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Contracts are the basis of an agreement between parties who expect services or goods from each other. They are legally binding agreements between the parties and are act as evidence for agreement between parties in courts. Failure of a party to honour the deal as per the contract initiates court battles. The contracts are categorized into lump-sum or fixed-price, cost-plus, and guaranteed maximum price contracts.
Lump-sum contracts, also known as fixed-price contracts, transfer the risk of losses from the buy to the seller. Buyers and sellers agree on the total cost incurred in the process and combine it with the profits the contractor demands (Haidar 44). The losses or gains made by the contractor depending on how well they manage the work in progress. In cases where the contractor mismanages the materials, the resulting loss is excellent. On the other hand, if the contractor spends wisely on the resources, they make a higher profit than expected. The customer uses these contracts to transfer the mismanagement risks to the contractor. One of the demerits of using this type of contract is that the vendor may use poor-quality materials to increase profits, leaving a weighty burden on the owner. However, the vendor may incur extra costs that they had not budgeted for if a need arises since they cannot request additional fees from the customer.
Conversely, cost-plus contracts are agreements between two parties where the contractor receives payment for the actual cost of their work. Vendors commonly use this contract in construction and development works. The contractor transfers the risks encountered likely to be experienced to the owner. The contractor must account for every cost incurred in cost-plus contracts by providing money transfer documents as evidence (Flammer 1307). Without the proper documentation, the owner may deny them payment for the expenses tabled. In cost-plus contracts, the costs consist of the costs faced directly or indirectly as long as there is evidence to prove the occurrence of a fee. Besides the customer reimbursing the costs, the contractor receives payment for their activities in a percentage share of the total costs. They, therefore, make profits in return in this form. Cost plus contracts are also referred to as cost reimbursement contracts because they are contractor reimbursement for all expenses incurred.
Guaranteed maximum price contracts are agreements between the contractor and the customer to pay for the projects whose cost can be estimated quickly, and the actual amount does not deviate much from the projected amount. Customers compensate the contractor for the costs incurred directly or indirectly and the profit the contractor needs to get. The indirect overheads fees and profits are constant and should not surpass the threshold placed. In case the costs exceed the estimated threshold, the contractor takes the responsibilities and pays for them (Palihakkara & Perera p.5). Nevertheless, uncertainties are prone to these contracts because a slight change of orders from the customer may result in a different threshold amount. Therefore, both parties have to agree with the new threshold before the official modifications take place. Both parties must relay information and an affirmation on the effects of changes in all the costs involved.
Of the three contracts, fixed-price is the most common and most preferred. Many people and companies select this procurement contract type because the contractor receives payment during the signing of the contract; thus, no party extorts the others. Fixed-price contracts are fair to both parties because each identifies their roles and responsibilities towards completing the projects. The contractor guarantees their customer that the project completion will be timely. Contracts are essential when people enter into agreements because they lay the foundation for honouring the agreement between parties. All parties must be careful when joining the arrangements and should stick to their obligations to the end.
Works Cited
Haidar, Ali D. “Types of Construction Contracts.” Handbook of Contract Management in Construction (2021): 31-55. Web.
Flammer, Caroline. “Competing for government procurement contracts: The role of corporate social responsibility.”Strategic Management Journal 39.5 (2018): 1299-1324. Web.
Palihakkara, A. D., and B. A. K. S. Perera. “Identification of significant risk factors of guaranteed maximum price (GMP) contracts.” (2021). Web.
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