5.2 Contract Types & Payment Provisions

Construction Contract Types

The choice of contract type fundamentally defines the allocation of financial risk between the Owner and the Contractor. A Construction Manager must thoroughly understand these contract structures to effectively administer payments, manage changes, and protect the Owner's interests.

1. Lump Sum (Fixed Price)

In a Lump Sum or Fixed Price contract, the Contractor agrees to perform a specified scope of work for a single, predetermined price.

• Risk Allocation: The Contractor bears the majority of the financial risk. If the actual costs exceed the fixed price due to inefficiencies, poor estimating, or price escalation, the Contractor suffers a loss. Conversely, if the Contractor performs efficiently, their profit margin increases.
• Ideal Use Case: Projects with a clearly defined, complete, and fully engineered scope of work (e.g., traditional Design-Bid-Build).
• Administration: Contract administration focuses heavily on verifying that work is complete before approving payments. Changes to the scope require formal Change Orders, which add to or subtract from the fixed price.

2. Cost Plus Fee

In a Cost Plus contract, the Owner agrees to reimburse the Contractor for all allowable actual costs incurred in performing the work, plus a predetermined fee to cover overhead and profit. The fee can be a fixed amount or a percentage of the costs.

• Risk Allocation: The Owner bears almost all the financial risk, as there is no cap on the total cost. The Contractor is guaranteed their costs and fee, assuming the costs are allowable under the contract.
• Ideal Use Case: Projects where the scope is poorly defined, design is incomplete, or emergency work where time is of the essence and waiting for a full design and bid is impossible.
• Administration: This type requires rigorous, open-book auditing by the CM to verify all labor, material, and equipment costs submitted by the Contractor. Only costs explicitly defined as "reimbursable" in the contract are allowed.

3. Guaranteed Maximum Price (GMP)

The Guaranteed Maximum Price (GMP) contract is a hybrid, often used in Construction Management at Risk (CMAR) and Design-Build delivery methods. It functions as a Cost Plus contract up to a specified maximum price.

• Risk Allocation: The risk is shared. The Owner's risk is capped at the GMP. The Contractor bears the risk for any costs that exceed the GMP (cost overruns). If the project is completed for less than the GMP, the savings are typically shared between the Owner and the Contractor based on a pre-negotiated split (e.g., 75% to Owner / 25% to Contractor).
• Ideal Use Case: Projects utilizing fast-track construction where construction begins before the design is 100% complete, allowing the Owner to cap their financial exposure.
• Administration: Like Cost Plus, it requires meticulous auditing of actual costs. The CM must carefully monitor the budget against the GMP and manage the "contingency" fund built into the GMP for unforeseen issues.

4. Unit Price

In a Unit Price contract, the Contractor provides a fixed price for individual units of work (e.g., $50 per cubic yard of concrete, $100 per linear foot of pipe). The total contract price is determined by multiplying the unit price by the actual, measured quantity of work performed.

• Risk Allocation: The Contractor bears the risk of accurately estimating the unit cost, while the Owner bears the risk of the total quantity required.
• Ideal Use Case: Heavy civil and highway projects where the exact quantities of materials (like earthwork or paving) cannot be precisely determined before construction begins.
• Administration: The CM must accurately measure and verify the actual quantities of work placed in the field to approve payment applications.

Payment Provisions and Administration

Managing the flow of money is one of the most critical aspects of contract administration. Late payments can cause severe cash flow problems for the Contractor and subcontractors, potentially stalling the project.

The Schedule of Values (SOV)

For Lump Sum and GMP contracts, the foundation of the payment process is the Schedule of Values (SOV). The SOV is a detailed breakdown of the total contract price into discrete, manageable work activities or components (e.g., Site Prep, Foundation Concrete, Structural Steel, Roofing).

Before any payments are made, the CM and Architect must review and approve the Contractor's proposed SOV. The CM must ensure the SOV is "front-loaded." Front-loading occurs when a Contractor artificially inflates the value of early work activities (like mobilization or site prep) to receive more cash early in the project. While some mobilization costs are legitimate, excessive front-loading leaves the Owner under-collateralized if the Contractor defaults later in the project.

Progress Payments

Contractors typically submit an Application for Payment (often using AIA Document G702/G703) on a monthly basis. The CM's role in the progress payment cycle includes:

1. Field Verification: Walking the site to visually verify that the percentage of work claimed on the SOV for each line item accurately reflects the work completed in place.
2. Material Stored: Verifying materials stored on-site (and sometimes off-site in bonded warehouses) if the contract allows payment for materials not yet installed.
3. Lien Waivers: Collecting and verifying conditional and unconditional lien waivers from the GC and major subcontractors to ensure that lower-tier parties are being paid and to protect the Owner's property from mechanic's liens.
4. Certification: Recommending the payment amount to the Architect or Owner for final approval and funding.

Retainage

Retainage (or retention) is a contractual provision where the Owner withholds a percentage of each progress payment—typically 5% to 10%—until the project reaches substantial completion or final completion.

Retainage serves two primary purposes:

1. It provides a financial incentive for the Contractor to finish the project, including the punch list, rather than abandoning it when only minor, less profitable work remains.
2. It provides a pool of funds the Owner can use to correct defective work or settle claims if the Contractor defaults.

Many contracts allow for a reduction in retainage (e.g., from 10% to 5%) once the project reaches the 50% completion milestone, provided the Contractor's progress and quality are satisfactory.