When starting a project, the construction contract you sign with your general contractor and/or construction manager sets the stage for the entire construction process. Whether for a small renovation, a new metal building, or a large commercial development, construction contracts don’t just define price. Construction contracts are designed to identify risk, establish responsibility, and provide dispute resolution through the entire project.
You can prevent costly disputes and project delays by understanding the different construction contract types and the tools available to protect both project owners and contractors. In this article, Mammoth Construction reviews the most common construction contract structures, how they work, and what to watch out for as a project owner.
Comparison of Common Construction Contract Types
| Construction Contract Type | Best Used When |
|---|---|
| Fixed Price Contract | The project scope and construction drawings are complete and well-defined. |
| Cost Plus Contract | Complex projects with a still-evolving scope or design decisions are not finalized. |
Fixed Price (Lump Sum) Construction Contracts
A fixed price contract, also known as a fixed sum, a stipulated sum, or a lump sum contract, is the most commonly used in the construction industry between contractor and owner. The contractor agrees to a fixed price for delivering a defined scope of work, based on the provided drawings, specifications, and scope. Construction companies use this information to gather pricing and establish a project cost. The more details in the drawings, specifications, and project scope, the more confident both parties will be in the project cost and with executing a lump sum contract.
With a lump sum contract, owner’s risk lies in anything not captured by the design/engineering team or the owner hasn’t decided upon at the time of contract execution. However, general contractors assume the risk by agreeing to a set price, regardless of how the project progresses. Once a construction contract is signed:
- The construction contractor assumes the financial risk for cost overruns tied to labor, materials, or inefficiencies.
- The owner benefits from price certainty, knowing the exact project cost, assuming no changes occur.
The Catch: Change Orders
Even with a fixed price contract, the owner still carries risk. Any change to the original scope, design revisions, material upgrades, or unforeseen site conditions will result in a change order. A change order is a formal document that modifies either scope, money, or time agreed upon within the original executed contract. While most associate change orders with contractors pursuing to recoup costs from the owner, change orders can also benefit the owner and are required even for positive adjustments to an agreement.
Change orders:
- Modify the original contract language.
- May increase or decrease total project scope, cost, or schedule.
- Are required for any deviation from the original executed construction contract.
Change orders are commonly where many projects encounter conflict. Incomplete drawings, changing design decisions, or late owner input often trigger change orders that increase costs and extend schedules. Luckily, modern construction management software minimizes potential miscommunication to help reduce any conflicts. Procore CMS, keeps all parties updated with any changes in real-time, stores the most current documents in one primary location, and records communication between parties. Mammoth Construction has noted great improvements with job success and client satisfaction implementing Procore into their construction process.
Cost Plus Construction Contracts
Cost-plus contracts or cost-reimbursement contracts take a more transparent approach than a fixed price contract, with three different types. In a cost plus contract, the construction contractor is reimbursed for all allowed expenses incurred throughout a project plus an additional fee for overhead/profit, which is determined by the contract terms. A cost-plus construction contract allows greater flexibility and transparency between owner and contractor throughout the project. The 3 types of Cost Plus Contracts are:
Cost Plus Fixed Fee Contracts
A Cost Plus Fixed Fee Contract reimburses all construction costs, plus an additional fee established in the contract document. This percentage can be a percentage of the total project cost or an agreed-upon fixed dollar amount.
Cost Plus Incentive Fee Contracts
A Cost Plus Incentive Fee Contract reimburses all construction costs, plus an additional fee. The additional fee is adjusted by an agreed formula based on an established target cost, target fee, minimum fee, and maximum fee. Change orders would be required to adjust any of the fees after contract execution.
Cost Plus Award Fee Contracts
Cost Plus Award Fee Contracts reimburse all construction costs and a base fee plus an additional amount to incentivize excellent contract performance in cost, schedule, and quality. The additional amount can be earned in whole or in part during the project timeline based on clearly defined targets. Similar to incentive construction contracts, Cost Plus Award Fee Contracts allow for a wider range of milestones/incentives instead of limiting them to project costs.
