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This article is written by Mayank Jain, pursuing Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from LawSikho.

Introduction

Construction contracts are contracts like any other contract. but what if, someone asks what is the difference between construction contracts and any other contracts then, my answer is the purpose of a contract. Every contract has its own purpose which is different from other contracts and if you notice the title of any contract. you can see, the title of a contract in itself showcases the purpose of the contract. I take an example of a construction contract; a construction contract is a contract in which construction of a building, floor or commercial office, etc. takes place, the purpose of a contract is to construct something. Another example is the residential lease agreement showcase the purpose of renting out the property for the resident purposes. 

So, this article will throw some light on the meaning of construction contracts, their importance, general clauses that must be covered under construction contracts, types of construction contracts with their pros and cons and a sample draft of construction contract. 

What is a contract?

A contract is a mutual or legally binding agreement between two parties based on policies, conditions, obligations of a party, consideration, and terms etc. recorded in document form. An agreement has no fixed format, parties can draft according to their needs and wants by protecting both party’s rights. But certain rules are laid down by law and by specified Act i.e., The Indian Contract Act,1872. Which parties have to make sure that they are not violating any rules. So that they can enforce their agreement legally to create a contract. 

Understanding construction contract

In construction contracts the two parties are involved, one part is one or more property owners and another part one or more contractors. Property owner referred to in this contract as a client or employer and constructor referred to as a service provider or employee. The purpose behind the construction contract is to construct a particular thing as per the client which the service provider provides for consideration.

Why is a construction contract important?  

The client and constructor relationship is a very delegated relationship in terms of the agreement. As construction includes a huge or diversifying scope of work, it should include every point including quality, quantity, budget, and time as per the client’s choice or need. If we did not register an agreement between the above-said parties or registered an incomplete or improper agreement, in the future definitely, it creates disputes, problems, and losses either faced by one party or maybe by both the parties. If we did not clear all the points properly including quality, quantity, budget, and time as per the client’s choice or need then it creates assumptions on the same point, which creates ambiguity in the future and then creates further disputes. You also see so many examples around us where clients need the specific brand in the service but in lack of clarity in agreement, a contractor takes advantage of using a local product to gain high margin profits. In this, you can see the client pay a higher amount with the intention to obtain high-quality products used in his building but the same lack of clarity in agreement makes client loss.

General clauses of construction contract

Every party should read the whole agreement once or at least read General clauses before signing the agreement. Important clauses herein mentioned below:

  • Scope of work and obligation of the constructor

All the work that the constructor shall do is mentioned in this clause including the brand names or quality of the product that he used in their construction. If parties want, they also refer to the quality or brand name of the product in the schedules as well.

  • Term

The term is a period or duration of the agreement decided by both parties. This clause resolved the question “till what time the obligations and duties are supposed to be performed or continued by parties”. In a construction contract, the Term denotes the duration of the time in which the constructor has to complete the project and the consequences of delay in completion of the project.    

  • Consideration

Consideration is an amount or anything (which is lawful) decided by the parties mutually under an agreement, which was paid or done by one party to another party against the services or products provided by another party. consideration is a very important or major clause of the agreement, in absence of this clause, the agreement can’t enforce or be legally valid as per Section 10 of the Indian Contract Act, 1872. In construction contracts, consideration is an amount or anything paid/done by the client to the constructor against the construction. The consideration clause contains the fixed amount of the project or points and factors on which final consideration can be calculated, there are different types of factors of consideration to calculate final consideration, which we will further discuss under this article. 

  • Mode of payment

This clause clears the procedure of payment, how payment takes place between the parties, parties either pay in a lump sum or pay in intervals to another party, depending upon the understanding or negotiations between the parties. For example, Party A agrees to pay Party B Rs. 50,00,000/- in 5 equal instalments on different stages of work herein referred under schedule 1.

  • Jurisdiction, governing law, and alternative dispute resolution

In the future, any dispute arises between parties then, how (how means by using alternate dispute resolution or approaching court) or where (which jurisdiction apply) parties resolve and what laws applicable on it (applicability means which State’s law governed for example Indian law, UK law basically, this point only used when one of the parties is from another country). 

