Construction contracts 101: What general contractors need to know

Sign it and forget it: Viewed as paper- and process-intensive, contracts have gotten a bad rap. Not just in construction but across industries. However, in reality, these should be the foundation of your home building business.

Construction contracts are a vital part of any project, yet many contractors still neglect to use them. Without a contract in place, there’s no legal protection for either your business or your clients should something go wrong. This can result in costly disputes, delays and other issues that can derail an entire project. The cost of litigation alone can be anywhere between $3,000 and $150,000.

By having a comprehensive, legally binding agreement in place, contractors and other stakeholders mitigate these risks and protect themselves from potential losses or liabilities down the line. Imagine hearing it: “You’re being sued.” There’s not a more fearsome string of three words to small business owners. 

Fortunately, understanding the different types of construction contracts available and how they work can help ensure that your next home building venture is successful. Buildertrend is here to help.

In this blog post, we’ll discuss the basics of construction contracts and what general contractors need to know when it comes to protecting themselves from potential risks on their projects.

What is a construction contract?

A construction contract is a legally binding agreement between two or more parties, typically the builder and the owner. It outlines the details of a particular project, such as specific tasks that need to be completed, how much each party is responsible for paying and any other relevant terms. This could include deadlines and materials to be used.

A construction contract also outlines how disputes between the parties will be handled, making it an essential part of any job.

To dive deeper, we’ve put together the following webisode. Here, we’re talking all about contract basics and why they’re important for forging strong customer relationships. Our experts have put together all the important information and elements you need for establishing a successful building agreement.

Why do general contractors need contracts?

A contract was what Ursula used to steal Ariel’s voice in “The Little Mermaid” – but, when done right, you don’t have to worry about being tricked. As we stated earlier, contracts are a positive and not just needless busywork.

Don’t worry about losing your voice; the benefits of contracts to your construction business are boundless.

Legal protection

Contracts provide legal protection by clearly outlining the rights and responsibilities of both parties involved in a construction project. One example of this is payment. A construction contract can outline terms of collecting from clients – when it’s required they pay and through which methods – as well as making payments to subcontractors.

Don’t let legalese muddy the terms and agreements, though. The language used in a contract should be clear and concise to avoid any ambiguity or confusion. By using precise definitions and terminology, both parties can be sure they understand what is required of them under the contract’s terms.

Cost management

Contracts help manage construction costs by providing clear guidelines for how expenses should be allocated between the general contractor, subs, vendors and clients. This ensures each party is paying their fair share associated with the project, protecting them from unexpected financial losses.

In addition, contracts may also include clauses that provide details on cost overruns and how they should be handled in the event that they occur.

Project management

Contracts can also help to minimize costs associated with a construction project by setting out specific timelines and milestones for its completion. By setting timelines, both parties have a better understanding of when certain tasks must be completed, which encourages efficient work practices and prevents delays or unnecessary spending.

That’s not all. Contracts also will often specify reimbursements for goods and services related to the project, allowing the general contractor to pay only for what is necessary. This prevents any overspending or misuse of resources as well as provides an incentive for contractors to stay within budget where possible. When dealing with complex projects, such as a custom home build, this becomes doubly important.

It’s up to you as the business owner to determine how much detail you want to include in a contract. If you want to be more detailed, you can even include how parties should be communicating. To keep a record of all back-and-forth in one easy-to-access place, you might require in the contract that communication occurs in construction management software.

Dispute resolution

Despite our best efforts, disputes arise in construction projects. It’s important to ensure that any contract includes a dispute resolution clause that specifies how disagreements be resolved. Some common methods of dispute resolution include mediation, arbitration and litigation.

General contractors need to ensure that the dispute resolution clause is fair and reasonable and that it protects their interests.

3 types of construction contracts

It’s crucial to understand the types of construction contracts available before working with your legal team to draft anything up. Different types of contracts have their rewards and challenges, and it’s essential to know what you’re getting into.

1. Guaranteed maximum price contracts

This type of contract is often used when the scope of work is unclear, and it carries several advantages. It offers the contractor a maximum fee that’s guaranteed regardless of any cost overruns or unexpected increases in scope. This can provide the contractor with reassurance they will not be out-of-pocket for any additional costs that might arise.

On the other hand, the client can be sure that their budget won’t be exceeded. The downside of this type of contract is that it offers little incentive for contractors to keep a close eye on costs as they are guaranteed to receive their maximum fee, no matter how much money they spend on the project.