Why Owners Choose Cost-Plus Contracts for Construction
- A cost plus contract provides true transparency into real costs. Every receipt and invoice is submitted to the owners or the owner’s representatives to reflect in the payment schedule. This allows owners to see exactly what project costs are and how their money and time are being spent.
- Flexibility when the scope is not fully defined. If the owner has not fully committed to design choices or needs to start work before completing the project scope or drawings, this can allow both parties to feel protected moving forward.
- Potential cost savings if the project runs efficiently. Excellent GCs and/or construction managers can identify opportunities to value-engineer cost savings or reduce timelines, financially benefiting the owner as construction costs decrease.
The Trade-Off
The owner assumes more risk throughout the construction project. Contractors still deliver a budget/bid based on drawings and specs, for owners to budget and plan accordingly. However, because costs aren’t capped, the final price may vary from the original budget. The amount of variation depends heavily on:
- Project Management Quality
- Market Conditions
- Weather / Seasonal Limitations
- Decision-Making Speed
- Design Completeness
Even with a cost plus contract, change orders still exist. However, most cost adjustments become part of the ongoing project reconciliation rather than renegotiation.
Change Orders: The Most Common Source of Conflict
Change orders are used in every construction project, regardless of contract type. Common causes of conflict around change orders include:
- Design Omissions or Unclear Drawings
- Owner-Driven Changes
- Site Conditions Differ from Assumptions
- Material Availability Issues
Change orders can either increase or decrease the contract value. The key is clarity: before work proceeds, all changes should be documented, approved, and priced. Construction projects with incomplete drawings or vague scopes tend to generate the most change orders, along with the most disputes.
Bid Bonds, Performance Bonds, and Payment Bonds
Bonds act as insurance policies for owners from the financial repercussions if a contractor can no longer complete a project. Owners often use bonding to qualify a builder by the surety company rating and the bond capacity that a contractor can obtain. Bonding companies validate a contractor’s previous performance, finances, and any claims they may have to determine bonding capacity. Any owner may request bonding. However, the contractor must build the additional cost for bonding into their price, with the owner paying usually a minimum 2% fee, on top of the project cost.
Comparison of Common Construction Bond Types
| Bond Type | Who It Protects | When It Applies | Primary Purpose | Typical Use Cases |
|---|---|---|---|---|
| Bid Bond | Project Owner(s) / Developer(s) | During the bidding phase | Ensures the contractor will honor their bid and sign the contract if awarded | Public projects, government work, fast-tracked or competitive bids |
| Performance Bond | Project Owner(s) / Developer(s) | After contract award, during construction | Guarantees the insurance company will complete the project if the contractor defaults | Large commercial projects, retail chains, high-risk or first-time contractors |
| Payment Bond | Project Owner(s) & Subcontractor(s) | During construction | Ensure subcontractors and suppliers are paid and prevent liens | Public projects, lien-sensitive developments, bonded contracts |
What are Bid Bonds?
Bid bonds protect the project owner during the bidding process by ensuring that the contractor who submits a bid honors that bid if selected. If the contractor backs out, the bond compensates the owner, typically a percentage of the bid amount.
Bid bonds are most common on:
- Public sector projects
- Large commercial developments
Performance and Payment Bonds
Once a contract is awarded, a performance bond guarantees the contractor completes the project, while payment bonds ensure that subcontractors and suppliers are paid. These construction bonds protect parties from financial effects if a contractor is unable to do the work or finish a project.
Payment & Performance bonds:
- Act like insurance for the owner
- Are underwritten based on the contractor’s financial health
- Typically, at least 2% of the contract value
If the contractor defaults, the bonding company steps in to complete the project or compensate the owner.
