What type of contract should I use?


There are three major items that you need to consider when reviewing a contract along with some common sense guidelines. The three major items are all about risk management. You cannot eliminate all risk; but, if you understand where the risk lies, you can make a plan to mitigate the risk factors and ensure your project is executed according to your organization’s goals.

The three risk factors are schedule, cost and quality. All three factors are interconnected. If you fix a risk in one area, you will create more risk in another area.

Schedule risk

If you have enough time from concept to handover, you can typically mitigate the cost and quality risk to the greatest extent. The issues typically arise when a lease is signed, production is halted or high-interest bridge loans are in place and time-to-completion is the highest priority.

A tight schedule pre-construction does not give the owner time to vet contractors, to finalize drawings or to flesh out the specifications.

During construction, these pre-construction decisions will compound because now crews are working overtime to keep the deadline, additional crews are added, installed work is changed and products are shipped by expedited services rather than traditional shipping.

The “additional crews” piece can be confusing. Let’s say a buildout will take 5,000 hours of total labor hours which will include demo, new walls and new finishes. If you have 5 crews, with 5 guys and working 40 hours per week, it would take 5 weeks to complete. So, if you have 6 crews, a little over 4 weeks and the cost to the contractor is the same, right?

No. An ideal crew size should be working at 80% capacity. If you can keep a crew busy with 6 guys at 100% capacity, it is most effective to have 5 guys. By having 1 less guy below full capacity, everyone is working and there is little to no standing around. They still get breaks, but they will always have a follow-on task. If you now put 7 guys on that crew, the contractor is losing capacity and paying for that lost labor as guys stand around. The job will get done faster but it will cost the contractor extra money which they will pass on to you.

In order to protect your interest, get a schedule, preferably with a Gantt Chart (Wikipedia article on Gantt Chart). A job never follows the contract schedule (it will end early or late and tasks will start early or late, inevitably). What it does though is get the contractor’s means and methods defined and how the contractor will move from Task A to Task B all the way through to contract completion. If there is a disruption to the means and methods (tasks are moved around so rental equipment is on site longer, additional crews or personnel are added, etc.), the contractor can show the disruption and why additional monies are owed. If there is no schedule, the additional costs will be murky and will corrupt the relationship between the contractor and owner.

Cost Risk

There are two types of methods to price a contract: time and material (T&M) and fixed-price. A fixed-price contract is where a contractor gives you a total cost for the job as it has been described in the contract. A time and material means that the contractor will bill you for the labor hours and material at actual cost plus a markup. The only time you should consider a T&M contract is when time is the most critical factor and the design is in its very early stages. The owner takes a huge risk with T&M.

The owner should always insist on a price that is broken down for complex projects. Defining a complex project is usually done by the Construction Specifications Institute (CSI)'s MasterFormat. If a project is only using one CSI Division, it is a simple project; otherwise, it is a complex project. There are either 16 or 50 Divisions (contractors use both) but there are thousands of CSI Codes.

For instance, you have a retaining wall you want built from cinder blocks and to have a granite face. Cinder blocks use the CSI code of 04 22 00.13 (Concrete Unit Veneer Masonry) and the stone would use the CSI code of 04 42 13 (Masonry-Supported Stone Cladding). Both of these CSI codes are Division 04 (Masonry), so accepting a lump sum price would not be unusual.

However, if you are remodeling a bathroom, you would use install a new door (Division 08), new tile (Division 9), a new toilet (Division 10) and a new towel rack (Division 12). In this instance, get a broken down quote. Wikipedia shows the 16 Divisions here and the 50 Divisions here. An online version of CSI codes can be found here and a PDF version can be found here.

Quality risk

The quality risk comes into play when the finishes are chosen. The contractor will always price the project with the cheapest material (hence the term “contractor-grade”) unless you specify what finishes you want.

For instance, let’s say you want to replace the tile on your bathroom floor and you didn’t specify the type, color or shape of the tile. The contractor is going to choose this nice tile from Home Depot that costs $1.52 per square foot. When you propose the tile you wanted (this nice Grecian polished marble mosaic), you are not only going to make up the difference in cost (going from $1.52 a sq. ft. to $9.99 a sq. ft.), you’re also going to pay for the additional labor of cutting mosaic tile versus standard tile, the additional labor in laying the two types of tile and the markup as a percentage of cost. At this point, you will have to make the very hard decision of using the cheaper material you hate or going way over-budget for what you really want.

