In the previous article, we discussed the types of contracts in construction. Now you are going to study how to select an appropriate contract Type for your construction project.
The choice of an Appropriate Contract Type
The choice of an appropriate contract type (lump sum, unit rate, cost-reimbursable, target cost contracts) depends on three essential criteria as follows.
This refers to the provision of adequate incentives for efficient performance from the contractor.
This refers to the provision of the Client with sufficient flexibility to introduce change which can be anticipated but not defined at the tender stage.
The risk could be a hazard, danger, the chance of loss or injury, the degree of probability of loss.
Examples of risks in construction.
- Physical risks
- e.g. ground conditions of the site, Natural disasters like flood, fire, etc. and bad weather conditions,
- Construction risks
- e.g. availability of plant and resources, delay, failure to complete, damage.
- Design risks
- e.g. incomplete design, availability of information, changes in design.
Characteristics of the Contract Type
What the Appropriate Contract Type Would You Recommend in the Following Situations and Why?
Situation 1: Selecting an Appropriate Contract Type
At the tender stage, the design is complete, and no changes are anticipated. The Client wishes to minimize the involvement of resources in contract administration.
Lump-sum contract type
- The Client does not need flexibility because the design is complete, and there are no expected changes. (remember that having a contract that facilitates flexibility has negative implications for you as a client if you do not need that flexibility). So if the design is complete, there is no need to go a type of contract that facilitates flexibility.
- Also, the Client does not wish to involve his resources in contract administration. Other types of contracts would require some involvement by the Client, while a Lump Sum contract does not require that.
- By adopting this contract, you, as a client, would have minimum risk and would create a top level of incentive for the contractor to perform efficiently.
Situation 2: Selecting an Appropriate Contract Type
There are high risks involved (considerable change and disruption are expected), but the Client’s procedures and regulations prevent the use of a cost-based contract.
Unit Rate Contract
- Ideally, the high risks involved in the project would lead you to use a cost-based contract (i.e. cost reimbursable or target cost).
- However, because your procedures and regulations prevent the use of a cost-based contract, you need to go to a contract within the price-based system.
- Within the price-based system, a unit rate contract is more appropriate to use than a lump-sum contract. The reason is that Client needs a type of contract that can give you flexibility (due to the considerable changes and disruption) and which, at the same time, is allowed by your procedures and regulations.
Situation 3: Selecting an Appropriate Contract Type
The definition of work at the time of tender is inadequate, owing to the emphasis on the expectation of substantial variation in work content. The work is technically complex and involves major unquantifiable risks. The Client wants to create some incentive for the contractor to perform efficiently, and you are willing to be involved in managing the project.
Target cost contract type
Because of the high risks involved, a cost-based system (i.e. involving cost-reimbursable and target cost) needs to be adopted. However, because the Client wants to create some incentive for the contractor to perform efficiently, a target cost contract would be more appropriate to adopt than a cost-reimbursable contract.
Situation 4: Selecting an Appropriate Contract Type
At the tender stage, the design is complete, but changes to quantities of work are anticipated. New items of work would not be introduced.
Unit Rate Contract
- Because your design is complete, you need to adopt a price-based system (i.e. Lump Sum or Unit Rate).
- However, because the facility needs to accommodate changes in quantity, a lump sum contract would not be appropriate (because a small margin of flexibility is needed to accommodate changes in quantity).
- Therefore a Unit Rate contract is the appropriate type of contract to adopt.