Guide to Construction Contracts for Project Managers

Contracts shape every construction project long before the first shovel hits the ground. They decide who takes on risk, how payments flow, and what happens when things don’t go as planned. Yet, many project managers focus on schedules and budgets while overlooking the fine print—until it’s too late.

This guide breaks down the most common construction contracts, explaining when to use them, their risks, and how they impact project delivery. Whether you need cost certainty, flexibility, or performance incentives, understanding the right contract can mean the difference between a smooth project and a legal nightmare.

What Is a Construction Contract?

A construction contract is a legally binding agreement between the parties involved in a building project. It defines scope, costs, timelines, payment terms, quality standards, and responsibilities. Whether for a small home renovation or a billion-dollar infrastructure project, construction contracts set expectations and allocate risks to prevent disputes and financial losses.

At its core, a construction contract answers:

• Who is responsible for what? (Owner, contractor, subcontractors, suppliers)
• How much will it cost? (Fixed price, cost-plus, unit-based, etc.)
• How long will it take? (Project duration, deadlines, penalties for delays)
• What happens if something goes wrong? (Dispute resolution, defect liability, force majeure)

Key Elements of a Construction Contract

1. Scope of Work – Clearly outlines what the contractor will build, including materials, specifications, and design details.
2. Payment Terms – Defines how and when the contractor gets paid (lump sum, progress payments, cost-plus, etc.).
3. Project Timeline – Includes milestones, deadlines, and penalties for late completion.
4. Change Orders or Variation Orders – Explains how changes to the scope, design, or materials will be handled.
5. Risk Allocation – Details who is responsible for cost overruns, delays, or unforeseen site conditions.
6. Warranties & Quality Standards – Sets expectations for workmanship, defect liability, and maintenance responsibilities.
7. Dispute Resolution – Establishes methods for handling conflicts, such as mediation, arbitration, or litigation.

Contract Type vs. Project Delivery: What’s the Difference?

Not every construction project follows the same playbook. Some projects require strict cost control, while others demand flexibility. Some owners want a hands-off approach, while others need full oversight. That’s where contract types and project delivery methods come in.

While they work together, they serve different roles. One controls how payments and risks are handled, while the other defines who does what and when. Understanding both helps you avoid delays, budget overruns, and miscommunication.

What Is a Contract Type?

A contract type defines how the contractor gets paid, how risks are shared, and who is responsible for cost overruns or delays. Some contracts lock in a fixed price, while others allow costs to change based on actual expenses. Picking the right contract type ensures financial clarity and minimizes disputes.

For example, a lump sum contract guarantees a fixed price for the entire project, shifting risk to the contractor. A cost-plus contract, on the other hand, reimburses actual expenses plus a fee, giving the owner more flexibility but less cost certainty.

What Is a Project Delivery Method?

A project delivery method determines how the project is structured—from design to construction to final completion. It outlines who is responsible for each phase and how they interact.

For example, in a Design-Bid-Build (DBB) approach, the owner first hires a designer, then puts the project out for bid, and finally hires a contractor. This separates design from construction, which can slow things down but ensures a clear scope before work begins.

In a Design-Build (DB) model, one firm handles both design and construction, speeding up the process but reducing owner control over design decisions.

How Contract Types and Project Delivery Methods Work Together

The contract type you choose must align with your project delivery method. For example, GMP contracts are commonly used with Construction Manager at Risk method because they offer cost control while allowing early construction to begin. Lump sum contracts often pair with DBB, where a fully designed project is put out for bid. T&M contracts may be useful in Integrated Project Delivery (IPD) or fast-track projects where the scope evolves.

10 Key Types of Construction Contract

Choosing the right contract can make or break a project. Some contracts offer cost certainty, while others provide flexibility. The best choice depends on the project's scope, budget, and risk tolerance. Below, we break down the most common contract types, their benefits, and when to use them.

1. Lump Sum Contract (Fixed-Price)

A lump sum contract, or fixed-price contract, means the contractor agrees to complete the project for a set price. This price stays the same, no matter how actual costs fluctuate. The contract is simple—the owner pays a fixed amount, and the contractor takes on most of the financial risk.

