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Watch Out for Lump Sum Contracts

Here at Cotney Law, we’ve made it our mission to educate contractors on the pitfalls they may come across in the industry, many of which can be found within the contents of a poorly negotiated and drafted construction contract. In this article, one of our Houston construction lawyers discusses what you should watch out for when using a lump sum contract. While this type of contract can be advantageous on certain projects, its disadvantages should not be ignored. 

When Lump Sum Contracts Are Appropriate 

Lump sum contracts are contracts with a predetermined price for the entire project. This kind of contract is appropriate for straightforward jobs — jobs with a well-defined scope of work. If you’re a subcontractor, the majority of your contracts are likely lump sum contracts, since they make it easy for general contracts to put together a bid and secure jobs. 

Lump sum contracts can be beneficial for ensuring that the owner is not privy to the contractor’s books, meaning that a contractor can reap the benefits of cost-saving measures without having to turn over savings to an owner. This is in stark contrast to cost-plus contracts, or time and material contracts where the scope of work is not clearly defined and costs can grow as the project advances. The simple nature of a lump sum contract can certainly be beneficial, but with this rigidity comes the potential for risks. 

Related: The Most Commonly Misunderstood Construction Contract Clauses

When They Aren’t Appropriate 

Contractors should carefully consider which contract is right for their project, a decision that can be reached with the help of a Houston construction lawyer. Here are several factors that can make a lump sum contract the source of a legal dispute on a project: 

Poorly Defined Scope of Work 

Lump sum contracts aren’t appropriate for projects with a poorly defined scope of work. Contractors, eager to secure work, often agree to lump sum contracts without considering additional costs that would be placed squarely on their shoulders later in a project. Because there’s always the possibility of unforeseen circumstances interfering with a project (delays, rising costs, etc.), even a relatively straightforward project can succumb to a payment dispute between an owner and contractor.

Related: Scope of Work Is the Leading Cause of Construction Disputes

Lack of Transparency 

As mentioned above, lump sum contracts can be a benefit to contractors because it allows them to hide their profit margins. While this is beneficial on paper, it can foster distrust between owners and contracts, leading to a breakdown in communication. And as we all know, communication is essential for avoiding disputes and ensuring that projects go off without a hitch. Any owner you work with is going to want to ensure that subcontractors are being paid in accordance with the amounts provided to the general contractor. If you think you can get around this by providing lien waivers from your subcontractors, think again. 

Related: Texas Cracks Down on Lien Waivers 

To further complicate matters, this lack of transparency goes both ways. Under a lump sum contract, owners are incentivized to cut corners and leave out standard items that should always be included in the price of a contract. Contractors who fail to properly review their contracts could end up footing the bill for services that should have been included in the contract from the start. 

Paying Taxes 

Because there is no state income tax — the state actually just voted to make it even more difficult for income-tax legislation to pass — Texas has to get its funding from somewhere. Tax revenue is brought in from sales tax and taxes on businesses. In the State of Texas, labor is not taxable, but materials, equipment, and supplies on both residential and commercial properties are. How these taxes are accounted for will depend on a number of factors, including the type of contract you use. 

If you have a lump sum contract, the burden of paying sales tax for materials will be on you, whereas this cost would be passed on to an owner in a time and material contract. While this isn’t necessarily an issue, it’s just one more thing for contractors to watch out for. For contract negotiating, drafting, and reviewing services, turn to the Houston contractor attorneys from Cotney Law. 

If you would like to speak with a Houston contractor attorney, please contact us today.

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.