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Last edited 24 Nov 2021
Guaranteed maximum price for construction contracts
Typically, this is a mechanism used on design and build contracts where the contractor has responsibility for completing the client’s design and for carrying out the construction works, so they are in a good position to control costs.
If the actual cost of the works is higher than the guaranteed maximum price, then the contractor must bear the additional cost. If the cost is lower than the guaranteed maximum price, then the contract should set out whether the savings made go to the client, to the contractor or are shared. This can create a ‘pain/gain’, or a target cost agreement, where the contractor is incentivised to make savings, but the client has the security of a cost cap.
Effectively, this sort of contract transfers risks for delivering the project from the client to the contractor. For example, if events such as exceptionally adverse weather or strikes occur, or if items that might otherwise have been the subject of provisional sums (such as complex groundworks, the nature of which cannot be determined until the ground is opened up), which on other forms of contract might have resulted in a claim by the contractor for loss and expense, on a guaranteed maximum price contract, the contractor has to bear any additional costs.
As a consequence the contractor is likely to tender a higher price. Effectively they price the risks that they are taking on. This may be acceptable to the client if their priority is certainty rather than the lowest possible cost, for example, if the client has fixed funding available that cannot be exceeded.
However, a guaranteed maximum price is not a panacea, and the price is not necessarily fixed. If the client requests ‘extras’, for example, if the scope of the works increases, then the contract must provide for the price to be increased. Similarly, if work is omitted, then the price should be reduced.
There is obviously scope here for disagreement about what constitutes a change that should result in a price adjustment, and there is the potential for the contractor to use the valuation of changes to recover costs they have incurred elsewhere. This can cause tension in a form of contract that was selected to provide certainty.
In deciding whether to seek a guaranteed maximum price, the client should assess the nature of the project, the likely risks and whether it is sensible to expect the contractor to bear those risks. If risks are priced by the contractor, but then do not transpire, the client will have paid for nothing, whilst if serious unforeseen problems are encountered, the contractor may attempt to find a way out of their obligation, or may be at risk of insolvency.
Whilst a simple project on a greenfield site might be suitable for a guaranteed maximum price, works to existing, older properties, or complex projects with inherent uncertainty (in particular in relation to ground works) might not. To assess these risks, it is important to ensure that proper investigations are undertaken and a fair apportionment of risks made. It is also important to ensure the client’s requirements have been clearly defined to avoid potential dispute about the nature of the works. A guaranteed maximum price is not an excuse to leap into the unknown and hope for the best.
Guaranteed maximum price contracts tend to be either bespoke (on small projects, often written by the contractor, and so potentially including hidden get-out clauses), or modified standard form contracts – which themselves have potential risks. It is important that these contracts have unambiguous wording, particularly where there are pain/gain provisions.
- Construction contracts.
- Construction manager at-risk.
- Contract sum.
- Design and build.
- Fixed price contract.
- Guaranteed maximum price with target cost.
- Force account work.
- Loss and expense.
- Lump sum contract - pros and cons.
- Modifying clauses in standard forms of contract.
- Procurement route.
- Provisional sum.
- Relevant event.
- Target cost contract.
- Time and material contract (T&M).
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