It is the most common contract in construction because it simplifies budgeting and helps control costs. However, it requires a complete and detailed project design before signing. Any changes after work begins can lead to costly variations.

Best for:

• Commercial buildings, offices, and schools with finalized designs.
• Government-funded projects with strict budgets.
• Small to mid-size projects needing cost certainty.

Pros

• Predictable costs, making budgeting and financing easier.
• Less administrative work with fewer cost adjustments.
• Encourages contractors to complete work efficiently.

Cons

• Higher bid prices since contractors add a risk buffer.
• Costly changes if modifications are needed mid-project.
• Limited flexibility if unexpected site conditions arise.

Recommendation

Use this when the design is complete, and changes are unlikely. Ensure all scope details, inclusions, and the variation process are clear before signing.

2. Time and Materials (T&M) Contract

A Time and Materials (T&M) contract allows the owner to pay for actual labor hours and material costs, plus a contractor’s fee. Instead of locking in a fixed price, the contractor gets reimbursed based on time spent and resources used. This contract is best when the full scope of work isn’t clear from the start.

Best for:

• Renovations and remodeling, where unforeseen conditions often arise.
• Emergency repairs, where fast action is needed before defining a full scope.
• Custom projects or prototypes, where designs evolve during construction.

Pros

• Provides flexibility if the project scope changes.
• Ensures transparency—owners see actual labor and material costs.
• Allows work to begin before finalizing all project details.

Cons

• Costs can escalate if labor hours and materials aren’t closely monitored.
• Contractors have less incentive to work efficiently.
• Requires strong oversight to avoid unnecessary spending.

Recommendation

T&M contracts are useful when project details are uncertain, but they require strict cost controls. Set a not-to-exceed cap or milestone-based cost reviews to prevent overspending. 

3. Unit Price Contract

A unit price contract divides project costs into specific, measurable work units. These units can include cubic meters of concrete, tons of steel, or meters of piping. Instead of receiving a lump sum, the contractor is paid based on the actual quantities used. 

Each unit is billed at a pre-agreed rate, ensuring transparency in costs. This type of contract is especially useful when some project details are uncertain. However, it still provides a predictable pricing structure, making budgeting and cost tracking more manageable.

Best for:

• Roadwork, pipelines, and infrastructure projects with repetitive tasks.
• Earthworks and excavation, where final volumes may change.
• Utility installations, where different site conditions impact material needs.

Pros

• Flexible for projects where exact quantities aren’t known upfront.
• Owners pay only for actual work completed, avoiding overpayment.
• Easier to adjust scope if conditions change, such as needing more concrete or excavation.

Cons

• Requires accurate unit pricing—small errors in rates can lead to major cost overruns.
• Contractors may bid low on common items but increase prices on less frequent units.
• Quantity tracking and verification must be strict to prevent overbilling.

Recommendation

Use a unit price contract when work involves repeatable, measurable units, but be prepared for fluctuating total costs. Before signing, ensure unit rates are competitive and tracking systems are in place to verify actual quantities used. 

4. Guaranteed Maximum Price (GMP) Contract

A Guaranteed Maximum Price (GMP) contract establishes a fixed cost limit for a project. This ensures the owner will not pay more than the agreed maximum amount. 

If the actual project costs come in under the GMP, the savings are usually shared between the owner and the contractor. This arrangement incentivizes the contractor to control costs and work efficiently. However, if expenses exceed the GMP, the contractor is responsible for covering the overrun. The only exception is if the extra costs result from changes requested by the owner.

Best for:

• Public buildings, hospitals, and infrastructure projects needing cost control with some flexibility.
• Projects with early contractor involvement for better cost estimation.

Pros

• Protects owners from budget overruns.
• Encourages contractors to control spending.
• Allows work to start even if some details aren’t finalized.

Cons

• Contractors may inflate estimates as a safety buffer.
• Requires strict cost tracking to prevent overbilling.
• Scope changes can lead to contract renegotiation.

Recommendation

Use when cost certainty is critical but flexibility is needed. Ensure open-book pricing, a fair savings-sharing clause, and clear cost definitions to keep contractors accountable and costs in check.