If you have the time, do the research and pick the specific finishes you want. Copy the links from the vendor and tell the contractor which finishes you want him to price. You might be tempted to buy the material that you want, and just pay the contractor to install the works. This usually leads to bad results and at C&A we do not do this type of work.

Continuing with our tile example, let’s say we calculate that 1,000 square feet of tile needs to be laid. You buy 1,100 square feet for a 10% overage for cuts and damage. The contractor gets to the end of job and needs one more box of tile. As the owner, you notice several tiles that are cracked and tell the contractor that if he hadn’t cracked those tiles, you wouldn’t have to cover the cost and he should buy it. He tells you the tile came that way. Or, you need an extra bag of mortar and now you have to go an pick it up and burn up your time. Of the contractor goes to pick it up and a $15 purchase is now $150 because he is charging you for sending a laborer to go get it, the truck cost, the gas cost and his markup.

Types of contracts

There are three types of contract vehicles that a General Contractor typically uses.

The traditional format is Design-Bid-Build or DBB. In this instance, the Owner retains an Architect who develops a complete set of plans and specifications. The plans and specifications are put out to bid to numerous contractors. The contractors submit their bids and the Owner chooses the most responsive bidder with the lowest price. If a bidder is substantially lower than everyone else, they will typically be considered non-responsive. This type of contract has the lowest risk for quality and cost; however, it has the highest risk of time. If time is not a factor, this is probably your best option.

Design-Build (written as D/B) is a great option if you need to balance time with quality and cost. The owner will execute a contract with the contractor and the contractor will hire the architect. Oftentimes, this can actually save money because the contractor and designer can collaborate on means, methods and design. Roughly half the construction projects in today’s market are D/B because construction will actually start before a full design is complete.

If you have a standard design concept (such as a company that owns multiple franchise restaurants), you can work out a negotiated contract which develops a standard price for a scope of work (i.e. $120 per linear for for installed, 8’ wall partitions; $5 per sq. ft. for installed flooring). Once a location needs construction or remodel, the pricing is a function of multiplying the unit rates by the quantities.

General advice

Know that you cannot mitigate all risk and that there will be trade-offs. Understand these and no where you will accept risk and where you will want it mitigated before you get started. Make a one-pager and write your thoughts on each risk area: Time. Cost. Quality.

Make sure all contracts and changes are in writing. An email with 2-3 sentences and a price for a change order is perfectly fine; but don’t accept anything verbally.

Use time as your friend to mitigate most construction risks. Try to get your plans and specifications as close to completion as possible before getting contractors to bid the work. If you are under the gun with time, know you are taking more risk and have a plan to mitigate the risk.

Get a schedule from the contractor so means and methods are defined.

If you have a project that uses more than one CSI Division, ensure you get a quote with line-item pricing. If you are getting multiple bids, try and get all of your contractors to submit their pricing using the CSI breakdowns so that you can compare the quotes on an apples-to-apples basis.

Plan on paying the contractor every two weeks and based on a percentage of completion. This is another reason you want line-by-line pricing. It easier to determine that the contractor is 50% complete on the electrical install than if they are 43 or 63 percent complete on a lump sum of $500,000. Use AIA form G702 and G703 for payment. Most contractors use this form as it translates the bid line-by-line to a payment form.

Deposits are typical and can range from 5% to 50% depending on the size of the job.

Paying quickly will get the job done faster. If a contractor knows he’s going to be holding an invoice for 30 days, he’s more likely to move his crews to a job that will pay him within a week. He will also promise faster payment terms to his subcontractors who in turn will provide faster service.

Get notarized lien releases. This will prevent lien’s on the property. There are two types of liens: Conditional and Unconditional. A conditional lien waiver states that once the contractor receives $XXX, they will have no lien rights. Use a copy of a cancelled check to prove that the terms of the Conditional lien waiver were meet. Once a payment has been made, an Unconditional lien waiver can be signed which states that because they have received $XXX, they have no lien rights. You don’t need both and it’s easier to get a Conditional lien waiver than an Unconditional because the contractor is waiting for his money until he gets the Conditional but is already paid and in no hurry to get the Unconditional. It’s commonplace to get lien waivers from all subcontractors to the GC which he can then use to defend you should a subcontractor place a lien on your property.