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How does a Guaranteed Maximum Price contract work?

AlabamaConstruction Contract

I would like to request some insight regarding a GMP (Guaranteed Maximum Price) contract works I am wondering how does it deal with variations from Contractors and those from employer?? What are the things put in place so that the client is in a safe position in terms of price not going haywire? How does it address the unforseeable difficulties?

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Dec 2, 2019

What are Guaranteed Maximum Price (GMP) Contracts?

A Guaranteed Maximum Price contract is cost-based contract that sets the upper limit of the contract price. This is a way to shift the risk of any cost overruns from the customer to the contractor. The price will typically include labor and material costs, overhead costs, and a percentage of profit (also known as a builder’s fee). This seems pretty straightforward, but rarely do construction projects go exactly according to plan; and changes and variations will inevitably occur.

Dealing with changes to the project under a GMP contract

When drafting a GMP contract, the customer will need to take extra precautions to avoid going over budget on the project. One way to achieve this is through a well drafted scope of work that is covered by the GMP price. The more details the better, this should include all drawings and specs, and some sort of acknowledgement that it may include any work that is reasonably inferable from the scope of the work.

Change Order Provisions in a GMP Contract

Typically, any changes to the actual GMP price should only be done by approved change orders. Getting all changes in writing is essential to finishing a project on schedule, and with as little push back as possible. The change order provisions in the contract should detail the entire process. Such as how changes in work or costs will be submitted, evaluated and approved. Along with notice requirements, if and how it will affect the GMP, and how any disputes will be resolved.

Contingency Funds in a GMP Contract

One common characteristic of GMP contracts is the existence of a contingency fund. This is usually requested by the contractor, to handle any unforeseeable difficulties. A contingency fund is a certain amount of money, agreed upon ahead of time, that the customer puts aside to act as a buffer in case of unforeseen costs, that are not the fault of the contractor. These funds can be applied to a number of things such as inaccurate estimates, differing site conditions, replacing subcontractors, etc. This is useful to maintain cash flow on the project. But keep in mind, these are emergency funds, and should not be used to pay for any change orders that alter the scope of work.

Allowances in a GMP Contract

Allowances in a construction contract are a way to lock down a price at the outset of a GMP project, even if the decision or end cost of a certain line item can't be established. Unlike contingency funds, which are meant for unforeseen cost increases, these are used to pay for any cost fluctuations that were identified at the beginning of the project. An allowance will set the upper and lower limits of the cost associated with line item work on the schedule of values. Most of the time, these are used to cover any cost differences for decisions regarding the types of materials to be used; but can also include any increased installation costs associated with the materials chosen.

Contract Incentives Build Trust Under a GMP Contract

As far as keeping costs from spiraling our of control, one common method is to offer contract incentives. Which is inherently, the biggest risk with GMP contracts. Contractors don’t have any motivation to keep costs down, trying to hit the maximum portion of the guaranteed price. The best way to build this trust, is to work together to provide rewards for staying under budget; such as a shared-savings provision. Maybe splitting the unused portion of the GMP, or any remaining funds in the contingency fund. Another way is to reward the contractor with the cost difference if they find subcontractors to perform line item work for less than what was stipulated in the schedule of values.  Incentives can be structured in a number of different ways, so get creative and work with your contractor as opposed to against them.
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