What Type of Contract is Best for You?
Updated: Nov 22, 2021
Creating a solid contract prior to when work begins protects both the contractor and the client. Even small jobs can lead to big misunderstandings when not clearly defined from the beginning.
We recently blogged about who should sign a construction contract (on both sides) and how to clearly define the scope of work. With those pieces in place, it's time to discuss what to consider when pricing your work and how to determine if fixed price or cost-plus budgeting is the best option for the job.
Is Your Contract Really Fixed?
Most residential contractors use fixed pricing in their contracts. It works like this: they submit a bid, the homeowner accepts, and that price is added to the contract. In reality, though, most contracts are not cut-and-dried, but are hybrid in nature, including 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, right? If so, it's important to know how you will account for these overages – and clarity is key!
So if you have a hybrid contract, make sure it 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.
When a client agrees to a fixed cost in their contract, they will likely be very attached to that number and unhappy each time an overage is incurred. To set better expectations and ensure a more congenial working relationship with your clients, it's a good idea to discuss with them fixed costs, hybrid pricing and how allowances and overages will work for the job at hand.
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 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 you can form an accurate bid. For instance, an allowance for fixtures in a high-end custom home should be higher than the same fixture allowance in a more standard one.
The common alternative to a fixed price contract is a Cost Plus agreement, which 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).
If this post reminds you that your contracts may need an update – contact us right away! It’s always better to be prepared rather than sorry you weren’t! Reach out to us before you and your client sign on the bottom line – we are happy to help you create and/or review your construction contract. And should you find yourself in a contractual dispute during a construction project, Downs Law has the expertise to help you resolve the conflict. Contact us today and get the help you need!