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Categories: Business

Various kinds of construction contracts explained

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This post will help explain the various kinds of construction contracts present in the industry. It will also explain how to choose the right kind of contract for the next project. Though the same general principles should be applicable to residential projects, this post will be focusing on commercial construction contracts.

Key questions that need answers

Though there are a number of different contracts to choose from, and a number of considerations to need to be taken into consideration. Yet, most of the time issues go down to three main questions:

  • Does the company need to start work?
  • Has the contractor placed orders before the design will be finished?
  • Do clients/contractors want their builder to provide input on the design before it is finalized and the price is hence fixed?
  • Would companies prefer retaining control of consultants throughout the project?

The answers to these questions will help determine the kind of contract that needs consideration. Here are the main options:

  • Lump-Sum Construction only (for instance AS 4000, AS 2124);
  • Lump-Sum Design & Construct (‘D&C’) (For instance AS 4902, AS 4300);
  • Early Contractor Involvement Construction only (for instance AS 4916, modified AS 4000 or modified AS 2124);
  • Early Contractor Involvement Design and Construction (For instance AS 4916, modified AS 4902 or modified AS 4300).

Although there are a variety of other forms of contract, as per the Australian Standard forms of contract, its examples were mentioned above. They also tend to be the most commonly used ones too.

Lump Sum compared to Early Contractor Involvement (ECI)

A lump-sum contract is a contract where the contractor is engaged to carry out an agreed scope of the works for a lump sum price agreed. In comparison, Early Contractor Involvement (ECI) contracts are often arrangements based on the ‘cost plus’ model.

This means, the contractor is paid a fee for its preliminary works, profit, and overheads (often referred to as cost), ‘plus’ an amount for the contractor’s third party expenses (often subcontractor and consultant costs) for conducting the project.

Lump-sum contracts have a tendency to be the most effective when the works’ design is insufficient detail, to enable contractors to propose a lump sum price. As a general rule, if more uncertainty is present in the scope, more risk is present for the contractor. Hence, higher likelihood of higher prices too.

Does the contractor really need to start work or has the contractor placed orders before the design’s completion and the price getting fixed?

If the answer to such a question is yes, then the parties involved have no option but to go for an ECI contract. The key difference between lump sum and ECI contracts is that, at the time when a party enters into the contract under an ECI contract, they are likely to have the least certainty around the final scope along with the price of the works.

Three key advantages of an ECI contract, as determined by Project Advisory experts, are as under:

  • These contracts are much better suited to fast-track projects.
  • ECI contracts are more flexible than lump-sum contracts.
  • These contracts usually include a competitive tender process for the trade works, which will usually be carried out on an open book basis.

If the project’s design is complete, almost, and there are only a handful of design elements outstanding, a lump sum project can still be used with provisional sums allocated to outstanding design elements.

Do clients want their builder to provide input on the design before its finalization?

Where work is straightforward, and there is an assumption that time is not an issue, conventional lump-sum contracting is often preferred. Reasons for such are as under:

  • A lump sum tender process ensures the principal will have the benefit of competitive pricing.
  • A lump-sum contract will give the principal more certainty regarding the project’s final cost at an early stage.

However, there are situations where a principal can benefit from input from the builder before the works’ design has been finalized. The most common situations are where the project involves complicated design or complex elements of construction. Another reason may be the principal desires input from a builder to help manage the budget (quantum analysis).

As part of their obligations under an ECI contract, contractors are often expected to provide help in the following places:

  • Buildability: Finding challenges that can arise during construction works. It also means working with the design team to look for solutions to avoid these issues, and possibly overcome them.
  • Value Engineering: Identification of potential changes to the design where savings might be possible, in case there are budgetary constraints.
  • Design management: coordinating with the design team to make sure that the design is finalized as per the program and within the principal’s allocated budget.

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