In today’s world, providing construction services to a potentially litigious public carries with it the need to know and understand owner/contractor contractual relationships. Let’s face it, few deals are “done on a handshake” anymore and
though perhaps lamentable, it would be
fool-hardy for any sound business person
to enter into an agreement worth
hundreds of thousands-even millions-of
dollars and not be protected through the
courts should something go awry.
The Contract
So bring on the contract. Now, for the
purposes of this article, “contract” will
refer to the owner/contractor agreement
and relationship about to be undertaken.
The actual paperwork drawn up will
simply follow the philosophy chosen by
the parties, available through such organizations
as the American Institute of
Architects, Associated General Contractors,
Associated Building Contractors,
your own legal department and more.
The contract is important because it
provides legal obligations and responsibilities
for both parties.
But for you, the contractor, there’s much
more. The contract also forms the foundation
from where you will rest much of
your ability to earn profit for your company.
Should you enter into a lop-sided,
owner-partisan arrangement, you will Competitive Bid
almost surely suffer financially before the
project is through. On the other hand,
if you insist on offering the consumer a
firmer contract too protective of your
own interests, it’s likely you won’t find
many takers, thereby suffering from lack
of work over the long haul.
So, the best of all worlds seems to lie
somewhere in between; in finding a contractual
vehicle where both (or all) parties
feel their interests are represented yet
with neither enjoying an undue advantage
over the other. Of course that’s far
easier said than done. And yet try we
must, for the reward of formulating an
agreement that is truly fair, clear and
equitable to everyone involved provides
for a construction project that is often
- More financially predictable. This
means no great killings profit-wise, but
no great losses either. - More efficient in achieving a speedy,
flowing construction schedule, which is
always profitable for all. - Far less stressful to all parties involved,
knowing their interests are represented. - Resultant in greater opportunities for
the contractor through repeat business-the
lifeblood of most construction firms-between
the project owner and contractor.
Now, formulating the “perfect” contract
may seem a daunting task-especially to
non-legal types, but I’ve got good news.
There’s no need to re-invent the wheel.
Many of the contractual relationships
you seek are already out there just waiting
for you and your owner to adapt
them to your own unique situation. So,
to this end, it makes sense to understand
them. Therefore, let’s take a look at some
common owner/contractor arrangements.
Competative Bid
To begin, it’s important to say a few
words about competitivebid. Yes, many
consider CB more a bid process than an
actual relationship, but I include it in
our discussion because it leads so strongly
into what will become the owner/contractor
relationship throughout the project.
I also include it because-particularly
when you’re new to construction-com-petitive-
bid is often the way you’ll earn
much of your living at first.
CB is the process where (most often)
lump-sum bids are submitted to a project
owner by a number (often three or
more) competing, bidding prime contractors.
Widely used for private and
public projects alike, architectural plans
and specifications for the project bid in
CB are normally completed prior to the
bid period. The documents are then distributed
to bidding contractors. Each
bidder then estimates a cost to complete
the project based solely on the information/
direction contained in the documents
and any new information un-earthed
during the bid (addenda). The
bidder then submits his/her bid by a
pre-determined bid date and time. At
that point, the bids are opened and, if it
is an open letting, read publicly. If the
letting is closed, the bidding parties may
or may not ever hear how they fared in
the competition. Generally, the lowest,
qualified bidder then receives the work.
The CB/Contract Relationship
Now, competitive bid has its good and
bad points, but suffice it to say that the
competitive-bid process is highly mercenary,
which is exactly why it aids so
strongly in molding the eventual owner/
contractor relationship . . . and contract.
The time, energy and cost expended
by a contractor to bid a CB project is
very costly and far more speculative
than, say, individually negotiated or
design/build arrangements (more on
these later). In unregulated CB bid scenarios,
there’s a very real risk of pouring
precious man-hours into a bid only to
be greeted with five, 10 and even 20
competitors. The downside is obvious.
All you have to do is ask yourself,
“Would I really want to be the low number
out of (*this really happened to me!)
