What is a Fixed Price Contract?
A fixed price contract is presented as the most commonly used type of contract in most business fields whether construction, manufacturing, product development, etc. This type of contract is quite popular among businesses and contractors when it comes to protecting themselves against future losses and to ensure getting paid even if the project cost them much more than what was initially anticipated.
So what is a fixed price contract? As its name implies, this contract sets a flat rate for the project and the Contractor will only be able to charge for that set price.
If the contractor spent less money and time executing the given task, they would still be paid the full price because they engaged into a contract with an agreed cost from the start rather than charging per hour or referring to expenses . So basically, this type of contract is rewarding if the contractor runs his stretching efforts and exceed the expectations with respect to both quality and time. While the contractor will not be able to charge extra sometimes if necessary, they can surely save some money instead.
McWane Inc., a leading U.S manufacturer of plumbing supplies, seems like the perfect case for a fixed price contract. The company managed to significantly increase profits by controlling the production costs for plumbing fittings. It also cut significantly its qualifying time for products thanks for suppliers’ acceptance of fixed price contracts.
Unlike other contracts, a fixed price contract is not open for negotiation. This means that once the contract is signed, there is no room for changes at least until the end of the project. As for deviations, they can only apply to the quality of materials and the required compliance to the agreed standards.
Essential Elements of a Fixed Price Contract
Fixed price contracts generally include the following components:
- Scope – this is the portion of the contract that defines the work to be performed and gives the expectation of the deliverables provided under the contract. It should also clearly state out any exclusions on the work to be performed. This is essentially the job description under the contract.
- Time – the contract should clearly set forth the time for performance under the contract. This could be as simple as giving a fixed date or, in some cases, even could be based on an event. Importantly, the contract should clearly set forth what happens if the work is not timely completed by the contractor. In some cases, the contract may provide pre-agreed consequences for late performance, while in other cases it may not. This is an important consideration as the consequences – which could range anywhere from damages to termination for cause – may all be different.
- Price – of course, the price is a key component of the contract. The fixed price should be clearly spelled out in the contract. Moreover, it should be abundantly clear exactly what is being purchased by the paying party. In other words, it is not uncommon to have a contract have a single lump sum of money as the price for the work to be performed, but the contract should still clearly state what is bundled into that amount. In other words, are progress payments to occur? Is there a fixed price for added work? Is sales tax included in the cost? These and many other such questions should be expressly addressed in the contract, or else the parties could find themselves in a dispute down the road over whether or not the fixed price for work includes other items?
- Payment – the contract should set forth the terms and conditions related to payment. This includes any amounts due upfront, in installments, upon completion and upon final acceptance of the work by the party receiving the products or services. Regardless, all parties should also ensure that they are clear on how often payments may be requested (i.e., monthly, bi-monthly, weekly, etc.) and whether there are any conditions or requirements on each party’s end for timely processing the payments (i.e., receipt of the invoice, etc.) If there are any other terms on payment, such as interest on outstanding balances, penalties for late payments, etc., these terms also should be expressly spelled out in the contract.
- Responsibilities of the Parties – similar to the scope of work, the contract should set forth the job description for both parties, not just for the performing party. The parties should be clear on who is responsible for what regarding performance. This is particularly important because how the contract is structured could have some major repercussions. For example, if the work is to be performed on a particular piece of equipment, say, a machine, but the original contract does not clarify who is responsible for preparing the machine for the work to be done, questions could arise. The parties may be agreeable to reconfigure the machine themselves or, alternatively, may expect the other side to do so. Regardless, the contract should clarify who is responsible for the prep work, as this will give the parties the certainty they need that their expectations will be met.
Advantages of Fixed Price Contracts
Benefits of Using Fixed Price Contracts – do you know the benefits of using fixed price construction contracts? They do not only benefit Clients but they can also greatly benefit Builders and Designers.
What is a Fixed Price Contract?
In simple terms, a Fixed Price Contract lets you know how much you have to pay and how much you should be getting paid. Usually Lynn will refer to a "Lump Sum Contract" but that phrase is so 90’s and does not stop people like me figuring out loopholes that mean you could end up paying more than you agreed. Is it a lump sum contract if it allows for extra payments? Don’t even get me started on whether its a Lump or a Base? Anyway, back to the main point which is fixed price contracts.
Contractors and Homeowners love fixed price contracts because they provide certainty. It allows homeowners to confirm there is an agreed budget with the contractor about work to be done, the materials to be used and the costs involved. For Builders, these types of contracts are a good way to manage cashflow and avoid the dreaded money-go-round where there is never enough money to cover unexpected expenses. Fixed price contracts also allow Builders and Designers to negotiate a contract price with rewards built in for their financial challenges and for overcoming potential costs.
