Understanding General Contractor Payment

Hart Wright Architects recently had a conversation with colleague, general contractor and estimator Lawrence Motta about general contractor payment methods. Below is the meat of our conversation which we think is important to share. 

Many times GCs use the term T & M (or “time and materials”) to describe billing for the work with an hourly rate and charging for the materials. Interestingly enough, California has specific requirements about how this form of billing can be done which we found interesting. Not only that, Lawrence carefully describes the nuances of the different formats helps explain the various situations. Here is Lawrence in his own words:

“T&M is illegal in CA.  Just charging T&M without a budget or schedule of values that places a cap on the estimated cost is illegal.  To clarify, GMP (Guaranteed Maximum Price) or Cost Plus Fee with a Not to Exceed Amount is an open book format and quite legal. 

“The different types of contracts are really about the billing format and where the GC generates their profit and overhead. The other common contract format is called Stipulated Sum and they are just that, fixed.  The Contractor will bill based on percent complete no matter the cost.  If the cost is less than what they bill the client, the extra goes in the GC’s pocket.  In a GMP format, the billing is based on invoices (costs) and there is usually strict oversight of the incurred costs by the construction manager (or, in most cases, the Architect in their CA role).  Applications for payment are submitted to the Architect for approval in a GMP format and they can reject or approve before sending on to the client.  The GC fee is usually a percentage of the costs.  There should be no other mark ups except for insurance.  The AIA A105-2007 allows for either format with slight modifications to the language. 
 
“There are so many variations of GC contracts that shift the profit incentive, risk and amount of paperwork along a spectrum from GMP to Stipulated Sum.  For clients who like to know exactly what they will be paying per month, the Stipulated Sum can be appealing.  For those who like to see where their money is going, the GMP is more suitable.  For the GC, the Stipulated sum encourages us to do the work as cheaply and quickly as possible to increase our profit.  With the GMP, contractors have every incentive to push to the maximum price, again to increase profit.  Many clients opt for a hybrid such as a fixed fee.  In this case, our fee is based on the overall duration of the project and is fixed regardless of shifts in the scope or costs – barring radical change.
 
“The real kicker in all this is the change order.  These apply no matter which style contract you choose.  This is because the price – fixed or GMP – is based on scope.  If the scope changes, the price changes.  It’s that simple.  So, the person who chooses a Stipulated Sum project should not expect zero change orders.  The only way to avoid those is by paying their architect to produce actual thorough construction drawings, referred to as CDs. An in depth conversation about Change Orders is a subject for another day.
 
Basically, just make sure to find out which sort of contract the client may want before sending plans out to bid.  Alert prospective GC’s to that type of contract and they will structure their estimates accordingly.  The worst that can happen is a GC estimates the job open book with no internal mark up (depending on their Profit/Overhead percentage only) only to have the client then want that same estimate for a stipulated sum. When this and the architect has not prepared Construction Documents, and only has schematic drawings, the GC’s back is placed squarely against the wall and he will be forced to be aggressive about each and every little change.  That’s just a recipe for war.”
 
A note about Lawrence Motta:

Lawrence is a master builder with over 30 years experience in high end residential construction and deeply versatile knowledge of methods, standards, architecture and codes as well as technical expertise in all phases of construction. He excels in the following areas: leadership, problem solving, client relations, communication (including public speaking and writing) and critical thinking. Extensive experience in estimating, scheduling, construction and field coordination.

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