5. Cost-Plus Contract

A cost-plus contract reimburses the contractor for actual costs incurred. These costs include labor, materials, and equipment. In addition, the contractor receives an extra fee, either a fixed amount or a percentage of costs.

Unlike lump sum contracts, there is no predetermined total cost. This makes cost-plus contracts ideal for projects with an uncertain scope or evolving design. However, without proper oversight, costs can rise quickly. Contractors have less incentive to control spending.

Best for:

• Complex or high-quality projects where design may change, such as hospitals or research facilities.
• Large infrastructure builds where unpredictable conditions (e.g., soil quality, material availability) impact costs.
• Fast-track projects where work begins before finalizing full designs.

Pros

• Maximum flexibility – The project can adapt without renegotiating the contract.
• Transparency – Owners see actual costs and can verify expenses.
• Encourages quality – Contractors aren’t forced to cut corners to stay within a fixed price.

Cons

• No cost cap – Final expenses can exceed expectations if not controlled.
• Less contractor incentive for efficiency – The more they spend, the more they earn.
• High administrative effort – Requires detailed tracking of all costs.

Recommendation

Cost-plus contracts work best when scope uncertainty is high, but they require strong financial controls. Owners should set a cost cap, conduct regular audits, and define allowable expenses to prevent unnecessary spending. Without strict oversight, costs can spiral beyond the original budget.

6. Design-Build Contract

A design-build contract combines design and construction under a single contract, meaning one entity is responsible for both phases. This streamlines communication, reduces conflicts between designers and contractors, and speeds up project delivery. 

Since the design and construction teams work together from the start, issues are identified earlier, reducing costly design errors and rework. However, because the contractor takes the lead, the owner has less direct control over design decisions, which can impact customization and quality if not managed properly.

Best for:

• Projects with tight deadlines, such as commercial buildings, warehouses, and data centers.
• Owners who prefer a single point of responsibility instead of managing multiple contracts.
• Projects where design changes may need to happen during construction without delays.

Pros

• Faster project completion – Design and construction happen in parallel instead of sequentially.
• Fewer disputes – One entity is responsible for both design and execution, reducing conflicts.
• Cost efficiency – Contractors can optimize design for constructibility, lowering costs.

Cons

• Less owner control – The contractor makes many design decisions, which can affect aesthetics and quality.
• Potential cost-cutting – Some contractors may prioritize savings over design quality.
• Difficult to compare bids – Since design and pricing are combined, it’s harder to evaluate proposals side by side.

Recommendation

Design-build works well when speed and efficiency are priorities, but owners must clearly define design expectations upfront. Ensure that quality standards, material specifications, and performance benchmarks are included in the contract. Consider hiring an independent design consultant to review plans if maintaining design integrity is a top concern.

7. Design and Construct (D&C) Contract

A Design and Construct (D&C) contract is similar to a design-build contract but gives the contractor more control over design decisions. The contractor is responsible for both designing and constructing the project, often with minimal owner involvement in design details. 

This approach focuses on efficiency, cost savings, and buildability, making it ideal for large-scale infrastructure and commercial projects where function is more important than aesthetics. However, because the contractor controls design, the final outcome may prioritize cost over design quality.

Best for:

• Infrastructure projects like highways, bridges, and tunnels where efficiency is key.
• Cost-driven commercial developments where speed and budget control matter more than customization.
• Public projects where government agencies want one accountable entity to reduce disputes.

Pros

• Streamlined coordination – Contractor handles both phases, reducing delays.
• Optimized for construction – Designs focus on efficiency, reducing buildability issues.
• Single point of accountability – Fewer conflicts between designers and builders.

Cons

• Less owner control – Aesthetics and material quality may take a backseat to cost efficiency.
• Risk of scope creep – If the contract isn’t clear, disputes may arise over what’s included.
• Difficult to modify designs mid-project – Late-stage changes can be costly.

Recommendation

D&C contracts work best when functionality and cost efficiency are the main priorities. Owners should define design expectations early to avoid compromises on quality. If aesthetics or public perception matter, hire an independent design consultant to review plans and ensure quality isn’t sacrificed.

8. Incentive Construction Contract

An incentive construction contract ties contractor compensation to performance goals such as early completion, cost savings, quality, or safety. Instead of just paying for work done, the contract rewards efficiency and penalizes delays. 

