CONTRACTS

Construction Contract

üAn agreement between two or more parties to provide

services in exchange for payment.
üEvery promise and every set of promises, forming the
consideration for each other, is an Agreement
üThe Agreement must create legal obligations between the
parties is an Enforceable
The Agreement should contain:

üThe names of contracting parties

üA brief description of the work
üA list of contract documents, including agreement, general
conditions, drawings and specifications
üThe procedures for payment
üThe contract time, or dates for start and completion
üThe signatures of contracting parties and witnesses
Contract Environment
Construction is a product-oriented activity that has many dimensions. One
of these dimensions is the business side of construction. The business world is
structured by contractual relationships, and the business aspects of construction
require the establishment of contractual relationships with a wide range of
parties. The central role played by contracts is reflected by the fact that
construction firms are referred to as “contractors.” In addition to the contractual
relationship with the owner/client, construction managers supervise contracts
with subcontractors, specialty firms such as scheduling services, labor unions, as
well as equipment and materials vendors.
Contract Environment
Insurance and bonds as well as the documents establishing the legal structure of a
company have the elements of contractual requirements. This chapter
investigates the major contractual forms used to establish contracts for the
construction of projects.
An agreement between two or more competent parties to do something
for a consideration establishes the basis for a contract. What is agreed to be
performed (or refrained to be performed) cannot be impossible or enjoined by
law. For example, a contract cannot bind a party to perform an illegal act or one
that would be virtually impossible, such as completing a 20-story building in a
week.
The courts are often called upon to determine:
1. Who are the parties to a contract?
2. What are their promises?
3. What are other aspects of the contractual agreement?