28 bids?” I’m guessing you wouldn’t.
But even so, the pressure to get work for
your people is real and omnipresent.
Many a prudent contractor has found
himself from time to time bowing to the
pressure of the CB atmosphere and lowering
profit margins and/or accepting
risks that he would likely not otherwise
consider in the heat of the CB moment.
In fact, the only positive aspect of CB
may be that the owner can end up getting
a very competitive cost for his project,
although this “savings” is often off-set
with poor owner/contractor
relations, increased change-orders, and
interruptions in project schedule
brought on by disputes. In short, CB
creates a breeding ground for polarization
and, since the contracts for these
deals are often cut by the owner or owner’s
rep (often the A/E firm), the language
tends to be more owner partisan
and less contractor friendly, forcing a
“me against them” mentality that permeates
the entire job.
Design/Build (and Partnering)
So what are the alternatives? One popular
contractual method in almost diametric
opposition to CB is design/build.
Design/build, sometimes referred to as
“negotiated design/build,” is where a
single contract covering both the design
and construction of the client’s project
is struck between the contractor and the
owner. The project is negotiated
between the parties from the very beginning
instead of simply being dumped
onto a group of contractors (whose
skills, reliability and financial strength
often vary markedly) to cost and submit.
DB is also sometimes referred to as
“turn-key” construction and takes into
account many positive aspects of a philosophy
known as partnering, where all
members of the construction process-owner,
contractor, and designer alike-essentially
enter into a “pact” to work as
a team to increase cooperation, reduce
change orders once work has begun,
generally creating a less adversarial and
often more efficient working atmos- Fast Track Design/Build
phere for all.
But though considered by many (especially
contractors) to be a more preferable
construction vehicle, DB opportu-nities
simply don’t come along as often
as CB, especially when you’re just starting
out as a contractor. You will likely
need to be patient. DB/partnered deals
require a trusting, two-way relationship
between you and your customer (and
even your on-staff or subcontracted
designer) that is mostly achieved only
with time and a proven, reliable track-record.
Trust is indeed the key word
here.
Technically, the primary difference
Competitive Bid, Design/Build
between design/build and competitive-bid
is in who controls the process.
Though an A/E firm may still be
brought in as part of the team, they no
longer have complete control over the
conception and design of the project-and
the contracts. Those tasks now
become more of a joint affair, with input
gathered from all members of the team:
owner, architect, general contractor and
sub-contractors. True, the contractor
does accept a greater amount of responsibility
and liability under D/B, but he
can also often count on slightly better-and
more predictable-profit margins.
Fast-Track Design/Build
Fast-track design/build is essentially the
same as design build except now the
project is started almost immediately
upon agreement and often before the
plans and specifications have even been
fully developed. This is construction-on-the-
fly and offers more risk for the team
from problems that could potentially
arise as details are flushed out after the
work has already begun.
But this risk can come with offsetting
reward. First, the project is started and
completed faster. The owner, often a
business person and often quite tuned in
to the “bottom line,” reaps benefit by
saving on interim interest on construction
funds, reducing (costly) down-time
during the period of transition to the
newly constructed facility, and more.
Competitive Bid, Design/Build
Competitive bid, design/build is a
hybrid form of both CB and DB where
a (generally limited and invited) group
of bidding contractors is given instruction
for an “end-result” the owner wishes
to achieve. There may be little detail
given the bidders other than information
including physical size parameters,
specific use and general needs of the project,
such as a medical or institutional
facility Or the information may be deep
and delineated. Either way, it’s then up
to the competitive-bid DB bidders to
provide the nuts and bolts in their bid.
Often with help of third-party design
firms, the bidding companies take the
information and work up individual
proposals they feel will best appeal to the
owner. All phases of construction are
included and costed, from conceptual
design to punchlist. The cost bid for the
work is based on each contractor’s own
unique design. Of course, this means the
bidders are not bidding “apples-and-apples,”
but that was never the intent.
