Types of Construction Contracts: Pros, Cons & Best Practices


What Is a Construction Contract?

In simple terms, construction contracts are legally binding agreements that explain the work to be performed by a general contractor and the payment that will be made by a project owner. They play a very important role in construction management.

However, construction projects vary greatly in terms of complexity and size, so there’s not a one-size-fits-all approach when it comes to construction contracts. That’s why several types of construction contracts have been developed over time, such as lump sum, cost-plus, time & materials (TM) and unit pricing contracts.

Whichever type you use, ProjectManager is project management software that can help you manage your construction contracts. Our unlimited file storage and real-time collaboration tools are ideal to keep track of your construction project’s documentation and stay connected to sub-contractors, vendors and suppliers. Get started for free.

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Why Is a Construction Contract Necessary?

Construction contracts protect both parties in the agreement. These construction administration documents detail what work will be completed, when it will be completed and how much it will cost. They also outline methods of communication and how disputes will be handled if they arise.

By including information about communication and changes, construction contracts streamline the decision-making process. Ideally, project risks have been anticipated and the contract outlines how best to proceed. A construction contract is, first and foremost, an agreement, but it serves as a roadmap of sorts as well.

Who Is Involved in Construction Contracts?

Construction contracts involve two parties; owners and contractors. Owners need a job outsourced and the contractor executes the job. The two parties work together to draw up a contract and agree on the terms of completion and payment.

Owners contract builders when they need to execute a specialized job they cannot perform on their own. They may also contract builders when the scale of the project is too large for them alone. Construction projects, in particular, often require owners to hire several different contractors. In this case, thorough construction contracts are crucial to the successful management of the project.

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Types of Construction Contracts

Because construction projects take many forms, different projects require contracts with different characteristics. All types of construction contracts define a timeline, budget, quality requirements and other aspects that need to be defined in every construction project. The two main differences between these types of construction contracts are the way in which the disbursement is going to be made and the risks and rewards that are assumed by each party.

Before creating a construction contract, it’s important to know the type of contract that best suits your needs.

Lump-Sum Contract

A lump-sum contract (also called a fixed price contract) names a total price for the entire job. This price accounts for all time and materials regardless of changes or issues. This type of contract protects owners against unforeseen changes and setbacks.

Lump-sum contracts can seem as though they favor the owner over the contractor, but there are ways to balance the scales. Many contractors charge an additional percentage for signing lump sum contracts, as they will be taking a higher risk. Additionally, incentive programs are often put in place by owners to reward jobs being completed early.

Cost-Plus Contract

Cost-plus contracts are made of two parts: a predetermined fee and accumulated costs. This fee is the agreed price owners will pay contractors. It can be a dollar amount, a percentage of the total project cost or another form of payment. The defining characteristic of a cost-plus contract is it reports expenses as they occur rather than deducting costs from a set budget.

A cost-plus contract is used when construction project expenses are uncertain. While this can seem like a liability, cost-plus contracts often include incentives for coming in under budget and set caps on expenditures. This avoids conflict and ensures contractors are paid a fair overhead.

Time and Materials Contract

Time and materials contracts are a fitting choice when the scope of a project is completely unknown. In this case, contractors charge an hourly rate for labor and for materials as needed. Because this leaves uncertainty, these contracts must be specific and prepare for almost anything. An owner should include incentives for construction projects completed ahead of schedule and/or under budget.

A time and materials contract is a good choice for small projects as they require close supervision. For example, all costs must be carefully monitored and classified in order to document them and ensure contracts are followed. As you can imagine, this becomes increasingly difficult the larger the project. The advantage of choosing a time and materials contract is it protects owners from overpaying contractors.

Unit Pricing Contract

A unit pricing contract is used when an owner wishes to buy a large quantity of a certain product. Each product is a unit and costs a set price. These items can also often be charged in bulk quantities for a reduced price.

Unit pricing contracts are advantageous when an owner knows exactly how much of a specific product they need. Using this type of contract and buying all the units at once is also a good way to protect against potential future inflation of material prices. By buying all of the items at once, owners generally pay less than they would in the future and don’t have to worry about drawing up future contracts.

Design-Build Contract

In most cases, project owners receive completed designs during the construction bidding process. However, in a design-build contract, the design and construction are done simultaneously and handled with just one contract, as opposed to traditional methods.

This type of construction contract allows for increased communication between the designer and the construction team and speeds up the bidding and construction process.