  • Breach and consequences of breach

If either party does not obey their obligations or does not perform their duty under agreement then it creates a breach of agreement and the party who breached shall have to pay an amount or any other remedies to the other party, depending upon the parties understanding and negotiations during the time of execution.

Types of construction contracts

The construction contract is one of the contracts which includes risk in terms of uncertain expenditure. so, different projects have different contracts as per the suitability of the owner and constructor. As I already mentioned the construction agreement has no fixed format, you can draft as per your needs and wants. But mainly and mostly construction agreement draft used according to the given mentioned types:

1. Lump sum contracts

A lump-sum contract is a very simple and basic type of contract in nature, in which the consideration amount is fixed against all the work done in the scope of work. Mainly, it is used in small amounts of projects.

Pros

  1. Not lengthy contracts: This type of contract does not create a higher no. of pages in the contract, The nature of terms is simple. 
  2. Fixed budget: It doesn’t raise the amount above the expectations of a client. As already the amount and budget fixed between the parties.

Cons

  1. Chances of error or miscalculation: In this type of contract there can be chances of error or miscalculation. As there is only one fixed price or consideration in the contract which includes all the things. The fixed consideration is decided and negotiated by the parties by conducting their calculation. If there is any error or miscalculation done by either party, then that party has to suffer a loss for their error and the other party gets an advantage.
  2. Uncertain loss: There are chances of loss for the contractor due to uncertain activity. A contractor also hired a subcontractor or vendor under the project or there may be chances of mistakes due to uncertainty which can create a loss for the contractor.

 2. Time and materials contracts

This type of contract is usually preferred where there is no specific scope of work. Consideration is based on time like amount per hour or amount per day and materials used in the project, that consideration only includes that amount of material used in the project and wages of the labour or employees as per the working hours or days. In this case, the contractor should provide earlier all the material price quotes to the client and attach it to the agreement, that material price added in consideration as per the list mentioned under the agreement only.

Pros

  1. Wide scope of work: As the agreement is not based on the scope of work, the clients can add and change the work as per their need and want during the agreement.
  2. Contract termination: The client can easily terminate the contract without bearing a huge amount if the client doesn’t like the contractor’s work.

Cons

  1. Require supervision: It is a time-consuming activity from the client’s side. As it requires daily supervision and calculation of hours and material used.
  2. Work delay: There are more chances of work delay, as the constructor receives the amount on a per-day or hour basis. So, the constructor tries to create more money by delaying work and there is no willingness on the contractor’s side to complete work earlier as there is no reward for the same and also some loss occurred to the contractor.

3. Cost-plus contracts

In this type of contract, consideration is decided on the basis of the cost incurred in the project and the additional fixed amount as a profit to the constructor. Profit can also decide on the percentage of the cost, depending upon the mutual consent of parties.

Pros

  1. Flexible in the scope of work: The client can change, add or remove any work from the scope of work at any point of time during the agreement’s term. 
  2. Fixed Profit:  The risk is eliminated for the contractor. Ensured and fixed profit to the contractor. 

Cons

  1. Ambiguity in cost:  There are two types of cost, the first is a direct cost and the second is an indirect cost. Direct cost is cleared but ambiguity arises in indirect cost, which indirect cost include or which not, justification for the same become difficult. For example, expenses of travel, office space expense and staff meal, etc. these are the indirect costs that the contractor bore during the project but do not create direct benefits for the client.  
  2. Uncertainty in cost: Cost is uncertain for the client; the client only can expect the cost but not calculate a fixed amount of the project.

4. Unit price contracts

A unit price contract is a contract in which total work is divided into different units of work and for the same, price is quoted by the contractor based on each unit of work. consideration is mainly based upon the measurements. This type of contract is also known as a measurement contract.

Pros

  1. Early start is possible: Not required defined scope of work at initial, contractor may start the work without an unclear scope of work and which will create scope of changes and alterations in the scope of work.
  2. Simplify bills: Unit price contract bills are very simple and more transparent towards the client. As the client can easily understand the unit price amount, which further adds to the final amount. 

