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January 13, 2023

A Guaranteed Maximum Price (GMP) contract is a construction agreement that sets a ceiling on the amount an owner must pay the contractor, regardless of the actual cost incurred. Under a GMP, the contractor absorbs any costs above the agreed-upon maximum price. This makes GMP contracts a powerful tool for both owners and contractors—but also one that requires a clear understanding of the risks and benefits involved. 

What is a Guaranteed Maximum Price (GMP) Contract?

A Guaranteed Maximum Price (GMP) contract is a construction contract in which the contractor agrees to complete the project for a set price, with the maximum price being the agreed-upon cap. The owner is only required to pay up to this cap, regardless of how much the project actually costs the contractor. This creates a defined cost for the owner but also puts the onus of any cost overruns on the contractor. 

The Contractor’s Perspective: Risks and Rewards of GMP

While GMP contracts provide a predictable cost for owners, they come with inherent risks for contractors. Under this contract, contractors are paid only for the work performed, not for any additional costs they may incur. This means that any missed deadlines, hidden expenses, or costly delays fall directly on the contractor’s shoulders. 

However, GMP contracts also present some benefits for contractors: 

• Attracting Owners: Contractors with a proven track record using GMP contracts can attract more owners, as this agreement shifts risk away from them. 
• Financing Benefits: Banks view GMPs as less risky because they provide a guaranteed budget. This makes financing easier for contractors who might otherwise struggle with capital procurement. 
• Incentives for Efficiency: Contractors have a strong incentive to finish on time, as cost overruns can erode their profits. Completing a project ahead of schedule can enhance their reputation and lead to more future projects. 

The Owner’s Perspective: Reducing Risk and Ensuring Cost Savings

For owners, the primary advantage of a GMP contract is the reduced risk and potential cost savings. Contractors are incentivized to work efficiently, as they bear the financial responsibility for any cost overruns. This can lead to significant savings for the owner. 

Moreover, GMP contracts typically come with strict reporting requirements, ensuring that contractors keep owners updated on cost expenditures throughout the project. However, while GMPs offer protection, owners must also be vigilant in ensuring quality. The one-sided nature of the contract can sometimes lead to contractors cutting corners, using low-quality materials, or opting for cheaper subcontractors to meet the budget. 

To mitigate these risks, owners should: 

• Vet Contractors Thoroughly: Ensure the contractor has a proven track record and solid references. 
• Spot Potential Red Flags: Watch out for any signs that the contractor may be compromising on quality to stay within budget. 

Key Considerations for Both Parties

How GMP Contracts Benefit Contractors

• Risk Management: Contractors have clear financial limits, allowing them to plan more effectively. 

• Financial Security: Easier access to financing, as GMP contracts reduce perceived risks for banks. 

• Positive Reputation: Contractors who meet deadlines and manage costs effectively can build a solid reputation for future work. 

Challenges Contractors Face with GMP Contracts

• Financial Risk: If the project exceeds the agreed-upon price, the contractor must cover the additional costs. 

• Cost Overruns: Unexpected costs, missed deadlines, or delays can lead to financial losses. 

Cost Control and Reporting Requirements for Owners

• Efficiency: Contractors are incentivized to minimize inefficiencies to keep within the GMP. 

• Transparency: Regular reporting ensures owners are kept informed about the project’s financial progress. 

Conclusion: Is a GMP Contract Right for Your Construction Project?

If you’re a contractor, it’s crucial to assess your company’s ability to manage GMP contracts effectively. Review past projects, analyze your budget performance, and determine whether your business can handle the risks associated with a GMP. If you’re confident, move forward when the opportunity arises. If not, proceed with caution until your business is ready for this type of agreement. 

If you’re an owner, due diligence is key. Carefully vet contractors, ask detailed questions, and review references before entering into a GMP agreement. While GMP contracts can provide significant cost savings and reduce risk, improper execution can lead to undesirable outcomes. By understanding the intricacies of these contracts, both contractors and owners can achieve successful results. 

Remember: A GMP contract is a powerful tool that, when used properly, can benefit both contractors and owners. With careful planning, clear communication, and the right preparation, these agreements can lead to successful, cost-effective construction projects. 

AIA Contract Documents has provided this article for general informational purposes only. The information provided is not legal opinion or legal advice and does not create an attorney-client relationship of any kind. This article is also not intended to provide guidance as to how project parties should interpret their specific contracts or resolve contract disputes, as those decisions will need to be made in consultation with legal counsel, insurance counsel, and other professionals, and based upon a multitude of factors.