Types of Project Contracts
If you need to have something built, such as a home, office, barn or warehouse, you can hire a contractor to manage the project and arrange for construction. You and the contractor will enter into an agreement, or a project contract, that spells out what you will pay for, how much you will pay and how much the contractor will earn for his part of the work. You and the contractor are free to negotiate whatever agreement works best for your specific project. However, common types of project contracts include lump sum or fixed price, maximum guaranteed price, cost plus, and price per unit or unit price.
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Lump Sum or Fixed Price
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The lump sum project contract, also commonly known as a fixed price contract, is the simplest to understand. You and the contractor agree to a set price, and you pay that price no matter how much the project ends up costing.
Example: You hire a contractor to build your home for $300,000. If it ends up costing $215,000 to build, the contractor keeps the $85,000 difference as additional profit. However, if the project costs $345,000, then the contractor suffers a $45,000 loss; you still pay the agreed-upon $300,000.
Maximum Guaranteed Price
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The maximum guaranteed price project contract sets a limit on the amount you agree to pay the contractor. If the project costs less, you pay less. If the project costs more, you pay the maximum agreed-upon price and the contractor suffers the loss for the excess.
Example: You hire a contractor to build a home for the maximum price of $300,000. If the house costs only $215,000, you pay $215,000. But if the project costs $345,000, you still pay only $300,000; your contractor must pay the $45,000 excess as a loss. -
Cost Plus
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In the cost plus project contract, you agree to pay the actual cost of the project, plus a fixed amount of profit to the contractor.
Example: You hire a contractor to build a home for the actual cost, and you also agree to pay the contractor an amount equal to 10 percent of that actual cost. If your home costs $300,000 to build, you would pay the contractor another $30,000, making your total price $330,000.
Alternatively, you could agree to pay actual costs plus a specified, flat fee for the contractor. For example, if your home costs $300,000 to build and you agreed to pay the contractor a $20,000 fee, total costs to you would be $320,000.
Price Per Unit
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With this contract, you agree to pay a certain amount for a specific unit of construction. For example, you could agree to pay a certain amount per square foot for the entire project. Or you might pay a certain amount for each portion of the project, such as framing, electrical, plumbing, roofing and finish work. That way, if you decide halfway through the project that you want to double the square footage of a home or office, you can do that; of course, it will just cost extra at the stated amount.
Example: You hire a contractor to build a home for $70 per square foot. You want 2,000 square feet, so you will pay $140,000 total. Alternatively, you might agree to pay $4 per square foot for framing, $3 per square foot for electrical and plumbing, and $2 per square foot for painting and finish work.
Other Options
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The project contracts described in this article are not your limitations, but simply provide some examples of how projects are commonly constructed. You and the contractor should negotiate whatever agreement works best for your project and your relationship. It might include elements of two or more of the project contracts described in this article, or it could be something entirely different. The point is, you are free to negotiate whatever contract you want, and you should use these as examples, not restrictions.
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