A whole body of law has grown up around the many aspects of contractual
relationships. Because these issues remain constant for most construction situations,
contract language in the construction industry has been normalized over many years
and a variety of standard contract forms have developed.
Process of Pruchasing Construction
Construction Contracts structure the way in which construction is
“purchased.” It is interesting to compare the construction purchasing system with
the way in which we would buy a new lawn mower or a set of living room
furniture. Consumers who need to purchase something go to a store, look at the
range of product choices, and then pay a single supplier (the store owner) for the
item of interest. If, for instance, we need a refrigerator, we go to an appliance
store, inspect the various models, check prices, select one for purchase, pay for it,
and the store owner sends it to our house or apartment within the next few days.
Two major aspects of this process contrast with the way in which we “buy”
construction.
1. We have the finished product available for our inspection, and we can decide
whether it meets our requirements. That is, the manufactured product is
available for our inspection prior to purchase.
2. Because the final product is available, we purchase it from a single individual
or source
 In construction, the facility is purchased before it is “manufactured” based
on a set of drawings and work descriptions. Also, the end item requires the
purchaser to coordinate many entities to include designer(s), contractor(s),
specialty subcontractors, and vendors. It is as if to buy a refrigerator we must
develop a drawing of the refrigerator, purchase the materials required, and then
coordinate 10 different entities who build it for us. Typically, none of the entities
building the end item will warrant the proper operation of the refrigerator. They
will only warrant the work that they provide.
 In the building of the Brooklyn Bridge, Washington Roebling ordered a gigantic
wooden box (e.g., a caisson) that was built by a local shipyard. The shipyard required
payment in advance and would only warrant that the box was built according to plans
that Roebling provided. They would not guarantee that it would perform adequately as
a caisson because they did not know what a caisson was or how it was to be used.
Ideally, we would like to go to a single source and purchase the construction
project as a finished unit. Obviously, in construction this is seldom possible. Traditional
contract formats address this problem by focusing on the purchase of the design from
a single entity (e.g., the design professional) and the construction of the facility by a
general contractor who purchases the needed materials and services and coordinates
the work of all the entities building the facility.
 Major Construction Contract Types
The most widely used format of contract is the competitively bid contract. For a
number of reasons, almost all contracts that involve public funds are awarded using
competitively bid contracts. A competitively bid contract is used because it yields a low
and competitive price that ensures taxpayers that their monies are being equitably and
cost-effectively disbursed.
The two main categories of competitively bid contracts are
(a) the lump sum contract (also called stipulated sum contract) and
(b) the unit-price contract.
The names of both of these contract formats refer to the method in which the price for
the work is quoted.
 The second most widely used contract format is the negotiated contract. This
form of contract is also referred to as a cost-plus contract, although this refers to the
method of payment rather than the nature of the selection process. The contractor is
reimbursed for the cost of doing the work plus a fee. In this type of contract, the
contractor risk is greatly reduced because the requirement of completing the work at a
fixed price is not present.
 Competitively Bid Contracts
Essentially, the owner invites a quote for the work to be performed based on
complete plans and specifications. The award of contract is generally made to the
lowest responsible bidder. The word responsible is important since the contractor
submitting the lowest bid may not, in fact, be competent to carry out the work. Once
bids have been opened and read publicly (at the time and place announced in the
notice to bidders), an “apparent ” low bidder is announced. The owner then
immediately reviews the qualifications of the bidders in ascending order from lowest to
highest. If the lowest bidder can be considered responsible based on his or her
capability for carrying out the work, then further review is unnecessary
The factors that affect whether a contractor can be considered responsible are the
same as those used in considering a contractor for prequalification:
1. Technical competence and experience
2. Current financial position based on the firm’s balance sheet and income
statement
3. Current amount of work under way
4. Past history of claims litigation
5. Defaults on previous contracts
Because of shortcomings in any of these areas, a contractor can be considered
a risk and, therefore, not responsible.
 Generally, the advantages that derive from the use of competitively bid
contracts are two fold. First, because of the competitive nature of the award, selection
of the low bidder ensures that the lowest responsible price is obtained. This is only
theoretically true, however, as change orders and modifications to the contract tend to
offset or negate this advantage and increase the contract price. Some contractors,
upon finding a set of poorly defined plans and specifications, will purposely bid low
(i.e., zero or negative profit) knowing that many change orders will be necessary and
will yield a handsome profit. That is, they will bid low to get the award and then
negotiate high prices on the many change orders that are issued
 The major advantage, which is essential for public work, is that all bidders are
treated equally and there are no favorites. This is important because in the public
sector political influence and other pressures could bias the selection of the contractor.
 The competitive method of awarding construction contracts has several
inherent disadvantages. First, the plans and specifications must be totally complete
prior to bid advertisement. This leads to a sequentiality of design followed by
construction and breaks down feedback from the field regarding the appropriateness
of the design. Also, it tends to extend the total design-build time frame as the
shortening of time available by designing and constructing in parallel is not possible. In
many cases, the owner wants to commence construction as quickly as possible to
achieve an early completion and avoid the escalating prices of labor and materials. The
requirement that all design must be complete before construction commences
preempts any opportunity for commencing construction while design is still under way
 Stipulated-Sum Contracts
A lump-sum, or stipulated-sum, contract is one in which the contractor quotes
one price, which covers all work and services required by the contract plans and
specifications. In this format, the owner goes to a set of firms with a complete set of
plans and specifications and asks for a single quoted price for the entire job. The price
quoted by the boat builder is the total cost of building the vessel and is a lump-sum
price. Thus, the lump sum must include not only the contractor’s direct costs for labor,
machines, and so forth but also all indirect costs such as field and front office
supervision, secretarial support, and equipment maintenance and support costs. It
must also include profit.
 In stipulated-sum contracts the price quoted is a guaranteed price for the work
specified in the plans and supporting documents. This is helpful for the owner because
he or she knows the exact amount of money that must be budgeted for the project,
barring any contingencies or change of contractual documents (i.e., change orders).
In addition, the contractor receives monthly progress payments based on the
estimated percentage of the total job that has been completed. In other contract forms,
precise field measurement of the quantity of work placed (e.g., cubic yards of concrete)
must be made continuously because the contractor is paid based on the units placed
rather than on the percentage of job completed. Because the percentage of the total
contract completed is an estimate, the accuracy of the field measurements of
quantities placed need only be accurate enough to establish the estimated percentage
of the project completed.
 In addition to the disadvantage already noted (i.e., the requirement to have
detailed plans and specifications complete before bidding and construction can begin),
the difficulties involved in changing design or modifying the contract based on changed
conditions are an important disadvantage. The flexibility of this contract form is limited.
Any deviation from the original plans and specifications to accommodate a change
must be handled as a change order. This leads to the potential for litigation and
considerable wrangling over the cost of contract changes and increase the adversary
relationship between owner and contractor.
 The stipulated-sum contract is used primarily in building construction in which
detailed plans and specifications requiring little or no modification can be developed.
Contracts with large quantities of earthwork or subsurface work are not normally
handled on a lump-sum basis as such contracts must be flexible enough to handle the
imponderables of working below grade. Public contracts for buildings and housing are
typical candidates for lump-sum competitively bid contracts
 Unit-Price Contracts
In contrast to the lump-sum, or fixed-price, type of contract, the unit-price
contract allows some flexibility in meeting variations in the amount and quantity of
work encountered during construction. In this type of contract, the project is broken
down into work items that can be characterized by units such as cubic meters/feet,
linear and square meters/feet, and piece numbers (e.g., 16 window frames). The
contractor quotes the price by units rather than as a single total contract price. For
instance, he or she quotes a price per cubic meter for concrete, machine excavation,
square meter of masonry wall, and the like. The contract proposal contains a list of all
work items to be defined for payment.
 Most unit-price contracts provide for a price renegotiation in the event that the
actual field quantity placed deviates significantly from the guide quantity specified. If
the deviation exceeds 10%, the unit price is normally renegotiated. If the field quantity
is over 10% greater than the specified guide quantity, the owner or the owner’s
representative will request a price reduction based on economies possible due to the
larger placement quantity. If the field quantity is less than the guide quantity by more
than 10%, the contractor will usually ask to increase the unit price. He or she will argue
that to recover mobilization, demobilization, and overhead, prices must be increased
because they were based on the larger guide quantities provided in the bid schedule.
That is, there are fewer units across which to recover these costs and, therefore, the
unit price must be adjusted upward.
 In developing the unit-price quotation, the contractor must include not only
direct costs for the unit but also indirect costs such as field and office overheads as well
as a provision for profit.
In unit-price contracts, the progress payments for the contractor are based on
precise measurement of the field quantities placed. Therefore, the owner should have
a good indication of the total cost of the project based on the grand total price
submitted. However, deviations between field-measured quantities and the guide
quantities will lead to deviations in overall job price.
 One disadvantage of the unit price contract is that the owner does not have a
precise final price for the work until the project is complete. In other words, allowances
in the budget for deviations must be made. In addition, the precision of field
measurement of quantities is much more critical than with the lump-sum contract. The
measured field quantities must be exact because they are, in fact, the payment
quantities. Therefore, the owner’s quantity measurement teams must be more careful
and precise in their assessments as their quantity determinations establish the actual
cost of the project.
 Unit-price contracts ca n a l s o be
manipulated using the technique called

