Construction Law
For contractors, a lump sum contract, or a stipulated sum contract, is one of the most common types of contracts drafted in the construction industry because they are pretty straightforward. Owners and contractors can usually rely on a lump sum for less complex projects with a clearly defined scope of work.
Lump sum contracts allow for work or services to be agreed upon and performed for a single price, unlike contracts like the cost-plus. In spite of this contract being a popular choice, our Fort Lauderdale construction attorneys know that there are some potential pitfalls contractors should understand.
Increased Risks
Contractors will carry much of the risk with a lump sum contract. With the exception of owner-initiated changes, if there are any cost overruns outside of the agreed fixed price, the contractor is responsible for those costs. This is why it is crucial that contractors estimate overall cost and profits and execute the project seamlessly in order to classify a project as successful.
Lien Waiver Issues
A dispute could arise if the contractor provides the owner with statements of payment without actual payment amounts listed. Technically, a contractor is not obligated to show owners their accounting detailing how much subcontractors have been paid; however, this could be an issue for owners. Owners will want to protect their own interest against a lien against their properties and will want to know every party on the project as well as when and how much they are paid to secure themselves against a lien.
Engineering Costs
If contractors do not thoroughly read their lump sum contract, this could lead to unexpected costs that relate to the work they hire subcontractors to perform on a project. Without standard architectural and engineering approval clauses drafted into the contract, the contractor can be stuck paying thousands of dollars to have drawings examined and stamped by another engineer.
Lump sum contracts have many advantages and can still work for contractors, they just require strict management. Contractors should also have the contract reviewed by a knowledgeable Fort Lauderdale construction attorney to ensure it will not go from a lump sum agreement to a much more expensive arrangement.
To request a consultation with a Fort Lauderdale construction attorney, please call us today at 954.210.8735 or submit our contact request form.
Disclaimer: The information contained in this article is for general educational information only. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice for your specific factual pattern or situation.
FAQs
While lump sum contracts benefit from simplicity, they also present risks to both owners and contractors. Contractors may be incentivized to cut corners to stay under budget. May be on the hook for added costs due to change orders. Inaccurate estimating could cut into profit margin.
What are the problems with lump sum contracts? ›
While lump sum contracts benefit from simplicity, they also present risks to both owners and contractors. Contractors may be incentivized to cut corners to stay under budget. May be on the hook for added costs due to change orders. Inaccurate estimating could cut into profit margin.
What are the pros and cons of a lump sum? ›
A lump-sum comes with pros and cons. One advantage is that with a lump sum, you have more control up front, and once you receive it, you can invest the money however you wish. However, you may receive less money in a lump sum than you would have if you took periodic payments. Taxes are also a concern.
What are the advantages of a lump sum construction contract? ›
Lump sum contract advantages include:
- No unforeseen costs for the owners.
- Simple cash flow management.
- Opportunity for a larger profit margin for contractors.
- Easy access to financing.
Fixed Price
The most common type of contract is the fixed price contract, also known as the lump sum or stipulated sum contract. Fixed price contracts carry more risk to contractors than owners.
Who has the greatest risk in a lump sum contract? ›
Contractors will carry much of the risk with a lump sum contract. With the exception of owner-initiated changes, if there are any cost overruns outside of the agreed fixed price, the contractor is responsible for those costs.
What is a lump sum all risk? ›
In a lump sum contract, the owner has essentially assigned all the risk to the contractor, who in turn can be expected to ask for a higher markup in order to take care of unforeseen contingencies.
What are the advantages and disadvantages of lump sum method? ›
Advantages for owners include simplified accounting and little financial risk, and disadvantages include rigidity in project scope and a need to have every detail planned before beginning the project.
What type of projects are lump sum contracts best for? ›
Lump sum contracts work especially well for projects with a well-defined scope of work, which enables contractors to make an accurate estimate of the project's cost.
What are disadvantages of lump sum investing? ›
What are the disadvantages of lumpsum investment in mutual funds? Lumpsum investments in mutual funds lack the benefit of cost averaging and can be subject to market timing risks. Additionally, a large initial investment may lead to higher exposure to market fluctuations compared to periodic investments.
Contractors often include a contingency in their bids for lump sum contracts to cover potential risks and unforeseen expenses. This can result in higher initial cost estimates compared to other types of contracts.
What are the advantages of a lump sum settlement? ›
The pros of accepting a lump-sum settlement include taking advantage of liquidity and being able to choose how you spend your money all at once. With a lump-sum payout, you get all the money you need up front, so you don't have to wait to start paying down debts or balance your finances.
What is true of lump sum contracts? ›
In a lump sum contract, a price is presented to the owner to complete the entire project for a fixed amount — no more or less.
Which is a disadvantage for fixed price or lump sum contracts? ›
Estimation Risks. The key drawback to a lump sum contract is the risk associated with cost estimation. If your cost estimates are inaccurate, you could end up undercharging for your services, eroding your profit margin.
Which type of contract is more risky for the contractor? ›
For example, the contractor bears the greatest risk for a firm-fixed-price contract because the contractor's promise is that it shall deliver at the agreed-to price in the contract to receive the price.
What is the difference between GMP and lump sum? ›
A lump-sum contract is when the price will be for a set amount regardless of what the contractor's actual costs may be. In contrast, with a GMP contract, the owner pays the contractor's actual costs plus the profit. The project costs are capped at the price maximum.
What is the accounting problem in a lump sum issuance? ›
The accounting problem in a lump sum issuance is the allocation of proceeds between the classes of securities. An acceptable method of allocation is: The pro forma method.
What is the alternative to a lump sum contract? ›
Cost plus contracts and guaranteed maximum price contracts (GMP) are common construction contracts and popular alternatives to lump sum contracts. In contrast, the intricacy of unit price contracts makes them less popular in the industry. The contractor must know and quote the unit price for all cost centers.
