What is a contract?

A verbal or written agreement between a person and a firm, for undertaking construction, material supply, maintenance, and repair work which is enforceable by law is termed as a contract. The person who undertakes the contract for execution of the work is termed as a contractor. The contracts are classified into different types depending on the nature of the contract.

There are 11 types of contracts which are discussed below.

Lump-sum contract

This contract is also called a fixed-price contract. In this fixed-price contract type, the contractor agrees to perform the specified work for a fixed amount of money within a specified time. A Schedule of Rates (SOR) is specified to add or deduct money from the fixed price on account of additions and alterations not covered by the contract. Detailed measurements are not mandatory except for the additional quantity of work under this fixed-price contract type. Payments are given in installments after completing each stage or quantity of work. In such types of contracts, the risk of financial security is high for the contractor than the employer. Usually, 10% of the contract money is to be deposited as earnest money at the beginning of the project work. In such types of contracts, the profit to the contractor will be high if the project is completed as soon as possible to avoid over-head cost or incurrence of expenses on additional works.

Image showing how lump sum contract is divided among contractor and sub-contractor
CC BY-SA 4.0 | Image credits: https://en.wikipedia.org | Hsadeh

Scheduled contract

Such types of contracts are also termed Item rate contracts or Unit price contracts. In such types of contracts, the contractor agrees to work for a project as per the drawings and the rates given in the SOR specified by the public works department. Under Unit price contracts, the contractor is paid depending on the quantity of work done by him. The quantity and rates of each work are mentioned in the contract agreement to prevent the incurrence of extra expenses and earnest money of 10% is deposited before the beginning of the project.

Lump-sum and scheduled contract

This contract is similar to lump-sum contracts, except that a SOR is also mentioned in the agreement to add money in case of any extra work done by the contractor.

Firm-fixed-price contract

A firm-fixed-price contract is a contract in which the company (contract owner) decides the cost of executing a project and negotiates any revision in the project cost. In such types of contracts, the contractor is responsible for the profit and loss gained through the project.

Incentive contract

An incentive contract is a sub-segment of a fixed-price contract and are used when precise cost or time obligations are sought for a project. The conventional incentive contract stipulates that work must be done by a particular deadline and at a specific cost for a fixed payment. If the contractor can complete the project faster, cheaper, or both, he or she is rewarded with an incentive.

Cost-reimbursement contract

The final pricing in such types of cost-reimbursement contracts is set when the contract is completed, or at some other pre-defined date throughout the contracting period. Before contract work begins, the total contract price estimate will be determined, allowing the company to set a budget for the project and maximize the reimbursement amount. The cost-reimbursable contracts are of different types, namely, cost contracts, cost-sharing contracts, cost-plus fixed fee (CPFF) contracts, cost-plus incentive fee (CPIF) contracts, cost-plus award fee (CPAF) contracts, and cost-plus percentage of cost (CPPC) contracts.

Target cost contracts

Target cost contracts are a type of cost-reimbursable contract in which the contractor is paid the entire cost of the project, plus a fee that is subject to the target cost agreed upon, by the parties at the start of the project.

Business contracts

Business contracts are an agreement between two or more parties in which each agrees to an exchange of money, commodities, or services. As this is a written agreement, both parties are risk-free. There are different types of business agreements depending upon the nature of the work, they are nondisclosure agreements, partnership agreements, indemnity agreements, property & equipment lease contracts.

Bilateral contracts

A bilateral contract is a two-sided agreement in which each party undertakes to carry out half of the agreement. This contract type often contains equal obligations or consideration from both the offeror and the offeree.

Time and materials contracts

A time and materials contract is a construction contract in which the contract owner agrees to pay the contractor based on the time spent by the contractor's workers performing the work, as well as for the materials used in the construction, regardless of the amount of work required to finish the project. This type of contract is used when it is impossible to correctly predict the size of a project or when it is expected that the project requirements will most likely alter time and materials.

Labor-hour contracts

It is a type of time-and-materials contract. The contract's owner provides the materials and pays a fixed price for a specified amount of labor hours, including overhead and profit. In this time-and-materials contract type, the requirement of materials is not included in the contract and is also not supplied by the contractor.

Context and Applications

Contracts are a vital part of construction contracts and are significant in the following fields of engineering:

  • Bachelors in Civil Engineering
  • Masters in Construction Engineering and Management

Practice Problems

1. Which of the following is a term that denotes a situation in which there is a fluctuation in an item cost owing to market conditions?

  1. Ceiling price
  2. Contract
  3. Profit
  4. Tender

Answer: Option a

Explanation: Ceiling price is a situation when the price charged is more than or less than the original price determined by the market forces of demand and supply.

2. In which of the following contract type, the contractor has a requirement of handing over the project as a completed product?

  1. Turnkey contract
  2. Lump-sum contract
  3. Unconscionable contract
  4. Unilateral contract

Answer: Option a

Explanation: In turnkey contract type, the contractor has a requirement to submit the project as a completed product. In this contract type, the contractor is responsible for all the works from planning, designing to execution.

3. What are allowable costs in a contract?

  1. The actual cost of the project
  2. The cost that a contract owes to pay after completing the project
  3. The profit made by the contract owner
  4. The profit made by the contractor

Answer: Option b

Explanation: Allowable costs are those expenses mentioned in a contract that can be billed to the contract owner.

4. In which of the following contracts, one party supplies the goods in exchange to which the other party pledges to take the order from that party only?

  1. Requirements contract
  2. Materials contract
  3. Cost-plus contract
  4. Construction contract

Answer: Option a

Explanation: A requirement contract is a contract in which one party commits to supply an item as per the requirement of the other party, in exchange for the other party promising to receive its goods or services exclusively from the first party.

5. The contract which has automatic renewals after completing the contract period until the contract is terminated by any one of the contract owners or contractors is called,

  1. Unilateral contract
  2. Cost-plus contracts
  3. Incentive fee contracts
  4. Evergreen contract

Answer: Option d

Explanation: Evergreen contract renews automatically after its initial period gets over until it is terminated by any one of the parties.

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