It is also intended to provide comfort to Builders and Designers because they should have the ability to include some rewards for the time and effort they put into devising the Contract. It also provides them with some clarity about the method of payment and the timing of payments but in practical terms this does rarely work out.
A fixed price contract also means that Contractors can confidently price the work because the set price is "at risk". The price is based on the assumption that nothing extra will be charged to the Homeowner so the Contractor is rewarded for managing the budget and giving value.
Homeowners also benefit from a fixed price contract because it allows you to make all your decisions upfront. It gives you certainty and a great deal of control about your budget. If the Builder or Designer tries to charge you above the fixed price you know it is a variation and you can have a discussion about scope and price.
Contractors also benefit from a fixed price contract because it allows them to effectively manage their cashflow. If they can make arrangements with the Homeowner so that all materials under the Contract are paid for without delay they can then make a profit on the remaining works. If the Builder or Designer thinks extra time will be needed the fixed price contract allows that time to be added at the end of the Contract.
Fixed price contracts also mean the Work doesn’t stop. When variations start becoming a problem there is a tendency for Builders and Designers to say they will sort it out later and for Contractors to keep providing credit until they find they have to withdraw materials or withhold stages of work. These disputes are very difficult to resolve without imposing others costs before they can be sorted, such as prolonged delay or professional fees.
Benefits Summary
The benefits of fixed price contracts are:
What to Beware Of
Even with a fixed price contract not everything goes to plan. Builders, Designers and Contractors have all been known to try and get out of paying for something by saying there has been a variation.
Unless the Contract includes a detailed breakdown of the fixed price you can be sure that you will need to supply extensive information to prove what you agreed and then review the Contract to ensure the Builder or Designer is asking for a variation of the Contract price.
Make a Big Difference
Each time the Builder, Designer or your staff tell you there is a variation it pays, no matter how small, to get them to provide you detailed calculations and supporting information required under the Contract.
With each variation that the Builder or designer notifies you the costs will add up but so will your chances of making a successful claim against the Builder or Designer. If you are left with the choice of accepting the overcharge or getting legal advice, I suggest you take the legal advice. Always question overcharges and get your friends to help you ask questions. Take those questions to your law firm and see the difference you can make.
Common Mistakes Found in Fixed Price Contracts
Since a fixed price contract requires the contractor to complete the contract at a specific price agreed with the other party, it’s not surprising that one of the biggest potholes in fixed price contracts is a failure to properly deal with the scope of work. If the contractor doesn’t charge for all of the work it needs to do and the contract does not account for that additional work, there will be trouble (and litigation); and if the contract requires the contractor to do work that is not clearly within the scope of the contract, the contractor will need to contend with a fight over the price to be paid for the additional work.
It’s impossible to overstate just how important it is to be clear on the scope of work that is to be done in a fixed price contract. The contractor may believe the amount bid for performance of the contract will be sufficient, but many different factors can cause the costs of performance to be more than expected, including:
Sometimes (often?), the contractor will realize that the scope needs to be expanded after the contract is signed, and it will often want to take the position that the fixed price contract does not cover the additional or changed or expanded work. That position will be very difficult to maintain if the language in the fixed price contract makes it clear that the contract covers all of the scope of work that will be performed.
Not providing enough "wiggle room" in a fixed price contract may require the contractor to absorb costs that exceed what was budgeted for the task or project, or to fight with the other party when the contractor believes that the contract requires it to be compensated more than it bargained for. It’s also true that large and complex contracts often require changes or additions after the contract is entered into. A contractor is better off taking that obstacle into account when it prepares the fixed price contract rather than fighting about it after the fact.
Sample Template of Fixed Price Contract
Below is a sample fixed price contract template for use as guide only. The parties to a contract should create a document that is appropriate to their particular circumstance. Always seek legal advice before entering into any binding agreement.
Agreement made this ____ day of ________, 20__, between [NAME], of _________, ("Builder"), with an address of [ADDRESS], [CITY], [STATE], [ZIP], and [NAME] of ________, ("Owner"), them, hereinafter called the "Party" or the "Parties," upon the terms and subject to the conditions hereinafter set forth. For and in consideration of the mutual promises contained herein, the Parties agree as follows:
- WORK: Builder agrees to perform and furnish labor, material, fixtures, equipment, appliances, and supervision for the completion of [DESCRIBE THE JOB] in accordance and in strict compliance with the plans and specifications marked Exhibit A, which are a part of this Agreement including any addenda and/or amendments, at the property located at [ADDRESS] in the city of [CITY], [STATE] ("the Property"), for the total sum of $__________.
- PAYMENT: Payment for the work performed under this Agreement including all fixtures, labor, materials, and other Work, shall be made as follows: Payment shall be made no later than ____ days after the Builder completes the work. Payment shall be made to [NAME] at [ADDRESS] , [CITY], [STATE], [ZIP].
- TIME OF COMPLETION: Completion shall be no later than [DATE].
