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Risks in Various Types of Construction Contracts/ Payment Schemes

The document discusses different types of construction contracts and payment schemes that allocate project risks differently between owners and contractors. Fixed lump sum and unit price contracts transfer most risk to contractors, while cost plus and negotiated contracts share more risk with owners. Cost plus contracts with a guaranteed maximum price provide owners budget certainty while incentivizing contractors to control costs below that level.

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Ishtiaque Aziz Channa
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127 views

Risks in Various Types of Construction Contracts/ Payment Schemes

The document discusses different types of construction contracts and payment schemes that allocate project risks differently between owners and contractors. Fixed lump sum and unit price contracts transfer most risk to contractors, while cost plus and negotiated contracts share more risk with owners. Cost plus contracts with a guaranteed maximum price provide owners budget certainty while incentivizing contractors to control costs below that level.

Uploaded by

Ishtiaque Aziz Channa
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Risks in Various Types of

Construction Contracts/
Payment Schemes
Contracts Based on Risk Sharing
Competitive Bidding Contracts

An owner can enter into contract with a constructor by competitive bidding


(open or closed). A number of formats of contract can be concluded such as:

 Fixed Lump Sum Price

 Fixed Unit Price


Contracts Based on Risk Sharing
Fixed Lump Sum Price Contract

 In this contract, the contractor agrees to perform the work for a predetermined
price that includes profit.
 The award of contract is generally made to the lowest responsible and
responsive bidder.
 The price is determined through a competitive bid but sometimes may be
negotiated.
 The owner must have a clear idea about the project requirements. Changes
and variations during the execution of the project can be extremely costly and
time consuming.
Contracts Based on Risk Sharing
Fixed Unit Price Contract
 Similar to Lump Sum except that the prices of specified units of work
are fixed, and the total cost to the owner varies with actual quantities.

 Applies best where the details and general character of the work are
known but quantities are subject to variation within reasonable limits.

 Incorporates a ‘bill of quantities (BOQ)’ or ‘schedule of rates’, and the


payment to contractor is usually on a monthly basis.

 The main advantage of unit price contracting is that the work can be put
to tender before the design is fully completed.

 The downside of this is that the final cost of the project is not known
until the project is completed in all respects.
Contracts Based on Risk Sharing
Negotiated Contracts

An owner can enter into contract with a constructor by negotiating the price and
method of reimbursement. A number of formats of contract can be concluded
based on negotiation between owner and contractors such as:
 Cost + Fixed Fee
 Cost + Percent of Cost
 Cost + Fixed Fee with Guaranteed Maximum Price
 Target Cost Incentive
 Cost + Sliding Fee
Contracts Based on Risk Sharing

Cost plus Fixed Fee (Cost reimbursable)

 Contractor agrees to perform work for a fixed fee covering profit and home-
office costs, with all field costs (material, equipment and labor) being
reimbursable at actual cost.

 Such contracts do not reward the contractor for an increased project cost but
still fails to provide an incentive for the minimized cost.

 These contracts are appropriate for situations where the contract work is not,
or cannot be, clearly defined at the time of contracting.

 Most of the financial risks are borne by the owner.


Contracts Based on Risk Sharing

Cost plus Percentage of Cost Contract

 This contract pays the contractor a fee that is a percentage of the


project’s actual cost, and provides no incentive for the contractor to
reduce project cost, i.e. the higher the project cost, the greater the
contractor’s fee.
 Such contracts are only good for extra work or minor works where the
scope is indeterminate such as remedial works, retrofitting and
renovation projects.
Contracts Based on Risk Sharing

Cost plus Fixed Fee with Guaranteed Maximum Price

 The contractor guarantees that the total contract price will not exceed the
specified amount - GMP.

 Costs above the guarantee are absorbed by the contractor.


 However, the contractor fee is usually higher to compensate for the added
risk involved.

 Such contracts are good for situations where the client has limited funds as
in many government projects.

 Sometimes, to give incentive, the savings below the GMP are shared
between the owner and the contractor
GMP Risks

 Contract price may be higher than for fixed price because design often
not complete when contract is set.

 Can be fights over what falls below GMP.

 Bad if unclear scope after GMP agreed to (must renegotiate).

 Quality may be sacrificed whereas without GMP, cost and/or


schedule would have increased.

 Risk Reduction: Owner must monitor contractor spending.


Contracts Based on Risk Sharing

Cost + Sliding Fee

 A variation of the profit-sharing approach is the sliding fee, which not


only provides a bonus for under run but also penalizes the contractor
for overrunning the target value.
 The amount of the fee increases as the contractor falls below the
target and decreases as he overruns the target value. One formula for
calculating the contractor's fee based on a sliding scale is:

Fee = R(2T -A)


where T = target price
R = base percent value
A = actual cost of the construction

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