Understanding Construction Contracts

A construction contract is a legally binding agreement between a project owner (client) and
a contractor. It serves as a comprehensive roadmap for the entire project, outlining:

 Project Scope: A detailed description of the work to be performed, including plans

and specifications.
 Financial Considerations: The agreed-upon price for the project, including payment
schedules and change order procedures.
 Rights and Responsibilities: A clear definition of the obligations and expectations of
each party throughout the construction process.
 Project Timeline: Defined start and completion dates, along with procedures for
addressing potential delays.

By establishing these parameters upfront, construction contracts promote clear

communication, minimize misunderstandings, and ensure a successful project execution.

Construction Pricing Methods

Unlike standardized products, construction projects require unique pricing structures.

Here's an overview of common methods:

 Separate Pricing for Each Facility: This method considers the specific requirements
of each project and assigns a distinct cost based on its complexity and materials.

Competitive Bidding Process

Competitive bidding allows qualified contractors to submit proposals for a construction

project. This process typically involves:

1. Project Definition: The client develops detailed plans and specifications outlining the
project scope.
2. Contractor Selection: Qualified contractors with relevant experience and financial
stability are invited to submit bids. Public sector projects may have stricter
regulations for contractor selection.
3. Bidding Options: Contractors can choose between:
o Lump Sum Bids: A fixed price for the entire project, encompassing all labor,
materials, and equipment.
o Unit Price Bids: Prices are established for specific tasks or materials, with the
final cost determined by the actual quantities used during construction.
Negotiated Contracts: An Alternative Approach

In some instances, negotiated contracts may be preferable to competitive bidding. This

approach is often used for:

 Complex Projects: Projects with intricate designs or unique requirements may

benefit from tailored negotiations with a qualified contractor.
 Leveraging Expertise: When a contractor has demonstrably successful experience
with similar projects, direct negotiation allows the client to utilize their expertise.
 Expedited Start: Negotiated contracts can expedite project initiation, particularly
when final plans are still under development, provided there is a strong foundation
of trust between the client and contractor.

Beyond Bidding and Negotiation: Additional Contract Examples

 Speculative Residential Construction: Developers may construct residential units in
anticipation of buyer demand. In this scenario, the market dictates the pricing
structure.
 Force-Account Construction: Clients may utilize their own workforce, often for
smaller projects like renovations or repairs. The total cost becomes the project price,
factoring in labor, materials, and equipment.

Risk Allocation in Construction Contracts

Construction projects inherently involve unforeseen circumstances. Contracts typically

address risk allocation through various provisions, such as:

 Force Majeure: This clause relieves a party from financial obligations due to events
beyond their control, such as natural disasters or labor strikes.
 Indemnification: This provision protects one party from financial losses caused by
the actions of a third party.
 Lien Waivers: This ensures that claims from workers or suppliers are settled before
project completion, preventing financial complications.
 Labor Law Compliance: The contract clarifies which party is responsible for adhering
to labor regulations on the construction site.
 Differing Site Conditions: This provision addresses unexpected site conditions that
may necessitate additional costs.
 Schedule Considerations: Procedures for addressing project delays and extensions
of time due to unforeseen circumstances are outlined.
 Liquidated Damages: Predetermined compensation for specific project defects, such
as substandard materials or missed deadlines.
  Occupational Safety and Health: The contract emphasizes the importance of worker
safety during construction.
 Permits and Regulations: The contract clarifies which party is responsible for
obtaining necessary permits and complying with relevant regulations.
 Equal Employment Opportunity: This ensures compliance with anti-discrimination
laws during the hiring process.
 Termination for Default: The process for terminating the contract if the contractor
fails to meet their obligations is outlined.
 Suspension of Work: Procedures for pausing construction work under specific
circumstances are established.
 Warranties and Guarantees: The contractor specifies the warranties offered on the
completed project, ensuring quality and performance

The Power of Contracts

Construction contracts serve two primary purposes:

1. Pricing the Project: They establish the agreed-upon cost for the project.
2. Risk Allocation: They define how risks are shared between the project owner and
the contractor.

The owner ultimately decides the contract type for a project and outlines the terms within
the agreement. However, it's crucial for students to grasp the risks associated with each
contract type for both the owner and the contractor.

Types of Construction Contracts

Here's a breakdown of common construction contracts and how they distribute risk:

 Lump Sum Contract:

o Risk for Contractor: High. The contractor receives a fixed sum for the entire
project and bears the risk of underestimating costs. Unexpected situations
can lead to profit reduction.
o Risk for Owner: Lower. The owner pays the agreed-upon price regardless of
actual costs but may face higher initial bids due to the contractor's risk
premium.
 Unit Price Contract:
o Risk for Contractor: Lower (for quantities). The contractor sets prices per unit
(e.g., per cubic yard of concrete). The owner bears the risk of inaccurate
quantity estimations. However, the contractor might submit "unbalanced
bids" to adjust for perceived discrepancies in quantity estimates.
 o Risk for Owner: Higher (for quantities). The final cost depends on the actual
quantities used, potentially exceeding initial estimates. Additionally,
unbalanced bids from contractors can be a concern.
 Cost-Plus Contracts:

These contracts shift most of the cost risk to the owner:

o Cost Plus Fixed Percentage: The contractor receives actual costs plus a fixed
fee, with minimal incentive to control costs.
o Cost Plus Fixed Fee: Similar to above, but the contractor has some incentive
for faster completion (fixed fee regardless of project duration).
 Incentive-Based Contracts:

These introduce risk-sharing between owner and contractor:

o Cost Plus Variable Percentage: The contractor's fee is a variable percentage

of the direct cost, with a penalty for exceeding the estimated cost or a
reward for coming under budget.
o Target Estimate Contract: Similar to the above, with predetermined
percentages of cost savings or overruns shared by both parties. Bonuses or
penalties may apply based on completion dates.
 Guaranteed Maximum Cost Contract:
o Risk for Contractor: High. The contractor guarantees a maximum project cost
and takes all risks for cost overruns and project delays. This is suitable for
well-defined projects with minimal change orders.

Contract Agreement Documents A well-structured contract agreement typically includes

the following elements:
 Owner Information
 General Contractor Information (including license number)
 Worksite Details
 Description of Work to be Performed
 Contract Price and Payment Schedule
 Reference to Contract Documents (plans, specifications)
 Materials and Labor Requirements
 Project Start and Completion Dates
 Licensing and Permits Required
 Subcontracting Procedures
 Change Order Management Process
 Warranties on Completed Work
I. Construction Specifications
 Definition: A detailed written document outlining the project scope, materials,
installation methods, and quality standards.
Main Types of Specifications:
 Prescriptive:
o Specifies materials, installation methods, and quality measurements.
o Subcategories:
 General Provisions: References building codes and standards.
 Required Products: Lists materials based on performance and
structure.
 Execution Procedures: Details installation methods and quality
checks.
 Performance:
o Focuses on the final product's functionality and operational requirements.
 Proprietary:
o Specifies a single-source product for a specific installation. (Less common)
II. Construction Project Organization
 Project Organization:
o Varies based on project complexity, company culture, project manager
preferences, team skills, and presence of a project management office
(PMO).
 Factors Influencing Project Organization:
o Project complexity
o Company culture
o Project manager preferences
o Team knowledge and skills
o Presence of a PMO
 Span of Control:
o The number of people reporting to a manager.
o Project manager avoids overloading managers by assigning senior personnel
to oversee others.
 Engineering Team Structure:
o Reporting structure for engineering disciplines.
o Smaller projects: Engineering disciplines report directly to the Engineering
Manager.
o Larger projects: Area Team Leaders oversee discipline managers (Structural,
Electrical, Mechanical).
o Geographically dispersed projects: Area-based structure improves
coordination.
 Important Project Functions:
o Sponsor
 o Controls
o Project Manager
o Procurement
o Technical Management
o Quality
o Administration

 Project Sponsor
o Focuses on the big picture: Provides resources, removes roadblocks, and
ensures the project aligns with the organization's goals.
o High-level leader: Typically a senior executive with the authority to make
things happen.
 Project Manager
o Leads the project execution: Oversees all aspects, from start-up to
completion, ensuring efficient and effective work.
o Project "CEO": Manages staff, resources, and processes, similar to a company
CEO's responsibilities.
o Adapts to project size: May manage large budgets and complex projects with
broader impact than some company divisions.
o Visionary leader: Defines success, motivates everyone involved, and provides
the means to achieve goals.
 Project Control
o Tracks progress and plans for success: Monitors costs, schedules, and
changes, keeping everyone informed.
o Provides critical information: Analyzes trends, estimates costs, and plans
schedules to support informed decision-making.
o Works with the project manager: Collaborates to assess options and their
impact on cost and schedule.
o Separate from accounting: Focuses on estimates within ranges rather than
penny-perfect accounting.
o Key activities: Estimating, cost tracking, trend analysis, scheduling, change
management, and progress tracking.
 Project Procurement
o Obtains resources: Manages how the project acquires needed supplies and
equipment.
o Adapts to project complexity: Smaller projects may leverage existing
procurement services within the organization.
The procurement manager is part of the project team.

Overall Responsibilities:

 Acquire all necessary supplies and equipment for the project team (office supplies,
computers, etc.)
 Obtain supplies and equipment needed to execute the project itself (training
equipment, construction materials, etc.)

Examples on a Construction Project:

 Renting a construction trailer, office supplies, and computers for the on-site project
office.
 Purchasing building materials like concrete, rebar, and steel.