Common Construction Contract Damages
| Damage Type | What It Covers | How It’s Determined | Common in Contracts? | Key Considerations |
|---|---|---|---|---|
| Liquidated Damages | Pre-agreed cost for project delays | Fixed dollar amount per day or week stated in the contract | Yes | Provides clarity and predictability; often increases contract price due to added contractor risk |
| Consequential Damages | Indirect losses, such as lost revenue or missed business opportunities | Calculated after the fact based on actual or projected losses | Rarely (usually waived) | Can be unlimited and highly litigious; commonly waived by both parties |
| Compensatory Damages | Direct and special damages tied to actual costs incurred | Based on documented expenses or repair costs | Sometimes | Typically limited to direct impacts and easier to quantify than consequential damages |
| Nominal Damages | Small, symbolic damages for minor breaches | Fixed minimal amount stated or implied | Occasionally | Does not extend indefinitely; used when harm is minimal |
| Punitive Damages | Punishment for extreme or willful misconduct | Determined by courts, not contracts | No | Generally excluded from construction contracts and difficult to enforce |
Liquidated Damages: Protecting the Construction Schedule
Liquidated damages are pre-agreed financial penalties for missing contractual deadlines. These are added to a construction contract to guarantees the completion of a project within a specific number of days, and if not, a set amount of money will be paid back to the owner. Liquidated damage clauses exist because “time equals money”, a saying that Mammoth Construction prioritizes for each of our clients. This is especially true in retail, healthcare, multifamily residential construction, or other revenue-driven facilities.
Why Liquidated Damages Matter:
- Liquidated damages create accountability within construction contracts
- Allow owners to plan staffing and operations
- Help avoid lawsuits by defining damages upfront in the construction contract
Liquidated damages also set a known, capped exposure instead of open-ended claims to protect contractors. While liquidated damages can act as negative reinforcement, performance bonuses can be added to construction contracts as a type of positive reinforcement. It is common for construction contracts that include liquidated damages to also include early completion bonuses which incentivize early completion and keep projects on schedule.
Other Construction Contract Damages
Consequential Damages are indirect damages that occur as a result of an incident, usually failing to fulfill a construction contract, and are compensable in a lawsuit. These damages are often not immediately apparent and go beyond the contract itself. Consequential Damages include indirect losses such as lost revenue, missed business opportunities, or delayed openings. Not only do they hold the contractors accountable, but owners are also held financially responsible if they cause delays to the project, preventing the contractor to move onto a different project. It is typical for construction contracts to waive consequential damages for both parties to avoid unlimited financial exposure and a litigious atmosphere.
Compensatory Damages are monetary payments awarded to a party in compensation for losses incurred due to the negligence or unlawful conduct of another party. In construction contracts, compensatory damages cover direct losses resulting from a breach, such as rework costs or repair expenses.
Nominal Damages are small, symbolic amounts that are used when a breach of contract occurred but caused minimal harm. These damages are simply used to acknowledge wrongdoing by one party, even if no actual financial loss is proven.
Punitive Damages, or exemplary damages, are monetary payments awarded to punish intentional wrongdoing and reckless behavior. These are paid to a party in addition to compensatory damages and do not compensate for loss. Punitive damages are rare in construction and are usually excluded from construction contracts.
Planning and Clarity Matter More Than the Type of Construction Contract
The most common source of construction disputes isn’t bad intent; it’s poor planning. Every unresolved detail increases the likelihood of change orders, delays, and frustration. Typically, construction projects run into trouble when designs are incomplete, decisions are deferred, or when bids are rushed before having finalized drawings. The more clarity you have upfront, the fewer surprises you’ll face later. Fully defined scopes and material selections are critical to a well-planned project because they set clear expectations, prevent costly changes during construction, and allow accurate pricing, scheduling, and accountability for both the owner and contractor. Lastly, the earlier owners begin contractor involvement on construction projects, the better. Early contractor involvement brings experience and industry knowledge around cost, schedule, and constructability to the planning phase, reducing risk and preventing costly issues before construction begins.
Good construction contracts don’t create conflict; they prevent it.
Clarity, communication, and trust build best construction projects, not loopholes or legal leverage. Before signing any contractual agreement, understand what’s important to you and make sure it’s defined within the contract. Therefore, a generic construction contract template may not fit your priorities. The best way to ensure a successful project outcome is to select a solid construction contract that aligns expectations and manages risk for all parties. Whether it’s a fixed sum agreement, cost-plus structure, or performance-based contract, the goal is the same, providing a roadmap for a successful project delivery by all parties.
Before you start planning your next project,
reach out to the Mammoth Construction team.
Our experienced professionals can discuss what construction contract type is best for your next build, regardless of partnering with a general contractor, construction manager, or owner’s rep.
