Understanding the Most Popular Types of Construction Contracts: Lump Sum, Cost Plus, and Guaranteed Maximum Price

Contract of Construction Architech project signing on construction site. Architect design on planning project with yellow helmet man, stationery set

When starting a construction project, choosing the right contract type is crucial for owners. Your contract should help you to define the scope of work, allocate and define costs, allocate and manage risk, and set up a deadline for the project.
The three most common types of construction contracts are lump sum, cost plus, and guaranteed maximum price contracts. While there are certainly more contract types, these are the contracts you are most likely to run into, and most other contract types are just more advanced versions of these contracts. Each of these contracts comes with its own set of advantages and considerations. In this article, we will explore the differences between these contract types to help owners and contractors make informed decisions.
Lump Sum Contract
A lump sum contract, also known as a fixed-price contract, is a straightforward agreement where the contractor agrees to complete the project for a set price. The contractor bears the risk of cost overruns, making it a popular choice for clients who want a predictable budget. This is a particularly good option for owners who have plans in their possession, especially plans prepared by an architect. Since the plans are already in place, the contractor should easily be able to determine all work that needs to be done, and therefore the contractor can make an accurate bid for the entire project.
Key features of a lump sum contract include:
Clear Budgeting: Owners know the total cost upfront, providing budget certainty.
Limited Change Orders: Changes to the project scope may result in additional costs as change orders are handled separately.
Fixed Scope: The scope of work is well-defined, and any deviations may incur additional charges.
Risk Transfer: The contractor assumes the risk of cost overruns and project delays.
Cost Plus Contract
A cost plus contract involves the owner paying for the actual costs of labor and materials, plus a predetermined fee for the contractor’s overhead and services, typically a percentage of the total cost of the project. Cost plus contracts are beneficial for projects with uncertain scopes (such as projects with no plans in place) or projects that will frequently be changed.
Key features of a cost plus contract include:
Transparency: Owners have visibility into project costs and can monitor expenses, including approving or disapproving work before the work is performed.
Flexibility: Allows for changes to the project scope without significant financial impact.
Known Risk: Owners are aware of risks, such as cost overruns, and can either choose to commit to those increased costs or simply not perform the additional work.
Guaranteed Maximum Price Contract
A guaranteed maximum price (GMP) contract combines elements of both lump sum and cost plus contracts. In a GMP contract, the contractor agrees to complete the project for a set maximum price, with cost savings typically shared between the owner and contractor, which provides an incentive for the contractor coming in under budget.
Key features of a GMP contract include:
Cost Control: Provides cost predictability similar to a lump sum contract.
Risk Management: Contractors assume the risk of cost overruns up to the agreed-upon maximum price.
Transparency: Homeowners have visibility into costs and can monitor project expenses.
Selecting the right type of construction contract is a critical decision that can impact project outcomes, costs, and overall success. Whether you decide to enter into a lump sum or cost-plus contract, the important thing is to have a contract in place that defines the work, the costs, the risks, and the liabilities of the parties. Contract disputes are common in construction projects, and having a well-defined and thoughtful contract can help mitigate some of those disputes before they happen. Fortney Law regularly assists clients with developing, understanding, and negotiating construction contracts. Don’t leave your project to chance. Make sure you have a rock-solid contract in place before you start construction.