Fixed-Price, Cost-Plus, or Time-and-Material? Which Contract is Right for Your Job?

If you are a construction professional, knowing which type of contract is right for your job is a crucial starting point in protecting your interests. The purpose of this article is to briefly identify a few contract types common to the construction industry, the circumstances suitable for each, and specific language you should be aware of before signing.

Fixed-price contracts are standard contracts for most construction contractors and subcontractors. Using a lump-sum approach, contractors typically agree to construct the project in accordance with the architect’s plans for a “fixed price,” consisting of the total cost of time, labor, materials, overhead, expenses, and profit that the contractor estimates they will require to complete the work. The obvious advantage of a fixed-price contract for the owner is that it provides a level of certainty regarding the costs of the project. The advantage for the contractor, however, is in the potential increase in profits if it can perform the work faster and more efficiently than presumed during the bidding process. Because the responsibility for all costs and profits (or losses) falls squarely on the shoulders of the contractor, fixed-price contracts are typically ideal for work with costs that can be easily or accurately estimated up front. Contractors who enter fixed-price contracts with tight margins, therefore, should note the importance of incorporating language into the agreement that authorizes price adjustments for change orders, differing site conditions, delay, and any other potential issues that may add unforeseen costs over the course of the project.

Unlike in a fixed-price contract, under a cost-plus agreement, the contractor is paid for providing the materials and labor that the project requires—the “cost”—and an agreed upon percentage of those costs as a profit—the “plus.” The “cost” may be marked-up by the contractor. Under cost-plus contracts, the owner lacks the certainty that a fixed-price contract provides. Because of the incentive for contractors to over-price and under-perform in these circumstances, parties engaged in cost-plus contracts tend to have an established relationship, or at least one in which the owner trusts that the contractor will act in the owner’s best interest by only charging reasonable costs for materials and labor. In most jurisdictions, because the owner must rely so heavily on the contractor’s ability to perform the work honestly and efficiently, the relationship between the owner and contractor in a cost-plus contract is considered a fiduciary relationship. In this fiduciary relationship, the contractor owes the owner a fiduciary duty to only charge reasonable costs for its materials and labor. Many standard cost-plus contracts reflect this understanding, including the American Institute of Architect’s AIA Form 111. Therefore, contractors in cost-plus contracts should be aware of whether the language in their contract expressly places upon them a duty to avoid cost overruns and to disclose an accurate accounting of all costs. In cases where contractors have failed to satisfy these expressed obligations, courts have often denied them the right of reimbursement for costs associated with the non-compliant work.

Contrary to both fixed-price and cost-plus contracts, time and material (T&M) contracts are essentially open-ended contracts, in which the contractor is paid for providing labor and materials for the job as well as a fee to account for overhead, expenses, and profit. Under T&M contracts, the “cost” is typically not marked up. Of the three construction contract types discussed in this article, this particular contract tends to place the least amount of risk or responsibility on the contractor. For this reason, T&M contracts are typically only utilized when an accurate estimate of the duration of the work or the costs associated with that work cannot be reasonably inferred at the outset of the job. Due to the heavy risk assumed by owners in T&M contracts, it is commonplace for owners to include language that expresses a certain maximum price that the total costs of the project may not exceed, commonly referred to as a “Guaranteed Maximum Price.” Therefore, when such language is present in the contract, the contractor should always first determine whether it would be reasonable to complete the work within that budget. Moreover, contractors should look to include language that allows for change orders, ensuring the costs associated with any design changes during the project are separate from that maximum preconstruction budget for the original scope of work.

Drafting a contract that provides a full understanding of all the obligations and rights of each party is a tricky process. It is further complicated by the unique nature of any given construction project. In addition to considering the form of the contract, a construction contractor should also consider issues like accurately defining the scope of work, identifying remedies available in the event of a breach, preserving rights to collect attorney’s fees and costs in the event of breach, specifically non-payment, and other significant clauses.

For more information or assistance in navigating complex contract issues, contact an attorney at Galvanize Law. We are happy to discuss any questions or concerns you may have regarding your construction contracts.