What is a Lump Sum Contract: Everything You Need to Know
Knowing what a lump sum contract is, also known as a fixed-price contract, is important for a contractor.3 min read
2. Disadvantages of a Lump Sum Contract
3. Why Does Delay Become a Common Mistake in a Lump Sum Contract?
Knowing what a lump sum contract is, also known as a fixed-price contract, is important for a contractor. The contract states one lump-sum price for all the work and the contractor agrees to finish the project under the set cost that's listed in the contract. If the contractor ends up finishing the project under the total cost that is stated, he will make an extra profit from the project.
This type of contract is often used in the construction field to decrease the costs of contract administration. It's the most common agreement form for both small and simple projects. It tends to be used where a project is already well-defined in responsibilities and scopes for the parties. There also is little chance for a change, so the owner needs to have specifications and drawings that are complete. The construction documents should also be ready when it's time to bid, so the bidders can correctly guess how much materials and labor will cost them.
There may benefits and incentives in the contract in case of early completion. There may also be penalties, known as liquidated damages, if the completion should be late.
Advantages of Lump Sum Contracts for the Owner
Clients enjoy the many advantages of this contract and how predictable a lump-sum arrangement is. Due to agreeing on a fixed price, the liability and exposure of the owner are limited during construction. The contractor has decided on a sum and the owner can't be liable for any of the overrun costs from the contractor. This means there's a decent amount of cost certainty, which is important when obtaining a construction loan.
These types of arrangements are quite easy to manage. The owner will make a payment, often on a monthly basis, that is based on what percentage of work is completed, compared to the balloon payment that other arrangements have. The designer and contractor often have a greater profit margin from this, compared to using a cost-plus contract. During negotiations, the designer and contractor give what they think is a fair price without needing to justify the materials or hourly costs.
It's less intensive to do lump-sum accounting, which decreases the overhead costs for the contractor. These arrangements allow for a cash flow that's more steady. Lump-sum arrangements have a greater degree of collaboration between the following:
- The contractor
- The owner
- The designers
Disadvantages of a Lump Sum Contract
The contractor defends his margins by having tight project management and good communication with the owner to make sure there's scope compliance. The owner wants to get as much work out of the money that's spent, while the contractor wants to make a maximum profit from the money he receives. This can cause a conflict of interest. It's important that the work is clearly defined, site conditions are explained fully, and specifications are clearly defined. If this doesn't happen, disputes can happen that could have easily been avoided if the contract was thoroughly looked over in the first place.
If intermediate payment is expected and listed in the contract, the work's value shouldn't be less than what the payment being made is. It's acceptable in a contract for a substantial amount of alterations and additions to be expected.
Why Does Delay Become a Common Mistake in a Lump Sum Contract?
A lump sum building contract states that the contractor is responsible for his own actions but not the actions of the employer. Appropriate commercial reasons as to why the contract should allow for the contractor to claim extra costs for disruption or delay by the employer include the failure to give proper instructions in a timely matter when it's necessary to receive them in order to progress the work. This type of provision decreases the risk of a contractor seeking legal assistance for a breach-of-contract lawsuit.
Due to this, it's essential to make sure there's a proper mechanism under the contract so the contractor will be paid any extra costs. Building contracts often have provisions for cases that are outside of the control of either party. You shouldn't assume that the best financial solution is to put the risk on the contractor.
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