Cons

  1. Final cost is unpredictable: at the initial point, it is unpredictable to calculate a fixed consideration amount. As the client can only estimate the final bill and there is a chance that the client’s bill comes above the expectation.
  2. Chances of error in measurement: as the unit price is based on measurement, in which it takes time, calculation, and maybe chances of error in measurements. And it also delays, if the client cross-checks the measurements which takes a huge time.

5. GMP contracts

GMP stands for Guaranteed Maximum Price, it is a type of contract where a maximum limit of cost is fixed, and if the limit extends then the contractor has to bear an extended amount. This type of contract can be worked with other types of contracts like Time and Material contracts. 

Pros

  1. Client’s security: Guaranteed maximum price is fixed between parties. So, it does not create panic for the client that the budget can extend above the client’s limit or expectation.
  2. Incentivize cost-saving: GMP contracts pressure a contractor to complete under the budget, which creates savings for the owner, and usually, the owner agrees to pay incentive to the contractor for reducing the cost and finish ahead within schedule.

Cons

  1. Constructor’s risk: There is a chance that the cost of the project exceeds the GMP if the contractor did not predict the cost of the project correctly, which raises losses to the constructor with no limit.
  2. Long negotiating in GMP: It creates tough to decide a mutually guaranteed maximum price between parties. The owner quotes less amount to achieve higher savings and the contractor quotes a higher amount to reduce the risk of extended cost.

Construction agreement

This Construction Agreement made at___, on this ___ day of ____, 202_, by and between: 

_______________________, S/o___________, residing at _____________, PAN no.________ (hereinafter referred to as the “Owner”, which expression shall, unless repugnant to the context or meaning thereof, include its successors, assigns and attorneys) of the First Part, 

AND

[Name of Contractor], a company registered under the Companies Act, 2013 and having its registered office at [__] (hereinafter referred to as the “Contractor”, which expression shall, unless repugnant to the context or meaning thereof, include its successors and permitted assigns) of the Second Part.

Whereas

  1. The Owner purchases the plot of land admeasuring ……………….. sq. meters bearing plot No. ……….. city survey No. …………………. Khasra No. ………………… situate, lying and being at …………………. Tahsil and District …………………. (Hereinafter referred to as the “site”).
  2. The Owner is desirous to construct 4 story building for residential purposes on the Site.
  3. The Owner publish an advertisement in the ______ newspaper for the requirement of the Contractor to construct the residential building, where the Contractor approach Owner and agreed to construct the residential building on Site. 
  4. The Contractor is a company, registered under The Companies Act, 2013, and having prior 10 years of experience in the construction of residential buildings.   

Interpretation:

  1. Project: Project hereinafter means the construction of 4 story building for residential purposes on Site, no any other construction hereinafter referred to as the Project. 

This agreement witnesseth and it is hereby agreed between the parties hereto as follows:

  1. Obligation of Contractor:
      1. Contractor shall prepare the plans, drawings, designs (in 3D and 2D), and elevations of the Project. 
      2. Contractor shall perform all the activities, which laid down under Scope of Work herein referred under Schedule 1.
      3. Contractor shall take the approval of plans, drawings, designs, and evaluations referred under clause1.1 from Owner before finalising, in case Owner not approved, Contractor will amend as per the changes required by Owner and again Contractor has to take approval. The Contractor shall not proceed further if approval is not granted by the Owner.
      4. Contractor shall make sure all safety norms should be followed as per the Indian law, central and state government notifications.
      5. The Contractor shall make sure the project complies with all necessary legal and regulatory requirements.
      6. Contractor shall only use those brands and products mentioned under List of Materials herein referred to under Schedule 2.
      7. All Work at the Site shall be performed between the hours of 7 AM and 5:30 PM, Monday to Friday unless otherwise provided in writing by the Owner.