2. Lump sum contracts

Fixed-price contracts, often known as lump sum contracts, are contracts in which the builder provides a detailed estimate of the project’s overall cost. This kind of agreement demonstrates to the homeowners a sense of budget certainty since they’ll know precisely how much they’ll be paying up front.

A lump sum contract typically involves a single fixed fee for all services provided by the contractor, and it also requires clear and accurate specifications for what is included in the job from the outset.

This helps to ensure that there are no misunderstandings over costs or services throughout the duration of the project. The main benefit of this type of contract is its simplicity; it clearly outlines all services provided and costs associated with them before any work begins – meaning there should be no surprises along the way.

However, one potential disadvantage is that if there are any changes in scope or unforeseen problems during construction, both parties might need to renegotiate terms, which could lead to delays or additional costs in some cases.

3. Unit price contracts

Unit price contracts are usually used when working on long-term projects, like infrastructure construction, where it’s difficult to accurately estimate costs at the beginning due to variables such as unpredictable weather conditions or changes in material prices throughout a project timeline.

In these cases, unit price contracts help to ensure all materials used and labor employed are paid proportionately for each unit completed. This means both parties agree upon an appropriate rate for each task prior to commencing work but still have flexibility if certain tasks take longer than expected or require more labor than anticipated.

What to include in construction contracts?

By this point, you know handshake agreements won’t cut it in construction. The only way to protect your business is through a foolproof contract.

Below we outline the 14 essential elements of a construction contract. For more detail on each one, download our free construction contract guide – and always be sure to work with a legal professional to draft agreements for your projects.

• State-specific language: States may have different rules and require language specific to these rules to appear in signed contracts.

• Delivery method: The delivery method establishes strategy for a minimum of three parties: owner, designer and contractor. This section of the document should define contractual relationships and the documents you are relying on to complete the construction.

• ID of key parties: This section of the contract is important to have in the event of a dispute. If these parties are misidentified or missing, it can cause issues with collection rights.

• Economics: This portion of the contract is where expectations are set and all financials (total price, draw schedule, etc.) need to be defined.

• Date of commencement and completion: These are the dates when construction will begin and when construction will be completed.

• List of docs included in the agreement: As the contractor, you will want to be specific and verify that you and your clients are relying on the same documents. If you plan to rely on a bid or proposal as the underlying plans, you should explicitly mention that in your contract to ensure that everyone is on the same page.

• Reps and warranties: The reps and warranties section sets obligations for the contractor and the homeowner. It fundamentally states that: “I, as the contractor, am going to build your project and you, as the homeowner, are going to pay me.”

• Indemnification: An indemnification clause serves to compensate a party for harm or loss resulting from another party’s actions. The language is designed to shift liability away from one party to the party causing the harm or loss.

• Insurance and bonds: In this section you will list your requisite coverages and, if necessary, include language that states the homeowner is maintaining coverage in relation to the work being done.

• Change order process: Very seldom does a project get completed without a change being made, and this is when most disputes arise. Changes can sometimes be made faster than the price of the change can be calculated. Be sure to record all changes and follow the process you laid out in your contract.

• Termination and suspension: This clause will ensure that neither party has the right to walk away or change the contract without the agreement of the other party.

• Dispute resolution: Having a dispute resolution mechanism such as mediation or arbitration in your contract will ensure you’re prepared in the event of a disagreement between parties.

• “Boilerplate” clauses: Boilerplate clauses are specific provisions that are the same in every contract and never change. For example: merger clauses, legal fees and advertising.

• Force majeure: This provision relieves a party from performing a contractual obligation when circumstances beyond their control arise.

Ace your construction contracts with Buildertrend

Contracts don’t have to be complicated – let Buildertrend help.

Construction management software like Buildertrend helps home builders manage contracts by providing them with streamlined solutions for tracking and managing all of the data associated with a project. This type of platform tracks everything from materials used to labor costs. Details and data like this are just what you need when drafting up a contract that is financially secure and accurate.

Additionally, Buildertrend comes with features for scheduling, takeoff and team management tools. All this works together to ensure that jobs are completed on time, on budget and, most importantly, within contract terms.

Consider Buildertrend your single source of truth for all your files, too – including your construction contracts. From one platform, you can organize docs by job, share with clients and gather electronic signatures. Now you can execute formal agreements at the speed of need, without manual paperwork or time-sucking administrative tasks.

Schedule a demo to check out what Buildertrend can do for your business now. No contract needed to see our platform in action.

Construction contract FAQs

Get answers to the most common construction contract questions.