Primer on Payment Terms in Residential Remodeling Construction Contracts

The most common contracts used by contractors in the residential remodeling context are fixed contracts and cost-plus or "time and materials" (T&M) contracts. Each type of contract approaches payment differently. This article will briefly highlight each type of contract, as well as their benefits and drawbacks.

Fixed Contracts

With a fixed price contract, the owner pays the contractor a set price for the work to be done. Fixed price contracts are best used when a project is easily defined and predictable. Contractors can maximize their profit because they already know how much their materials and labor will be, and homeowners take on less risk by bidding the work at fixed prices. A fixed contract can hurt a contractor if the project is not estimated properly, because cost overruns can reduce (or even eliminate) profits. On the other hand, such a contract can hurt homeowners because a fixed price may encourage corner cutting by the contractor if the job is not estimated properly.

Cost Plus and Time and Materials Contracts

When a project is not easily defined cost-plus and T&M contracts are typically used. There is no universal definition for these types of contracts and the terms are generally used interchangeably. These contracts operate under the same basic structure: the final price will be the contractor's costs for labor billed at hourly rates, and materials plus a markup for overhead and profit, which is usually a stated percentage of the labor and material costs.

Labor rates differ depending on the trade. The contract usually contains a labor rate schedule describing the hourly rate for each trade. Materials are generally invoiced at the contractor's cost. Excavation work is an example of when cost plus or T&M contracts are used. This type of contract is suitable because it may be difficult to determine subsurface conditions so the contractor cannot accurately estimate the job for a fixed price.

Although the use of cost plus or T&M contracts must be used when the project is not well defined or there are uncertainties as to site conditions or material and labor costs, they generate more disputes than fixed price contracts. Many times the final price ends up being higher than the estimate given at the start of the job. One major reason for this is that when an owner makes a change to the contract, the contractor does not create a change order to modify the original scope of work thinking that under this type of contract, the owner is required to pay for everything. Other problems occur when the contractor does not keep detailed records of time spent and materials purchased.

The need for a contractor to keep detailed records for the job increases the contractor's time on the job, which gets billed back to the customer. This time and expense is avoided in a fixed price contract. Additionally, the customer typically believes that a cost plus or T&M contract gives the contractor less incentive to complete the job efficiently and timely. This perception results in the customer constantly monitoring the contractor and the progress of the work.

While each contract has its benefits and drawbacks, clarity should be the ultimate goal in reaching an agreement. The preceding is not intended to be legal advice, but rather a primer on clarifying payment terms. If you have questions about what type of construction contract to use in your next project, an experienced attorney can advise you.