- CHANGES IN THE WORK: Any work performed by the Builder beyond that which is detailed in Exhibit A (as the same has been changed from time to time) shall be considered extra work and shall be charged to Owner at Builder’s cost, plus [INSERT NUMBER] percent ( %).
- LICENSES: Both parties represent and warrant to the fullest extent of their respective knowledge that they and their employees and agents possess all licenses and permits required to perform their obligations hereunder, and that Builder has provided all information required by law to those licensed authorities which would be applicable to the work and trade or craft involved herein.
6 . COMPLIANCE WITH REGULATIONS: The Builder and all subcontractors shall comply with the State of [STATE] building codes and rules, regulations, policies and ordinances pertaining to the construction of the work herein described. The Builder shall acquire all permits as may be required for the performance of the work hereunder at no additional charge to the Owner.
- INDEMNIFICATION: Builder shall indemnify and save harmless the Owner, and hold the Owner harmless from all loss, damage, or expense, including reasonable attorney fees and costs, on account of any claims, demands, litigation, losses, injuries, death, or damages, which may arise out of and as a result of the performance of this Agreement by Builder or any agent, employee, subcontractor, or any other third-party for whom Builder is responsible, or due to the fact that the owner is the owner of said Property. Further, as a part of the consideration for entering into this Agreement, the Builder waives its right to assert all such claims against the Owner for damages to the Property or the work itself, but no limitation or curtailment of Builder’s capability to assert any claim against any third party by virtue of this paragraph shall be effective.
- BINDING EFFECT: This Agreement shall be binding upon and inure to the benefit of the Builder, the Owner, and their heirs, administrators, executors, successors, and assigns.
- ENTIRE AGREEMENT: This Agreement, including all exhibits attached hereto, constitutes the entire understanding and agreement of the parties concerning the subject matter hereof and supersedes and replaces all prior and contemporaneous oral and written agreements and understandings relating hereto and containing the entire agreement between the parties.
- SEVERABILITY: If any provision of this Agreement shall be deemed to be invalid, illegal, or unenforceable, the validity, legality, and enforceability of the remaining provisions shall not be affected and the rights and obligations of the parties shall be construed and enforced as if this Agreement did not contain the invalid, illegal, or unenforceable provision.
- APPLICABLE LAW: This Agreement shall be governed by, and construed in accordance with, the laws of the State of [STATE].
When to Use a Fixed Price Contract
Fixed price contracts are particularly beneficial in industries or scenarios where the scope of work is not likely to change after the project starts. Examples are industries or projects in which the costs and time to complete specific tasks are truly known and unlikely to be impacted by a change in requirements. For example, industries such as Government contracting, manufacturing, construction, films and gaming tend to have well understood processes and tasks that have relatively stable costs and can easily be broken down into smaller discrete tasks.
The most commonly known examples of fixed price contracts are found in Government contracting in which the agency provides the contractor with a Statement of Work (SOW) that defines in detail the work to be performed, the specific items to be delivered, the delivery schedule, reporting requirements, etc. Fixed price contracts can also be used for more routine or predictable work such as highway repair and maintenance contracts, IT infrastructure as a service (IaaS) contracts, food and beverage contracts such as cafeterias, merchandise contracts for housing projects, art commissions, even janitorial services, etc. Fixed price contracts are best used for work where the product, service, or support is well-defined, with clear and concise requirements and specifications. In some industries, this is done using Statement of Work.
A major government agency has used fixed price contracts to issue multiple orders for work to upgrade the local area networks for multiple medical centers. Each local area network upgrade was contracted for a set price, scope of work to be completed within 90 days, with clear metrics for quality, and penalties for failure to meet all requirements in the contract. The fixed price allowed the agency to compare offers in a standardized way, make the best value selection based on price and technical qualifications, and reduce risk and exposure by defining the scope so tightly that the contractor had more to lose by failing to deliver the work than by exceeding the scope.
Fixed Prices in Contract vs. Other Kinds of Contract
There are three principle contract types: fixed price, time and materials and cost-plus. Each of these contract types has its advantages and disadvantages and its particular circumstances to which it is most suited. The fixed-price contract has the advantage that both the service provider and the client knows the cost up-front and can budget accordingly. A potential disadvantage is inflexibility should the scope of work be changed, but that can usually be mitigated if the fixed-price contract includes appropriate change order language. The time and materials contract removes the problem of inflexibility from the equation. However, both the service provider and the client run a risk . For the service provider there is the risk that they under estimate the time and therefore do not receive adequate compensation for all of the work they perform. For the client, there is the risk that the service provider takes too long and is paid more than the work is worth. A cost-plus contract offers the greatest financial protection for the service provider against under estimating their time. However, the client runs the risk that the service provider will take the longest possible time to complete the work, given that the longer the service provider works the more the client has to pay in labor compensation and other costs.