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What is a construction agreement and contracts — All you need to know

A closeup of a man signing a document.

As a construction business owner, contract agreements are key to establishing a clear understanding between you and your customers. Any deal that is entered into for construction purposes requires a legally binding document.

So, it’s important to understand what must be in a contract to protect your business and make your customers happy. 

If you’re looking to learn the ins and outs of construction agreements, you’ve come to the right place. This article will:

  • Explain what a construction contract is.
  • Highlight what a contract must include.
  • Provide tips on how to create agreements that satisfy both parties.

What is a construction contract agreement?

A construction contract agreement is a form that documents all of the work you will do for a customer. A contract is only valid once both parties ratify it by signing in agreement. 

In contrast to a contractor invoice, a construction contract is made before any of the work is done to ensure that both parties are in agreement. From that point, it serves as a point of reference throughout the job and enables the inspection and acceptance of completed work.

A contract always allows for modifications and change orders, but you must amend it accordingly — any area you modify requires proper documentation and reporting.

A construction contract agreement terminates upon completion or satisfaction of contractual obligations.

Purpose of a building construction contract agreement

The main purpose of a contract agreement is to ensure that everyone is on the same page before any work begins. It’s meant to resolve issues before they ever arise.

A construction contract is a legal document. It’s intended to reduce the chance of litigation or arbitration in the event that either party makes claims that were not initially agreed upon or denies claims that were.

Other purposes of a construction contract agreement are that it:

  • Protects intellectual property rights of design and plans.
  • Ensures confidentiality of sensitive information.
  • Facilitates collaboration and communication among stakeholders.

Let’s take a look at the different types of construction agreements.

Types of construction agreements

There are several different ways of going about construction contracts. Deciding which type to go with is one of the most difficult parts of making an agreement.

That said, it’s key to know how to price a job and what format works best for your business before agreeing to a contract and taking on a new project. Here’s a quick guide through the different types of construction contract agreements.

Lump sum contracts

A lump sum contract is the agreement to a single payment of money as opposed to a series of payments over time.

A contractor will deliver services for a predetermined set price. This is one of the simplest agreement forms and works well for projects with a defined scope. There is also room to renegotiate with your clients with this agreement type.

Cost plus contracts

A cost plus contract is a construction agreement where the hiring party pays a contractor all construction-related expenses (cost) with an additional payment for profit (plus).

These costs typically include direct costs such as:

  • Labor.
  • Materials.
  • Equipment and supplies.

Overhead costs such as insurance and administration are typically also included. At the end of a project, the contractor receives an agreed-upon amount which includes a markup percentage for profit.

Unit price contracts

Unit price contracts detail prices per unit, where the customer pays the contractor per unit based on an agreed upon rate. These units usually include:

  • Material.
  • Labor.
  • Supplies.

This type of contract works best for jobs that are easily divided into units such as drywalling. 

Design-build contracts

If your business offers several construction project services, namely architect and engineer services in addition to building, then a design-build contract might be your best choice.

Design-build contracts combine the design and construction of a project into one contract, as opposed to having two separate contracts 

Even if you’re collaborating with a designer and just doing the building, this contract type might still benefit the project as a whole. 

This method streamlines communication and makes it easier for you to account for changes.

Time and material contracts

A time and materials contract establishes a set hourly or daily pay rate and compensates builders for the cost of materials. 

This is one of the most straightforward types of construction agreements and permits flexibility in the overall job that provides for progress payments and retainage. It’s also a great format if you’re paying subcontractors to help you do the job. 

Guaranteed maximum price contract (GMP)

GMP contracts are exactly what they sound like. Under this contract type, the contractor guarantees the maximum amount that the customer will have to pay for a job.

Customers tend to enter into contracts with this format as it limits their risk. Any additional costs beyond the GMP are incurred by the contractor.

With these different types of construction agreements in mind, let’s take a look at the pros and cons of each format.

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Pros of different types of construction agreement formats

Here are a few benefits of the different types of building construction agreement formats:

  • Lump sum contracts: Contractors often get paid the full amount upfront, and determining cash flow is easy.
  • Cost plus contracts: There’s little risk in losing money on materials.
  • Unit price contracts: These contracts give you an easy method for inventory.
  • Design-build contracts: This format skips extra steps by avoiding disputes between designers and builders.
  • Time and materials contracts: Budgets are easier with this format and it’s generally low risk.
  • GMP contracts: Customers tend to love this format, making it a great tactic for closing sales.

