Business

The 3 major types of Contract risks and benefits

The only uncertainty that a contract manager faces in contracts is that of the changing prices in case of long term contracts because that might cause profit, but can lead to losses as well on the same hand. The contractors who have just set up their business or have begun always want to ensure their profitability and manage all type of Contract risks as far as possible. The primary type of Contract risk is from the price changes for which various pricing mechanisms are available like fixed-price contracts, cost-plus contracts and guaranteed maximum price contracts. 

Following are the three type of contracts risks contract managers face-

(i) Fixed Price Contract

Fixed price contract is also known as a lump sum contract and is a type of contract in which the parties often come together and settle upon a fixed sum after extensive negotiations that must be furnished for all the labour and material. Generally, the contractor prepares a proper timeline/schedule where the work is divided into separate portions, and pay is decided according to be given in quantum meruit that is in proportion to the amount of work done. And if the parties wish to change the nature of work, then they must make an adequately signed change authorized by all the parties involved whose interest might get affected so they can negotiate and agree to a particular price. 

But these types of contracts do not offer long term or extensive protection. In many contract management, to avoid any type of contract risks, the conditions are mentioned that if an unforeseeable event occurs or something happens, that makes it impossible for the parties to perform the contract, then their obligation would remain standstill. These events can be acts of God like floods, earthquakes etc. or riots, terrorist attacks etc. however, some circuits or boards consider the cost and price changes as predictable and regular risks and not something that would lead to non-happening of a contract. But if an agreement is drafted correctly with all its fixed prices, it would help all the parties involved to avoid huge losses that might occur, delays or material shortages as well. 

These provisions would work better if the contract also specifies the amount of percentage increase in price that is expected and can be absorbed for not dissolving the contract. 

(ii) Cost-plus Contract

While fixed price saves from the risk of the prices, the cost-plus contracts aim to protect the contractors and all the parties involved from the rise in costs of the material required to fulfil the obligations of a contract. These contracts are both time and material contracts that include the fees and value for all the labour and content that is required. 

These agreements help to cover the risk of cost and increase the chances of the owner to make a benefit out of it if the value decreases. 

(iii) Guaranteed maximum price contracts

While most of the people would find the cost-plus contract as a protection for the contractors and against the customers, for this limitation, secured maximum price contracts have been formed.

These are also known as GMP contracts. In such kind of contracts, the contractors work according to the cost-plus agreement plus their fee while the owner pays only the maximum agreed-upon amount making it less risky for both parties. Generally, the parties that contract under GMP also agree that if the cost of work and contractor’s fee and their sum is less than the maximum price, then the difference is split between the two main transacting parties. 

Conclusion

Whatever type of contract that the parties decide upon according to their needs, they must ensure to draft the prices in clear terms to avoid any confusion or conflict that may arise in the future. Because in case of dispute as well, courts would enforce the law only if there is preciseness as to the contract and no ambiguity.

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