Guaranteed Maximum Price (GMP) Contract

A guaranteed maximum price (GMP) contract defines the maximum price that a project owner will have to pay for a construction project. In the event that the costs exceed said guaranteed maximum price, the general contractor will cover all the additional expenses.

For that reason, this contract type requires that general contractors create the most accurate construction estimate possible. It might sound risky, but it doesn’t have to be. General contractors can easily create estimates using construction estimating software like ProjectManager or hire a specialized construction estimator to create realistic and profitable estimates.

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Incentive Construction Contracts

Under an incentive construction contract, the project owner and contractor agree on an extra payment fee that’s given to the contractor depending on whether the project is delivered on time and under budget.

If the contractor misses the timeline or exceeds the budget, they still need to complete the project and meet the owner’s requirements even without earning the extra payment fee.

Integrated Project Delivery Contract

This type of contract is mostly used for large, complex projects. Similar to the design-build contract, it uses a single contract for design and construction, but it also involves a multi-party agreement between owner, builder and designer where they share risks, agree on costs, set waivers and follow lean principles.

The main purpose of this construction contract is to provide a detailed framework that spreads the risk and rewards evenly among the parties. For example, an IPD construction contract involves a lump sum profit that’s divided among the owner, designer and builder if the project achieves financial results.

Construction Contracts Best Practices

No matter what type of construction project you’re planning, these best practices ensure your contract is a clear, detailed arrangement:

Include Incentives

One of the best ways to set a construction project up for success is by creating incentives. Incentives are useful when the scope is undetermined and the budget, time and labor costs are up in the air. Incentives encourage both contractors and owners to work efficiently and complete a project on time and under budget.

Clearly Outline Expectations

Be clear when conveying expectations on how expenses will be reported, how communication will be maintained or how any other aspect of a construction project is managed. Outline a contract and break it into key points to which the contractor can refer back.

Create Contingencies

The best construction contracts have contingency plans. More often than not, something unexpected will happen during a construction project. When construction contracts have contingencies, both the owner and the builder have a roadmap of what to do when something goes wrong.

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What to Avoid When Writing Construction Contracts

Here are three common mistakes to learn from and avoid in your construction contracts.

Not Being Specific

One common mistake is to generalize rather than specify. The point of a construction contract is to detail the exact terms of the agreement between an owner and a builder, and there should be no room for interpretation. There’s no such thing as an overly detailed contract.

With this in mind, construction contracts should remain clear and unclouded by unnecessary details. Find a balance between anticipating everything that should be included and editing down information that dilutes the key points. Our construction management templates are a great place to start creating your construction project documentation.

Not Establishing Communication

When writing a construction contract, specify exactly how and when a contractor should communicate. This communication can be in the form of regular check-ins or only in the case of significant changes, but both parties must know when to run something by one another before making decisions.

Lack of communication is detrimental to construction projects. Because there are so many moving parts, everyone must understand their role in relation to one another. A well-written construction contract sets up a system of communication and makes it clear where to direct questions and updates.

Not Detailing How to Manage Changes

Changes are inevitable in any project, but never more so than in construction projects. Construction projects have countless moving parts, involve many individuals and many different contractors. This means adjustments are a natural part of the project.

A detailed construction contract means these changes don’t have to be bumps in the road. When contracts stipulate exactly how changes should be made, who makes them, and how the process looks, everything runs smoothly. On the other hand, when these details are not clear, contractors won’t know how to make changes, who to go to for approval and how to document what changes were made.

ProjectManager & Construction Contracts

ProjectManager gives you the power to manage construction projects from start to finish, on the go. Create a comprehensive project plan, complete documents and assign tasks from the job site or anywhere else you get work done.

Interactive Gantt Charts

We have an online Gantt chart for you to plan your construction project from start to finish. Add durations to your tasks and a bar chart is generated. If any tasks are dependent, they can be linked while milestones can be set across the timeline.

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Resource and Team Management

Managing resources can be complicated, but our online resource management software gives you the real-time data you need to make informed decisions. Categorize your teams, supplies and equipment and add hourly rates. When hours are logged, the actual cost is automatically compared to the planned cost.

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As your teams log their hours, our time tracking feature automatically updates when workers finish their tasks, making payroll a breeze. You can also track your team’s progress on the real-time dashboard, which displays key project KPIs in scannable graphs and charts.

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ProjectManager is construction project management software that has the tools you need to manage your construction project. Our robust features make planning, scheduling and reporting down to the last task more efficient and effective. Plus, the data you get is more accurate because it’s updated as your team works. Try ProjectManager free with this 30-day trial offer.