2. Consideration: 

Owner shall pay consideration to the Contractor for the construction of building on the following basis:

  1. Labour Charges: Rs. 450/- per day per labour (including ESI and PF), more than 10 labours in a day not be charged or paid by the Owner.
  2. Material Cost:  Material Cost shall be paid as per the List of Materials herein referred to under Schedule 2. Only those materials will be charged which will be directly used in the project. Non-use of materials not be included or paid by the Owner.  
  3. Contractor’s Profit: 10 percent of the total cost of the project shall be paid as a profit of the Contractor.

The total cost of the Project shall be calculated as: 

No. of labours x No. of days (worked by labour) x labour charge (Rs. 450/-) = Total Labour Charges

The total cost of the project = Total Labour Charges + Total Material Cost

3. Mode of payment: 

  • The owner shall pay total consideration (referred under clause 2) to the contractor in 4 Equal instalments on different stages of the Project, which is mentioned under the Payment Installments Chart herein referred under Schedule 3.
  • Owner and contractor will mutually decide the mode of payment for the payment of consideration (referred under clause2) from the given options (cash, online banking, NEFT, DD, Cheque, and UPI).

4. Taxes and charges:

The Owner shall be liable to pay all taxes, government fees and charges, and stamp duty under this agreement. Owner shall be payable to the Contractor, if the Contractor pays any taxes, government fees and charges under this agreement to execute the Project, within 30 days after receiving an invoice.

5. Permission:

The Contractor shall take all required permissions from the Municipal Corporation, Sub-Registrar, statutory bodies, or any other local authorities in respect to the Project under this agreement. 

6. Term and termination: 

      1. Term: Contractor agrees to complete the Project under this agreement Within 1 year, if the Project is delayed more than 1 year then, Contractor shall pay Penalty of Rs. 10,000/- per month to the Owner. 
      2. Termination for breach: Each party may terminate this agreement with immediate effect by delivering notice of the termination to the other party, if the other party fails to perform, has made, or makes any inaccuracy in, or otherwise breaches, any of its duties under this agreement, covenants, confidentiality or representations.  
      3. Consequences of termination due to material breach or Term expire: Upon termination of this agreement, the Contractor hands over or destroys all Confidential Information herein referred under clause 5. 
      4. Notwithstanding anything contained in this agreement, the Confidential clause shall survive the termination of this agreement. 

7. Confidential information:

All information related to the Site provided by the Owner and information prepared by the Contractor related to the Site which is covered under clause 1.1 shall be treated as Confidential Information and must not be used by Contractor in any way which is inconsistent with the performance of their obligations under this Agreement.

8. Representation and warranties:

  • Owner represents and warrants that it:
  1. has all requisite and authority to enter into this agreement and to execute, deliver and perform its obligations under this agreement, 
  2. The Owner has all the authorities and rights on Site and Owner is a Sole Owner of the Site, there is no co-owner of the Site.  
  3. No case dispute is pending in the court of law, questioning the above-said Site and ownership of the Site. 
  • Contractor represents and warrants that it:
  1. Has all requisite and authority to enter into this agreement and to execute, deliver and perform its obligations under this agreement, 
  2. Is duly organized or formed and validly existing in good standing under the laws of its incorporation or formation.
  3. No case dispute is pending in the court of law, questioning the above-said Contractor as a company and Directors of the Company (Contractor).
  4. Contractor warrants that Contractor only uses that material or brand which is specified under Schedule 2 of this agreement.  

9. Indemnification:

The Party who breaches their obligations under this agreement hereby provides complete indemnity to the other party/aggrieved Party for any loss or damage caused to the Aggrieved Party or any of its affiliates and assignees.