Types of Procurement:

1. Commodity Procurement: Focuses on readily available, "off-the-shelf" items like

concrete or leased cranes.
o Key to success: Efficient bidding process to secure the lowest price that
meets project timelines.
2. Vendor Procurement: Deals with vendors who provide custom services or goods,
often involving bidding.
o Example: Specialized equipment.
o Key to success:
 Clear performance specifications.
 Effective communication to encourage innovative solutions.
 Bidding process focused on project goals (considering factors beyond
just cost)
3. Partnerships: Deep collaboration with another company, sometimes legally
formalized.
o Example: Partnering with a local construction company for expertise and
connections.
o Key to success:
 Dedicated project manager for partner coordination.
 Processes for shared goals, aligned work processes, and change
management.
Planning and Scheduling
1. Construction Planning
 involves the choice of technology, the definition of work tasks, the
estimation of the required resources and durations for individual tasks, and
the identification of any interactions among the different work tasks.
 Developing the construction plan is a critical task in the management of
construction, even if the plan is not written or otherwise formally recorded.
In addition to these technical aspects of construction planning, it may also be
necessary to make organizational decisions about the relationships between
 project participants and even which organizations to include in a project. For
example, the extent to which subcontractors will be used on a project is
often determined during construction planning.

Alternative Emphases in Construction Planning

Scheduling is when a plan is assigned specific dates and a chronological order to the tasks,
so that a plan can be put into action. These schedules need to include contingencies for
variances in the plan. This reflects the ‘when’ of a project, with the assigning of appropriate
resources to get it done on time.

Project- A project is an interrelated set of activities that has a definite starting and ending
point and that results in a unique product or service. Project management
 Project management- is a scientific way of planning, implementing,
monitoring & controlling the various aspects of a project such as time,
money, materials, manpower & other resources.
Methods used for network planning are:
 CPM
 PERT

Managing a project with network planning methods involves four steps:

 Describing the Project.

 Diagramming the Network.
 Estimating time of completion.
 Monitoring Project Progress.
Rules of Network Construction
 Each activity is represented by one arrow
 An activity can begin only when all its predecessors are done
 Length and bearing of arrows is of no consequence
 Arrow direction indicates general progression in time – tail events represent start
while head events represent end of activities
 Events are identified by numbers while activities are represented by their starting
and ending events
 A network should have only one initial and one final node
 Introduce as few dummy activities as may be necessary 8. Looping is not permitted

CPM
 Critical path is a sequence of activity between a project’s start and finish that takes the
longest time to complete
 Critical path method is based on mathematical calculations and it is used for
scheduling project activities.
 In 1950, Critical path method (CPM) was developed by Kelly and Walker to
assist in building and maintains of chemical plants.
 The initial critical path method was used for managing plant maintenance projects.
 Critical path is the sequential activities from start to the end of a project.
Although many projects have only one critical path, some projects may have
more than one critical paths depending on the flow logic used in the project
 The essential technique for using CPM is to construct a model of the project that
includes the following:
o A list of all activities required to complete the project (typically
categorized within a work breakdown structure ¢
o The time (duration) that each activity will take to completion
o The dependencies between the activities

Terminologies used in CPM

To explain the purpose, structure and operation of CPM, it is helpful to define the
following terms:

Activity: An activity carries the arrow symbol. This represent a task or

subproject that uses time or resources
 Event- A node (an event), denoted by a circle, marks the start and
completion of an activity, which contain a number that helps to identify its
location. For example activity A can be drawn as:

Dummy Activity: An activity, which is used to maintain the pre-defined

precedence relationship only during the construction of the project network, is
called a dummy activity. Dummy activity is represented by a dotted arrow and
does not consume any time and resource.

Parallel activity: There are two activity which being at same event and
end at same event.this activities are called parallel activity.

Not allowed…..
Path: A path is a series of adjacent activities leading from one event to another.
Critical path: A critical path is the sequence of critical activities that forms a continuous path.
Situations in network diagram between the start of a project and its completion

Forward pass:

 The Early Start and Early Finish Time Calculated by moving Forward Through the
Network.
 Consider Maximum.
Backward pass:

 The Latest Start and Latest Finish Time Calculated by moving Backward Through the
Network.
 Consider Minimum

Float activity:

 Float activity For an Activity is The Difference between its Earliest and Latest Start
Time or Earliest and Latest Finish Time.

Steps in Critical Path Method

Step 1: Make a forward pass through the network as follows:

For each activity i beginning at the Start node compute:
Earliest Start Time (ES) = the maximum of the earliest finish
times of all activities immediately preceding activity (This is 0
for an activity with no predecessors.) This is the earliest time
an activity can begin without violation of immediate
predecessor requirements.
Earliest Finish Time (Ef) = (Earliest Start Time) + (Time to
complete activity i. This represent the earliest time at which
an activity can end. The project completion time is the
maximum of the Earliest Finish Times at the Finish node.

Step 2: Make a backwards pass through the network as follows:

Move sequentially backwards from the Finish node to the Start node. At a
given node, j, consider all activities ending at node j. For each of these
activities, (i,j), compute:
Latest Finish Time (LF) = the minimum of the latest start times beginning at
node j. (For node N, this is the project completion time.). This is the latest
time an activity can end without delaying the entire project.

Latest Start Time (LS) = (Latest Finish Time) - (Time to complete activity (i,j)).
This is the latest time an activity can begin without delaying the entire
project.

Step 3: Calculate the float time for each activity by:

float = (Latest Start) - (Earliest Start), or = (Latest Finish)-(EarliesFinish).