Road Construction Contracts

A lump sum contract is the most commonly-used pricing mechanism in a construction contract. Under this arrangement the contract price is based on a single lump sum price for all of the works being agreed between the client and contractor prior to award of contract.

Unit price contracts set a fixed price for a distinct, repeatable aspect of a project, which is defined as a “unit.” For example, a contractor building 10 miles of highway may sign a unit price contract, with each mile of highway representing a unit. The same labor and materials will be used for each mile of road, so the contractor bills for each of those units at a fixed price.

If the scope of the project changes — for instance, if additional sections of highway need to be built — the contractor simply bills for additional units upon completion. Unit price contracts are especially helpful for situations where it’s unknown how many units of work will be needed. For example, a contractor may remove dirt during site preparation, billing for each yard of soil removed as a unit with a fixed cost.Importantly, the unit price includes all of the contractor’s costs — labor, materials, overhead — and a markup for profit.

Time and materials contracts — also called T&M contracts — reimburse contractors for material costs and pay a fixed daily or hourly wage for labor costs. This type of contract offers additional protection for contractors, who have greater assurance that their costs will be covered throughout the project. Notably, material and labor costs have several additional factors built in to the contract:

Materials costs include the cost of the materials themselves, the freight charges, and a markup charge (typically between 10 and 30 percent). Labor costs include the base pay, overhead and administrative costs, and a profit margin. This is called the loaded labor rate. Time and materials contracts can be beneficial in many situations, but it’s important to also understand the risks of this contract type.

A guaranteed maximum price (GMP) contract sets a maximum project cost for the property owner. Any costs that exceed the maximum price are the responsibility of the general contractor, who will see their profit margin cut as a result.

With a GMP contract, a general contractor uses a schedule of values to estimate the total project cost. In addition to these direct costs, the contractor will also include overhead costs and profit. With this type of contract, the general contractor acts as a construction manager at risk (CMAR). The CMAR oversees the project from start to finish, and they are at risk of paying out-of-pocket for going over budget.

A cost-plus contract reimburses contractors for construction costs — labor, materials, and equipment — along with a predetermined markup rate or fixed fee. With cost-plus contracts, both direct and indirect costs are covered, and markup is typically calculated as a specific percentage of the total costs. Direct costs are those specifically related to the project (like labor, materials, or equipment just for that job) while indirect costs are the overhead required to keep the business running (like insurance, office space, and software subscriptions).

While all direct costs are covered in a cost-plus contract, indirect costs are usually covered on a percentage basis, with the exact amount varying according to the length and scope of the project. Notably, a contractor cannot simply bill for costs without any justification. Before the project begins, the contractor provides the owner with an estimate of costs. The contract may also stipulate a maximum point beyond which costs will not be reimbursed.