The goal is to choose the best package
for the most competitive cost-a determination
made solely by the owner.
Needless to say, with the office cost of
estimating and design now worked into
the mix, CBDB can be an expensive and
highly speculative undertaking for the
bidding contractors. Therefore, competitive
DB is most often undertaken by
only the most seasoned, experienced and
financially stable of firms.
Fee Arrangements
In CB scenarios, the profit or fee that the
contractor inevitably enjoys (or doesn’t!)
is part of the bid cost originally submitted to the owner as a lump-sum. Barring change orders, this fee is fixed and pre-determined
at the time of bid. It can’t be
changed.
There’s more flexibility in DB and negotiated
arrangements. In these relationships,
there comes a time when the parties
decide on a fee, and it can be structured
in a variety of ways. Again, there
are pluses and minuses to almost all
arrangements, and the structure that
best suits your unique situation will likely
be dictated by the project, the owner,
the type of work being performed, and
even your own past experience with fee
structures. But, to get you started, here
are a few of the most popular fee structures
for construction arrangements:
Lump sum (fixed fee). This is as simple
as it sounds: A set amount of money
designated as a fee. It may be $5,000 or
$500,000, but it generally won’t change.
The fee arrived at will most often be a
product of the size and scope of the venture.
Percentage. This is a percentage of the
total overall construction cost. Generally
more common than the lump-sum
(in negotiated deals), the contractor’s fee
is a percentage of the final cost of the
project. The contractor’s take then rises
and falls accordingly based on the final
size and scope of the work. The amount
of percentage used by the parties varies
and is often dictated by factors such as
the type of job being undertaken, market
climate, your own business and fiscal
needs, and much more-even negoti-ating
skills.
Cost plus (percentage or fixed fee).
Often an “open book” arrangement
where the contractor shows the owner
the actual cost of the project through-out,
often at the time the contractor’s
progress payments are handed out. Budget
estimates are still prepared in the
beginning and used as guides, but, in the
end, the real costs-dictated by the success
or failure of the project-dictate the
final fee agreement. Now cost-plus has
many hybrid forms (as do all the relationships
we’re discussing here today),
but two types of cost-plus arrangements
are these:
Cost plus (guaranteed maximum). This
is the same as cost-plus except now the
parties agree to spend only up to a set
amount of capital. The positive side
cost-plus-guaranteed-max is that the
owner knows the job will not exceed the
funds set aside. The downside (and you
can see this coming) is that once the
fund maximum is reached-and assuming no more money will be pumped in,
the owner and contractor may need to
value engineer (find ways to cut costs and
still keep the original intent and quality
of the project) on the fly and late in the
game. Not fun. In even worse-case scenarios,
the contractor’s involvement in
the project may grind to a halt, leaving
the owner solely responsible to provide
final elements or provide some other
remedy to reach the original set amount.
Cost plus (with savings). Again similar
to cost-plus, but this time the owner and
contractor agree to split any savings realized
from the original estimate once the
job is closed out. The percentage of split
(50-50, 60-40, etc.) is negotiated prior
to signing the construction agreement.
This can be a very attractive fee arrangement
and often used to attract a particular
contractor to the project. But it
could also be argued that cost-plus-with-savings
offers incentive to both parties to
remain lean and cost-effective during
construction, possibly limiting petty
change-orders and arguments, in turn
propelling the construction schedule
along as well.
Scratching the Surface
It must be especially noted that the lines
between contract types, owner/contractor
relationships and fee arrangements
has become blended and homogenized
over time. It’s not at all unusual to see
many different hybrid combinations of
any one of the situations we’ve discussed
above used at any time.
Essentially, in the end, the contract
formed between you (the contractor)
and the owner will be limited only by
the imagination and willingness of
everyone involved to strike a fair and
provide a vehicle for a smooth and
beneficial-to all parties-construction
process. Good luck!
About the Author
S.S. Saucerman retired after 26 years in
the construction industry. Today he is
writing, speaking and consulting on a
full-time basis.