This structure motivates contractors to work smarter, reduce waste, and deliver better results. However, incentives must be fair, measurable, and realistic to avoid disputes. If not properly structured, contractors may cut corners to meet targets or argue that delays were beyond their control.

Best for:

• Time-sensitive projects like highways, bridges, and hospitals where delays cost money.
• Large-scale commercial projects where cost savings can be shared between owner and contractor.
• Safety-critical projects where minimizing accidents is a priority.

Pros

• Boosts efficiency – Contractors work faster and more cost-effectively.
• Encourages quality – Incentives can be tied to workmanship and safety.
• Reduces delays – Financial motivation keeps projects on schedule.

Cons

• Hard to define fair targets – Poorly structured incentives may lead to disputes.
• Tracking performance is complex – Requires clear benchmarks and data verification.
• Risk of cost-cutting – Contractors might reduce quality to hit bonus targets.

Recommendation

Use this contract when speed, cost control, or safety is critical. Clearly define performance metrics, tracking methods, and dispute resolution processes to ensure fairness. A well-balanced incentive contract aligns contractor goals with project success while protecting quality and safety.

9. Construction Management Contract

A Construction Management (CM) contract allows the owner to hire a construction manager (CM) as an advisor or project overseer rather than contracting directly with a builder. The CM coordinates subcontractors, manages costs, schedules work, and ensures quality, acting as the owner’s representative. Unlike a general contractor, the CM doesn’t perform the work but guides the project from planning to completion. This contract offers more flexibility and control but requires strong leadership and experience from the CM to prevent delays and cost overruns.

Best for:

• Large, complex projects like hospitals, commercial developments, and infrastructure.
• Multi-phase projects where different contractors work at various stages.
• Owners who want more involvement in decision-making and cost control.

Pros

• Greater control – The owner selects subcontractors and negotiates pricing.
• Expert oversight – The CM ensures work meets quality and budget expectations.
• Flexibility – Adjustments can be made without going through a rigid contract process.

Cons

• Higher upfront costs – CMs charge a fee, adding to project expenses.
• More administrative effort – Owners must be involved in subcontractor decisions.
• Risk of mismanagement – A weak CM can lead to budget overruns and scheduling conflicts.

Recommendation

Use this contract for large, high-value projects needing expert coordination. The CM’s skills will determine project efficiency, so hiring an experienced manager with a proven track record is essential. Ensure the CM has strong budgeting, scheduling, and negotiation skills to maximize project success.

10. Home Building & Improvement Contracts

Home building and improvement contracts govern residential construction projects, including new homes, renovations, and remodels. These agreements outline costs, timelines, materials, and workmanship standards, ensuring both homeowners and contractors understand their responsibilities. 

Since residential projects involve personal investments, legal protections are critical to prevent disputes over delays, defects, or cost overruns. Unlike commercial contracts, these agreements must comply with local housing laws and consumer protection regulations, which vary by region.

Best for:

• Homeowners building, renovating, or remodeling.
• Developers constructing multi-unit residential projects.
• Builders working on single-family homes or townhouses.

Pros

• Tailored for homeowners – Includes warranties, quality standards, and payment terms.
• Legal protections – Ensures compliance with consumer laws and local building codes.
• Clarity on work scope – Reduces misunderstandings about costs, materials, and responsibilities.

Cons

• Complex legal requirements – Must align with state laws, which can vary widely.
• Potential for disputes – Homeowners unfamiliar with construction may challenge costs or timelines.
• Limited flexibility – Changing the project mid-way can be costly and require contract amendments.

Recommendation

Use this contract for any residential construction or renovation. Ensure it includes warranties, defect liability terms, and a clear dispute resolution process. Since home projects often involve emotional and financial stakes, review all contract terms carefully and, if needed, consult a construction attorney. Cutting corners on contract details can lead to costly legal issues down the road.

What Is a Standard Form Contract?

Not every construction contract needs to be written from scratch. In fact, most projects use standard form contracts—pre-approved agreements created by industry experts. These contracts set clear rules for payment, risk, and responsibilities, making negotiations faster and reducing disputes. They provide a fair, balanced starting point that both contractors and owners can trust.

