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Construction contract basics

Construction contract basics

Paper with pen

If you’ve ever read a construction contract, you know they can be wordy and hard to understand. However, they are some of the most important documents the industry creates. Knowing exactly what is in a contract, before you sign, is key to protecting you and your company from potential issues down the road.

We’re going to briefly look at what the legal definition of a contract is, some of the common contract types, sources for contract templates, and some key clauses that you should know about.

What is a contract?

A contract is an agreement between at least two parties. It requires three things: offer, consideration, and acceptance. That means one party has to offer something to the other, either goods or services. There must be consideration, which means that both parties should get something from the exchange (work for payment, usually). And finally, the parties must agree to all the terms of the contract. If any of these elements are missing, the contract is considered not valid.

Written vs oral contracts

Written contracts are documented on paper or electronically and the parties sign the document to signify their agreement with the terms. Signatures can be written, or electronic, as federal law has upheld the validity of electronic signatures.

Oral contracts are spoken and not in writing. Oral contracts are just as valid as a written contract in the eyes of the law. There still needs to be an offer, consideration, and acceptance in order for the contract to be valid. This can be hard to prove if the parties don’t agree on whether there was a contract or not, so many contractors follow up a verbal agreement with a written contract.

Construction contract types

In the construction industry there are four main contract types: cost-plus, time and materials, lump-sum, and guaranteed maximum price.


Cost-plus contracts are used when the scope of work is not easily defined, or there are hidden conditions that might affect the work that needs to be performed. The contract will state that the contractor is to be compensated for the total cost of the materials, labor, and equipment to do the work, plus a fixed fee or a percentage markup. The contractor is required to keep detailed records of all the costs incurred on the project, so if the owner wants to see them, they can. The owner may also request a copy of invoices and timesheets.

Time and materials

A time and materials contract is similar to a cost-plus contract, in that the scope of work may not be easily defined and the contractor is compensated for all their costs. In a cost-plus contract, the markup is added to the actual costs to do the work. In a time and materials contract, labor is usually billed at an hourly rate that includes a markup, and materials are marked up a percentage. The contractor is responsible for keeping accurate records so the owner can review them if desired.


A lump sum contract is for a specific scope of work that will be performed for a specified price. No matter how much the material, labor, and equipment costs, the contractor will charge only the amount in the contract. If the scope of work changes, however, then the pricing may change accordingly. The contractor is not responsible for providing backup documentation to the owner.

Guaranteed maximum price

A guaranteed maximum price or GMP contract is used when the owner wants a strict limit on the cost of the work. It is often used in conjunction with cost-plus or time and materials contracts, and the scope of work may be partially defined or fully specified. As long as the scope of work does not materially change, the price to the owner will not go above what is stated in the contract. If the scope of work does change, then the price may change accordingly.

Contract form templates

Several construction groups and agencies have developed contract templates that can be used by designers and contractors when drawing up a contract. Some of the more well-known templates come from the AIA (American Institute of Architects)ConsensusDocs, and NAHB (National Association of Home Builders).

Contract templates are beneficial because they make writing a contract much easier and ensure that all the necessary terms and conditions are included in every contract. These documents are also well respected in the industry and are commonly used.

Key contract clauses

Now we’ll take a look at some of the clauses you may find in a contract and tell you what to look for when reviewing them.

Scope of work

The scope of work clause defines the amount and type of work that will be performed by the contractor on the project. When reviewing a contract, be sure to verify that the scope is correctly identified, because if it’s not, you could be liable for performing work that you didn’t agree to. Many contracts include a list of drawings or documents that detail the work to be performed. Always check this list carefully, paying special attention to the dates of the drawings. You want to make sure the dates match the drawings you used to develop your proposal.

Project schedule

Some contracts will have a detailed project schedule attached, while others may list start and completion dates. These dates are key when it comes to determining if a delay has occurred and assessing liquidated damages. Review these dates carefully to make sure they are reasonable for the project and your scope of work.

Payment terms

Always review the payment section of the contract so you know what the procedure will be and how soon you can expect payment. You also need to know what documents are required when turning in a payment application. Some contracts may ask for lien waivers or other documentation to show that lower tier vendors have been paid.

Dispute resolution

Most contracts include a section that details how disputes will be resolved if they come up. For example, the AIA Contracts state that the architect is the primary decision-maker, but when the architect cannot come to a resolution, other methods are to be used. The parties choose what method of dispute resolution to use: arbitration, litigation, or another method. It’s important to know how claims will be decided, who pays the costs, and what the process is for resolving conflicts before signing.


This clause determines what will happen if the owner or contractor terminate the project before completion. The contractor needs to know whether they will be able to recoup costs incurred when the owner decides to stop the project for convenience. Some contracts may stipulate a termination fee, partly to discourage termination and also to reimburse the contractor for expenses.

Changes to the work

Changes happen on almost every project. Most contracts don’t allow unapproved work to be performed. However, when time is of the essence, contractors are often required to keep the project moving even if a change hasn’t been approved. Review this section carefully so you know the process of change order approval and the consequences of performing unapproved work.


Most contracts contain an indemnity clause that attempts to push risk for claims on the job down to lower tier vendors. This can be acceptable, as long as a contractor is only responsible for damages caused by their work or materials. Things can get dicey when an indemnity clause states that a lower tier vendor is responsible for damages caused by an upper tier. Always read these clauses carefully and consult an attorney of you have any questions.

Waiver of subrogation

A waiver of subrogation clause is placed in a contract to minimize lawsuits and claims among the parties,” according to the International Risk Management Institute. “The result is that the risk of loss is agreed among the parties to lie with the insurers, and the cost of the insurance coverage is contractually allocated among the parties as they may agree. The risk, once assigned to the insurers by the parties, is determined to stop there, without allowing the insurer to seek redress from the party ‘at fault.’”


Reading and understanding contracts before you sign them is important, since once you sign, you have agreed to all the terms of the agreement as they are written or spoken. If you have a question regarding language in a contract, don’t hesitate to reach out to a contract or construction attorney for advice. It will save you money in the long run.

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