the brand and color of paint the client chose. This information can be essential if there is a disagreement about project details later.
- Project Schedule. Depending on the requirements of your state, you may also need to include a project schedule. Include the exact start and end dates or a proposed timeline. You should also add dates or timelines for stages in the project, making sure to leave room for variance and contingencies.
- Contingency Clauses. You should have a section that covers how to handle unexpected events. Weather events, issues with the site or materials, or existing deficiencies in the building could change the project drastically. You need to agree on set procedures should something unforeseen occur.
- Financial Requirements. This section will cover the financial responsibilities, requirements, and amounts associated with the project. You will state whether the client will offer a down payment or installments. You include due dates and the amounts required for every installment. Additionally, you can add information about late payment penalties.
- Additions and Subtractions. This section covers the procedures for changing the contract.
- Disputes and Claims. This section is a requirement in many states. It covers how to handle any claims and disputes between the parties, including whether cases should be handled via litigation or arbitration.
- Insurance Coverage. This section will state whether you have general contractors’ liability insurance and workers’ compensation insurance. Also, depending on your license requirements, you may need to provide proof of other types of construction insurance.
Tips on Writing a Construction Contract
So now that you understand the components and nuances of a construction contract, here are some useful tips you can employ when writing your own agreements:
- Clarity is your friend. A construction contract is a written expression of the understanding between both parties. You should be clear on the details to avoid ambiguities later on. Specific legal terms and phrases, such as “indemnification” and “time is of the essence,” have particular meanings. Make sure to look up what you don’t understand, and add more-specific details, such as dates or costs, if you feel something is not clear.
- Focus on the most important details. The three most essential elements of any construction project are its scope, time, and price. Be as clear as you can about these things. Provide exact details about the total cost of the project, the contractor’s profit, any extra fees, the scope of the project, and the time to completion.
- All changes should be in writing. Any changes to the agreement should be put in writing. The contract should stipulate how change orders get handled to avoid conflict between you and your client.
- Manage your risk. Even the best-laid plans can go wrong. Make sure you have a plan for unexpected events. First, get quotes on contractors’ insurance for yourself and for your employees. It would help if you also considered looking into the cost of a surety bond and signing up with a suitable bonding company. This coverage protects you if clients are unhappy with your work.