Lump Sum Contract

A lump sum contract or stipulated sum is a type of contract in the field of construction. Contractors offering these contracts quote a single price for the entirety of the project. The specifications and design of the project have a significant effect on the estimated cost of the project, which the owner shall get an idea of well in advance.

To quote a construction lump sum contract, one has to have a complete plan with specifications. Moreover, all costs, direct and indirect, and the profit margin of the contractor also is quoted along with the price. However, it is vital to understand that these types of contracts are highly inflexible.

A lump sum contract is an arrangement between a contractor/sub-contractor and the client for construction or its related work. The scope and quantum of work are clearly specified, and the quote for the entire project is also put forth accordingly.

A traditional lump sum contract has all direct and indirect costs and the profit margin for the contractor. It also has the monthly amount that the contractor shall be eligible to receive minus the costs of retention.

When clients and contractors come across projects that have clearly defined scope and a specific aim, they opt for these types of contracts to ensure a fixed timeline and cost can be determined.

With a fixed set of tasks to address and a fixed timeline, barring unexpected events, these projects have a predictable flow of work. Therefore, it is easier for the clients to arrange cash flow to fund the project, and the contractor can also plan their payments accordingly.

However, it is critical to understand that these contracts are not flexible in terms of design and scope of work. If the owner or the client wishes to change a design or get a little bit of extra work done, it affects the quoted price.

A good lump sum contract template shall address all the necessary areas that prevent any dispute between the parties involved. The three main factors that must be included are:

• Project Details: It is the program that helps clients or owners understand the timeline of the project, cost breakdowns, and material specifications. These details not only help the client but also help the contractor by acting as a target.
• Scope Of Work: It refers to the in-detail description of each task within the project. It is specific to the minutest of details to ensure there are no disputes between the parties during or after the completion of the project.
• Pricing: It is the fixed price put forth by the contractor. The figure includes the direct and indirect costs of the project plus the contractor's profit. Any work executed beyond the scope of work shall lead to a change in the price of the project.

Variations in a typical or traditional lump sum contract are either detrimental or beneficial. The former refers to costs that arise due to inefficiencies or rises in prices. In contrast, the latter refers to the additional costs of making sure the execution of the plan is better.

However, it is vital to understand that variations during the execution of a project are incurred through the following factors:

• Inflation
• Fluctuation in prices
• Statutory fees
• Provisional items
• Goods not delivered on time

The reason why a project turns towards a direction where there are variations in the price that was fixed could be:

• Inadequate design
• Changes in specifications
• Changes in scope
• Omission in design
• Lack of communication or coordination

Now that the basics and related factors are out of the way, it is time to understand the practical aspect of the concept with the help of the examples below.

Example #1

Joseph contacted Mohammad, who is one of the best contractors in the city, and proposed a project for an office space. The land has clearance for a three-floor building, and Joseph asks for a quotation accordingly after specifying his requirements.

Mohammad works out a detailed quotation with a clear scope of work, project timeline, and price. The cost of completing the project within the stipulated timeframe of 6 months would be $900,000.

However, almost halfway through the project, Joseph adds the requirement of an additional elevator to the project. As a result, Mohammad and his team had to redo a section of the civil work, provide electrical lines, and make sufficient provisions for an elevator.

After executing these tasks, Mohammad adds $150,000 to the cost of the project for the additional tasks, taking the project value over $1 million.

Example #2

Petrofac, one of the most prominent gas processing plants and fuel refinery companies, secured a construction lump sum contract with ORLEN Lietuva in 2023. The project value is just shy of 200 million Euros.

The project includes the design, construction, procurements, and facilitating of new facilities. Earlier in 2021, they were awarded a similar contract to work towards developing the infrastructure to improve the production of cleaner fuels and the facelift of the North-Western Lithuania region.

Agreeing on a contract of this nature, even with all the factors included in a typical lump sum contract template, has both advantages and disadvantages. The discussion below specifies both sides of the coin.

Advantages

• The foremost advantage is that these contracts are one of the most straightforward contracts in the construction world to curate and understand.
• These agreements show a clear picture of the scope of work, timeline, and the compensation expected by the contractor post the completion of the project.
• Contractors can take up insurance for the whole value of the project. This saves them from any unforeseen events that force them to complete the project after the decided timeline or for higher costs.
• Any other type of contract is subject to the fluctuation of prices of materials. However, in a fixed price contract, a fixed price is defined irrespective of inflation or fluctuations.
• For both the client and the contractor, a clear payment schedule helps them arrange and manage cash flows. Therefore, they do not have to worry about making huge payments throughout the project timeline.

Disadvantages

• In such agreements, contractors take full accountability for the completion of the project. They might be able to deploy some insurance money into the project. However, in unexpected situations, the amount might exceed the insurance money.
• These projects are incredibly inflexible. Therefore, any changes, minor or major, shall be reflected in the final process of the project.
• Due to the risk factor, contractors tend to overestimate the costs considerably. As a result, the project is costlier than other forms of completing a project.

The differences between a construction lump sum contract and a guaranteed maximum price (GMP) contract are mentioned in the comparative table below.

Lump Sum Contract

• A stipulated sum contract is an orthodox and the most common way of executing a construction project.
• Under these types of contracts, a fixed amount is decided upon beforehand for a set scope of work.
• It is best suited for projects that are least likely to have any changes. As a result, contractors can accurately put a price tag on the project.
• These types of agreements might not be the best fit for projects where speed is essential. Moreover, there is a higher risk for the contractor in comparison to other forms of contract in the construction industry.

Guaranteed Maximum Price (GMP)

• A GMP contract is usually used in projects where the contractor has to design and build the required infrastructure.
• As the name suggests, the contractor quotes a maximum price with their guarantee that the project cost will not exceed that value.
• However, if the value exceeds the GMP, the contractor shall bear those costs. If it is below the GMP, both parties decide how to share that amount beforehand.
• Since these contracts are awarded for design and build projects generally, contractors are in an excellent position to design in a manner that is cost-effective for them to execute the project under the GMP.

Both a traditional lump sum contract and a fixed price contract are the same. They are interchangeable terms that are widely accepted in the industry. These are the contracts that refer to an agreement between a client and a contractor to complete a project for a fixed price for a specific scope of work