10. Force majeure:

      1. For purposes of this agreement, “Force Majeure Event” means, with respect to a party, any event or circumstances, regardless of whether it was foreseeable, that was not caused by that party and that prevents a party from complying with any of its obligations under this agreement [(other than an obligation to pay money)] [(other than an event or circumstances that results in a party’s not having sufficient funds to comply with an obligation to pay money)], except that a Force Majeure Event will not include [a strike or other labour unrest that affects only one party, an increase in prices, or a change in law].
      2. If a Force Majeure Event occurs, the party that is prevented by that Force Majeure Event from performing any one or more obligations under this agreement (the “Non-performing Party”) will be excused from performing those obligations, on condition that (1) the Non-performing Party used reasonable efforts to perform those obligations, (2) the Non-Performing Party’s inability to perform those obligations is not due to its failure to take reasonable measures to protect itself against the event or circumstances giving rise to the Force Majeure Event, and (3) the Non-Performing Party complies with its obligations under clause 2.3.
      3. Upon the occurrence of a Force Majeure Event, the Non-Performing Party shall promptly notify the other party of occurrence of that Force Majeure Event, its effect on performance, and how long that party expects it to last. Thereafter the Non-Performing Party shall update that information as reasonably necessary. During a Force Majeure Event, the Non-Performing Party shall use reasonable efforts to limit damages to the other party and to resume its performance under this agreement.

11. Severability:

If any provision of this agreement is rendered void, illegal, or unenforceable in any respect under Applicable Law, the validity, legality, and enforceability of the remaining provisions shall not in any way be affected or impaired. Should any provision of this agreement be or become unenforceable, the parties shall use reasonable endeavours to agree upon a new provision which shall as nearly as possible have the same commercial effect as the ineffective provision. 

12. No waiver:

No waiver of any provision of this agreement, or consent to any departure from it by any party shall be effective unless it is in writing. No default or delay on the part of any party in exercising any right, powers, or privileges operates as a waiver of any right, nor does a single or partial exercise of a right preclude any exercise of other rights, powers or privileges. 

13. Assignment:

This Agreement and the rights and obligations under this Agreement shall be assigned in part, by Contractor to a third party, with the prior written intimidation to the Client. 

14. Governing law and jurisdiction:

This Agreement shall be governed by and construed in accordance with the Laws of India and Delhi shall have the exclusive jurisdiction over any matter relating to, in connection with, or arising out of, this Agreement.

15. Notices:

All notices and other communications under this agreement shall be made in writing and delivered either by hand against receipt or sent by certified or registered mail and shall also be sent by e-mail at the addresses of the addressee mentioned herein below. Any such notice or communication shall be deemed to have been duly given and served only upon actual delivery of the same irrespective of the mode of service. The addressees, contact details, and e-mail Ids of the parties for the purposes of sending Notices under this agreement are as follows: –  

  1. Owner-________,
    Registered Address-_____________________,
    E-mail -_______________.
  2. Contractor-__________,
    Registered Address-____________________,
    E-mail -_______________.

16. Entire agreement: 

This contract contains the final and entire agreement and understanding between the parties and is the complete and exclusive statement of its terms. This contract supersedes all prior agreements and understandings, whether oral or written, in connection therewith.

In witness whereof the parties hereto have executed this agreement as of the date first above written:

Signed and delivered for and on behalf of 

Owner Name:
Address: ______________________ 

Signed and delivered for and on behalf of 

[Contractor company Name]:
Director Name or Authorised person Name ______________________
Designation ______________________
Address ______________________

Conclusion

Construction contracts recognize and represent the commercial relationship between constructor and client to carry out the construction of a house, commercial office, and any other construction as per the requirement of the client.  Construction contracts are important for both the parties i.e., client and constructor to clarify the expectations in terms of quality, quantity, material’s brand, consideration, and skilled work expressly under the agreement to protect both parties’ rights and expectations of work, not encourage parties for disputes and set out the obligations on the parties to fulfil their duty. The construction agreement helps to fulfil the purpose of the parties without prejudice to any other party’s rights. Different types of construction contracts help to recognize the types of activity taking place between parties and how they want to execute the above-said construction contract.

You should always create, sign and execute construction contracts whenever you hire a contractor for construction or create any commercial relationship with the contractor regarding any construction, doesn’t matter small or large, as it protects your rights and creates obligations on other parties to perform their duty and it also protects you from future disputes or losses. You should always read, go through, and analyse the construction contracts as per your needs and wants and try to negotiate the agreement to get more and more protection and benefits of the contract. 

References

  1. The 5 Main Types of Construction Contracts Explained (levelset.com)
  2. https://www.thebalancesmb.com/common-types-of-construction-contracts-844483

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