There are many factors that come together to form a construction contract. Decisions about delivery models, pricing models, and contract modifiers all affect your final contract model.
I’ve written a number of articles addressing these factors and have crafted a word or two about how these come together to create best practices.
Regardless of how you structure your agreement, you need to be sure that when you move into contracting, you have a firm understanding of how your contract is structured and that the contract language and exhibits support the model you negotiated.
Note that I said the contract you “negotiated”. I make this distinction because sometimes through discussion and discovery you might just decide to modify your contract model to solve for certain conditions. All too often procurement people remain steadfast in their original intent and neglect to recognize where they landed. In this article I want to discuss what you need to keep in mind as you move forward into contracting.
One of the most common errors I see occurs with regards to pricing.
There are a number of pricing models that you can use for your project. Each pricing model is meant to address a specific condition and there are best practices for when to use each pricing model.
There are also best practices for how you solicit a quote.
When you solicit a quote, it’s best to request a long and detailed quotation. This is important for a number of reasons chief among them being that you need detail in order to level your bids.
That statement holds true for the solicitation, but depending on which pricing model you selected, all that detail may be misplaced as a contract exhibit.
We need to remain clear about which set of rates and quotations we need for the contract. For that, we need to let our contract structure inform our decisions.
Stipulated Sum (Fixed Price)
Let’s take a stipulated sum contract for example and consider what a stipulated sum means.
A stipulated sum is a single total sum of money for completing the scope of work you requested. This total sum includes the Contractor’s fee, the General Conditions Costs, and the Cost of Work. If the Contractor included any kind of contingency, that should be included in the stipulated sum too.
As the work is completed, you pay the Contractor a progress payment equal to the overall percent of work completed.
Notice that it does not matter how much the fee is or how much the General Conditions are. Under a stipulated sum contract, all that matters is the overall percentage of work completed.
The basic principal of a Stipulated Sum, is that you have a pile of money tied to a specific scope of work. You pay against the percentage of completion of that work. If the scope changes you adjust the stipulated sum.
So your contract only needs to identify the lump sum total of the stipulated sum. You should not include all the detail you requested in your solicitation. You don’t need to spell out the fee, you don’t need to spell out the General Conditions.
In fact, you don’t want to!
Why? you might ask, well let’s consider the implications of listing these values.
Stipulated Sum contracts are meant to transfer the risk of delivery to the Contractor. We tie the sum to the scope. This contract structure gives the Contractor leeway to manage the work and shuffle money around as needed. If the contractor is efficient and manages the work to an early completion, he makes a profit. Conversely, if he is inefficient and mishandles the work he makes less (or maybe no) profit.
There is an inherent transfer of risk that an Owner makes when he signs a stipulated sum contract. Assuming your scope is well defined and the Owner makes no changes, the stipulated sum is fixed and you have no responsibility to make adjustments if the Contractor mismanaged the work.
When you add details to a stipulated sum contract like the fee or a break-down of the cost of work, you open the door for the contractor to ask for more money on specific line items. It’s almost like you are creating several lump-sum line items in your contract. You are also limiting the contractors discretion to move money around.
These behaviors are all contrary to the intent of a stipulated sum contract and creates confusion about what the contract price actually is.
Now don’t get me wrong, you are still entitled to have the Contractor create a Schedule of Values to track percentage of completion for each line item. That is just good project management, but as it relates to the values that go into your stipulated sum contract, that detail would be misplaced.
Let’s look at how this same idea applies to a Cost Plus Fee Contract.
Cost Plus Fee contracts can either have a fee based on a percentage of cost of work or the fee can be a stipulated sum.
If your fee is a based on a percentage of cost of work then the contractual value you need to include in your contract is the percentage rate you negotiated.
Perhaps you have calculated what you think the value of the fee will be, but the fee is not fixed and therefore the value of the fee should not appear in your contract.
If your fee is based on a stipulated sum, then your contractual value is the value of the fee and it should appear in your contract. If you have established a change order rate and the rate is based on a percentage of cost of work then you can also include the percentage rate in the change order section, but it should be specifically called out as a change order rate and there needs to be a clear process for adjusting the stipulated sum fee.
Notice I did not mention the Cost of Work or General Conditions costs. That is because in a Cost Plus contract all of those values are considered variable reimbursable expenses. Even if you solicited an estimate for these expenses and even if the estimates came from the contractor. Your contract should not include these figures.
Once again harking back to the intent of a Cost Plus Fee contract, what we are doing with this form of agreement is locking in a fee for performing some scope that is likely a variable or undefined scope. As such, since the intent is to secure services for an undefined scope, we can only define the fee not the cost of the work itself.
Understanding the contracting model is very important for creating a strong enforceable contract. Too many people think that loading up a contract with exhibits provides some form of protection. The truth is that the intent of your contract matters as much as exhibits.
Be mindful of the intent of the contract and be careful not to expose yourself by adding details that create confusion.
What do you think? When it comes to contract exhibits do you think more is better? Has an exhibit you added to a contract created confusion on a project? Tell me your stories.
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