What type of Construction Contract Do You Need? (Fixed vs. Cost Plus)
Most residential contractors believe they have a fixed price contract. They submit a bid, which the homeowner accepts, and that price is included in the contract. In reality, though, most contracts are hybrids: a combination of fixed and fluctuating costs. For instance, the contract may specify a $5,000 allowance for appliances, but the actual cost may end up being $6,000. The contractor almost certainly would expect to receive the additional $1,000.
If you do have a hybrid contract, make sure the contract specifies which prices are subject to adjustment. In the appliance example above, you would need to ensure your contract requires the owner to pay costs in excess of the allowance amount. And it may also be a good idea to document any excess costs as a formal change order.
Ambiguity and uncertainty lead to disputes. A true fixed price contract should be just that: fixed. It should not be subject to adjustment unless there is a change order. To create a true fixed price agreement, you will want to bid on the project very carefully. Think through the Scope of Work carefully considering all the appliances, fixtures, etc. that the home will need, as well as the quality of these items, so that you can form an accurate bid. For instance, an allowance for fixtures in a custom home should be higher than the same fixture allowance in a standard one.
The common alternative to a fixed price contract is a Cost Plus agreement. A cost-plus agreement compensates the builder for their actual material costs plus an agreed-upon percentage on top of that cost for overhead and profit. A cost-plus agreement solves a lot of common problems. For one, it does not require the builder to estimate a price for unknown allowances. Since the cost isn’t fixed, however, homeowners (and lenders) are reluctant to agree to them for fear that there will be significant cost overruns. One solution to this problem is to build in a “cap.” That is, the contract would specify that the costs would not exceed a certain agreed-upon amount (absent a change order).
Whether you need a Fixed Price Agreement or a Cost Plus Contract, Downs Law is here to help! We know construction agreements can be confusing - but they don’t have to be. In our free e-book, we’ve taken 10 important contract provisions and distilled them into plain, understandable language. You will be able to use these as a guide to determine whether your contract is on solid footing, or whether it needs more attention. Contact us with any contract concerns today!