Using a standard form contract means you don’t have to reinvent the wheel. Instead, you get a legally tested framework that has been used across many projects. This helps avoid loopholes, misinterpretations, and drawn-out legal battles.

Why Standard Form Contracts Matter

Construction projects involve multiple parties—owners, contractors, subcontractors, designers, and suppliers. Everyone has different priorities, which can lead to conflicts. Standard contracts create a common understanding, ensuring that expectations are clear from the start.

They also save time and money. Instead of spending weeks negotiating every clause, project teams can use a contract that already reflects industry norms. This makes it easier to focus on project execution rather than legal debates.

Types of Standard Form Contracts

Australia

• AS 4000 – Used for lump sum contracts, where the contractor agrees to a fixed price.
• AS 4902 – Common for Design & Construct (D&C) projects, where the contractor handles both design and construction.

United States

• AIA (American Institute of Architects) Contracts – Covers various construction contracts, including design-build and construction management.
• ConsensusDocs – Created by industry groups, focusing on fair and balanced agreements.
• DBIA (Design-Build Institute of America) Contracts – Specifically designed for Design-Build projects, where one entity is responsible for both design and construction.

United Kingdom

• JCT (Joint Contracts Tribunal) Contracts – Covers traditional and alternative contract types, used widely in both private and public projects.
• NEC (New Engineering Contract) – Focuses on flexibility and collaboration, often used in infrastructure and government projects.

International

• FIDIC (International Federation of Consulting Engineers) – Used worldwide, especially for large infrastructure projects.
  
  • Red Book – Traditional contracts where the owner hires a designer first, then a contractor.
  • Yellow Book – Design-build contracts where the contractor is responsible for both design and construction.

When to Use a Standard Form Contract vs Custom Contract

A standard form contract is ideal when a project follows common industry practices, and the risks are well understood. It provides a structured, legally sound foundation that reduces negotiation time and legal costs.

A custom contract may be necessary for high-risk or complex projects, such as Public-Private Partnerships (PPPs) or large-scale infrastructure projects with unique risk-sharing requirements. While custom contracts offer more flexibility, they require extensive legal review and longer negotiations.

For most projects, the best approach is to start with a standard contract and modify key terms as needed. This way, you get the efficiency of a tested agreement while tailoring it to your specific project requirements.

Choosing the Right Construction Contract

Selecting the right contract is critical to a project's success. The wrong choice can lead to delays, disputes, or financial losses. To avoid these risks, project managers must evaluate key factors before finalizing an agreement.

Project Complexity and Scope Clarity

A well-defined project scope allows for a fixed-price contract, while an uncertain scope may require a more flexible agreement. Contracts should align with how much is known about the work upfront and whether changes are expected.

Risk Allocation Between Parties

Contracts determine who is responsible for cost overruns, delays, and unforeseen issues. Some shift more risk to the contractor, while others place more responsibility on the owner. A fair risk distribution reduces disputes and keeps the project moving smoothly.

Budget and Funding Structures

If cost certainty is a priority, contracts with fixed pricing provide stability. If flexibility is needed, agreements that adjust based on actual costs may be a better fit. Understanding financial constraints helps prevent cash flow issues and funding shortfalls.

Project Timeline and Delivery Expectations

Some contracts allow for faster project execution by enabling work to begin before every detail is finalized. Others require a structured approach where all planning is completed before construction starts. The right choice depends on deadlines and project priorities.

Legal and Regulatory Compliance

Regulations and industry standards influence contract selection. Some agreements follow well-established legal frameworks, while others need customization to meet specific compliance requirements. Ensuring a contract aligns with legal obligations reduces risk and protects all parties.

Final Note on Construction Contracts

Construction contracts are more than just paperwork—they shape how a project runs, who takes on risk, and how problems get solved. Choosing the right contract can mean the difference between a smooth, well-managed build and a costly legal headache.

The key is to match the contract to the project’s needs—considering scope, risk, budget, and delivery method. The right choice helps prevent disputes, control costs, and keep construction on track. Understanding contracts isn’t just a legal necessity—it’s a critical skill for project success.