Cons of different types of construction contracts

While the benefits are apparent, each type of construction contract format also has its drawbacks:

  • Lump sum contracts: The exact cost is agreed upon in advance, meaning it’s difficult to change the agreement if the job becomes more than expected as you progress.
  • Cost plus contracts: This format requires you to monitor your exact costs throughout the job which creates risk for financial loss.
  • Unit price contract: This isn’t a good fit for complex projects with many moving parts.
  • Design-build contracts: If you’re working with a designer, this method makes estimating more difficult (i.e. additional cost for drawings, schematics, etc.).
  • Time and materials contracts: This format requires very accurate estimates to remain on schedule and retain profitability.
  • GMP contracts: These should only be used by contractors with years of experience, as they’re a big risk to your business. 

Now that you know the potential construction agreement formats you can choose, let’s take a look at what your construction contract should include.

Components of a construction agreement

A construction contract contains provisions that outline the obligations of both the contractor and the customer. 

Every contract will look different based on the job and your business, but there are certain items that you should include in every contract.

To help you out, here are the main details to have in your construction agreements.

Property owner’s information & signature line

Every contract should be personalized to the customer. So, the first step to drafting a construction agreement is having the property owner’s — or customer’s — accurate information.

This information includes:

  • Customer’s name.
  • Address of work site.
  • Phone number and email.

Don’t forget to leave space for your customer to sign.

Contractor’s information & signature line

Your customer gets access to the agreement, so it’s important that your information is accurately detailed on the contract as well.

Your business information should include:

  • Business name.
  • Name of lead contractor (if applicable).
  • Business address.
  • Phone number and email.

Note: Don’t forget a signature line for yourself!

Detailed description of the project plans and specifications

This is the most important section of your construction agreement, as it specifies the scope of work and deliverables, which governs the payment terms and schedule.

Be as detailed as possible when outlining projects. In addition to describing the job process, this part of the contract should include your projected time frame as well as all costs and fees associated with the job. 

Materials needed for the job & any material shortages or delays in delivery

These days, there’s often material shortages that impact construction jobs, and they can happen suddenly and without warning.

To ensure that you cover all your bases, it’s a good idea to add a clause explaining what happens in the event of potential material shortages. Drafting a contract that provides remedies for breaches or delays keeps your finances secure. Draw your customer’s attention to this part of the contract before signing.

It’s one thing to know how to make a construction agreement, but it’s just as important to know what to do when forming an agreement. Let’s take a look at key mistakes to avoid.

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Mistakes to avoid while drafting a construction agreement

One of the most common mistakes made by construction business owners when making contracts is thinking that they don’t need a lawyer.

A contract is a legal document. If ever an issue comes up and you’re in need of mediation (or worse — litigation), the courts will use your contract to determine the outcome and whether you must pay damages. 

If you don’t abide by the terms of your agreement, the courts will enforce consequences once they review your contract. Full accordance with your agreement is the only way to fulfill the legal requirements of your contract.

Naturally, lawyers are integral to creating a bulletproof contract because it:

  • Requires compliance with building codes and regulations.
  • Includes provisions for insurance and warranties.
  • Specifies indemnification and liability provisions.

While you can draft your contract yourself, it’s important that you have a lawyer at least look it over before putting it to use. That way, you ensure everything’s in order and that you comply with any legal requirements. 

Here are some additional mistakes to avoid when drafting a contract:

  • Not putting everything in writing: Verbal agreements are not as strong as written agreements. Make sure that everything verbal is also in the contract in writing so that it effectively binds parties involved in the construction process.
  • Overpromising: If you aren’t sure of a particular outcome, do not make it binding by putting it in the contract. It might be a good idea to prepare a plan that sets forth dispute resolution mechanisms, just in case.
  • Unclear terms: Nothing’s worse than having both parties unclear on a specific clause of a contract, as this often leads to litigation. Make sure each contract clearly establishes the terms and conditions for construction projects before anyone signs.

Key takeaways

Construction agreements protect your business and provide your customers with peace of mind. That’s why it’s crucial to know how to draft a contract that will keep both parties happy.

Hopefully, you’ve learned some useful construction contract tips that you can apply to your agreements moving forward. Good contracts lead to better performance and happier customers! 

Building construction contract agreement FAQs

What is a contract agreement between owner and contractor?

A contract agreement between an owner and contractor is a legal document that sets out the roles and responsibilities of both parties in relation to the project at hand. 

A contract agreement is meant to protect both parties and indicate the intention of forming a legal relationship. It outlines the rights and obligations of each party on a given job.

How do I draft a construction agreement?

Before drafting a construction agreement, you need to have a thorough understanding of the state and conditions of the job, especially since it requires adherence to safety and regulatory standards. You must also determine the best contract format for your business.

It’s best to hire a lawyer to draft the agreement for you, or at the very least, to look over and finalize an agreement that you’ve already drafted.

What are the essential components of a construction contract?

The essential components of a construction contract include:

  • The information of both parties.
  • A full description of the job.
  • The terms of the agreement, including any warranties or late penalties.
  • Signatures from both parties.

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