u n b a l a n c i n g th e b i d . T h e re l at i o n s h i p
between the contractor’s expenditures and
income across the life of a typical project is
shown schematically in the figure. Because of
delays in payment and retainage, the revenue
curve lags behind the expenditure curve and
leads the contractor to borrow money to finance the difference. The shaded area gives
an approximate indication of the amount of overdraft the contractor must support at
the bank pending reimbursement from the client.
 One way to achieve this is to unbalance the bid. Essentially, for those items
that occur early in the construction, inflated unit prices are quoted. For example, hand
excavation that in fact costs 2,000 per cubic meter will be quoted at 3000 per cubic
meter. Foundation piles that cost 4,000 per linear meter will be quoted at 4,500 per
linear meter. Because these items are overpriced, to remain competitive, the
contractor must reduce the quoted prices for latter bid items. “Close-out” items such
as landscaping and paving will be quoted at lower-than-cost prices. This has the effect
of moving reimbursement for the work forward in the project construction period. It
unbalances the cost of the bid items leading to front-end loading.
The amount of overdraft financing is reduced,
as shown by the revenue and expense profiles
in the figure. Owners using the unit-price
contract format are usually sensitive to this
practice by bidders. If the level of unbalancing
the quotations for early project bid items
versus later ones is too large, the owner may
ask the contractor to justify his or her price or
even reject the bid.
Unbalanced bidding is a serious problem for capital project owners because it may
increase the risk of construction cost overrun as well as increase the risk of fraud. An
example of unbalanced bids is when a bidder frontloads the bid price whereby
overstating the unit price of line items scheduled to be performed early in the project
and understates the unit price of line items performed later. By allowing frontloading
the bid, the project owner will increase the risk of project cost overrun should the
contractor get terminated or walk away from the project as the remaining contract’s
balance could be much less than the actual cost needed to close the project.
Therefore, by disallowing unbalanced bids, project owners can ensure that the
bid price for each line item in the bill of quantity is credible and realistic and it can be
used to baseline the project cost with confidence.
 Negotiated Contracts
A negotiated bid involves a single general contractor who works on behalf of
the project owner. A designated construction manager forms a trusted relationship
with a project owner and architect from the very beginning of the planning process
through completion, designing and developing an attainable and affordable plan that
meets expectations.
The negotiated bid is the most common method of bidding. It is a more
straightforward, less formal process that is applicable for most projects. Also, most
project owners prefer to negotiate price and terms directly with the general contractor
of their choice.
Since project owners work directly with the general contractor, there is less risk of
leaving out important details that could affect the bid estimate. Also, consulting
directly with the client gives the contractor the ability to make recommendations
regarding materials, delivery method, value engineering principles and other variables
that can significantly reduce construction costs with higher quality work. Another
advantage of using the negotiated bid process is that it allows the client and contractor
to solidify their relationship. The mutual goal for both parties is the successful delivery
of the construction project that is within established budgetary guidelines.
 However, despite having the advantage o being more flexible, negotiated
contracts can also be less attractive for clients who may see the lack of competitive
tendering as driving up costs; though it is often the coase that a strong working
relationship with a contractor whose practice is well-known may more than make up
for this over the duration of the project.
Negotiated contracts may not be permitted by some organizations due to the
perceived lack of accountability. On public projects, or projects that include a publicly-
funded element, it may be necessary to advertise contracts.
 Advantages:

• Client has flexibility in terms of choosing their preferred contractor;

• Time and cost savings involved in removing the tendering process;
• It can allow early supplier involvement;
• Contractor’s cost and pricing are more transparent as they are not
seeking to win the bid purely on the lowest tender.
 Disadvantages:

• There are fewer options for the client to choose between and so there
may be less innovation;
• The costs may be driven up by the lack of competitive bidding;
• There is a heavy reliance on trust between the parties;
• Unless it is carefully structured and controlled, the negotiation process
can create an adversarial atmosphere, even before the contract has
been awareded;
• It can be seen as anti-competitive and exclusive, with the potential for
cozy relationships to develop between the client and the supplier.
 Project Delivery Methods

In ancient times, great structures were constructed by “master

builders” who developed the project concept, designed the appearance
and technical details of the finished building or monument, and mobilized
the resources needed to realize the final structure. This classical approach
was used to build the pyramids, the great castles and churches of the
Middle Ages, and the civil engineering infrastructure of the industrial
revolution.
Alcazar de Segovia, Spain Malbork Castle, Poland

Pyramid, Egypt
 Over the past 100 years, the processes of designing and building
were gradually separated. Design and construction were viewed as
separate endeavors. A design professional prepared the project plans, and
a separate firm was contracted to perform the actual construction of a
facility. This separation of activities also led to a sequencing of activities in
which design was completed before construction commenced. This
became the “traditional” sequence and is now referred to as Design-Bid-
Build (DBB).
 It has been recognized that the DBB method of project delivery, with
its sequential emphasis, leads to longer-than-necessary project time
frames. It is advantageous from a time perspective to have design and
construction proceed simultaneously. This has led to a reconsideration of
the master builder concept and a discussion of what is meant by “project
delivery systems or methods.”
 In the DBB approach, for instance, the owner holds a contract with
the designer or architect/engineer (A/E) for the development of the plans
and specifications and a separate contract with the construction
contractor for the building of the facility. In other delivery systems, the
owner contracts with a single group or entity for both the design and
construction of a facility.
Another accepted definition is as follows:
A project delivery method is the comprehensive process of assigning the
contractual responsibilities for designing and constructing a project
(Associated General Contractors [AGC], 2004).
 Design Build (DB) and Construction Management (CM) contracts
differ from the traditional DBB format in terms of how they address the
critical issues of project delivery methods. They also facilitate the use of
“phased construction” or “fast-tracking” based on design and construction
occurring in parallel (i.e., at the same time) in contrast to the sequential
nature of the DBB approach.
 Design-Build Contracts

In the 1970s, large firms began to offer both design and

construction services to provide the client with a single source for project
delivery. This approach of providing both design and construction services
can be viewed as a natural evolutionary step beyond the negotiated
contract. It has been common practice in industrial construction to use the
DB approach for complex projects that have tight time requirements. In
such cases, it is advantageous for the client to have a single firm providing
both design and construction services.
 Coordination between design and construction is also enhanced by
having both functions within the same firm. This system improves the
communication between designers and the field construction force and
assists in designing a facility that is not only functional but is also efficient
to construct. DB contracts also have the advantage that design and
construction can be done concurrently. That means that work can be
started in the field before a complete design is available. This allows for
“phased construction,” or a “fast-track” approach as described previously
and a compression of the schedule because design must not be totally
complete prior to commencement of construction
 Construction Management Contracts

In construction-management (CM) type contracts, one firm is

retained to coordinate all activities from concept design through
acceptance of the facility. The firm represents the owner in all construction
management activities. In this type of contract, construction management
is defined as that group of management activities related to a construction
program, carried out during the predesign, design, and construction
phases, which contributes to the control of time and cost in the
construction of a new facility. The CM firm’s position in the classical
relationship linking owner, contractor, and A/E.
Construction Management Contracts
 This firm has the function of a traffic cop or enforcer, controlling the
flows of information among all parties active on the project. The CM firm
establishes the procedures for award of all contracts to architect/engineers,
principal vendors, and the so-called trade or specialty contractors. Major
and minor contractors on the site are referred to as trade contractors. In
this control or management function, the CM firm uses the project
schedule as a road map or flight plan to keep things moving forward in a
timely and cost-effective manner.
 In the DB format, the owner enters into contract with a single
entity—the design builder. The basis of selection of the DB firm or
consortium is normally on the basis of considerations other than least cost.
Fast-tracking or phased construction is typical of DB contracts.
In CM format, the owner holds multiple contracts. In the case of the
Agency Construction Management format, the owner signs a management
contract with the CM, but holds contracts directly with the design and
construction firms involved. Fast-track construction is usual when using
this format.