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January 20, 2023

From time to time, everyone needs a reason to push, dig deeper, and do more. Athletes on the playing field, students in the classroom, and professionals in the boardroom, at some point everyone needs a nudge. This includes contractors.

Contractors are always encouraged to put their best foot forward. But, when they enter an Incentive contract, their interest in performing well increases. Timelines, expenses, quality of workmanship, and safety are all areas where, going above and beyond could yield financial rewards from the owner.

Incentive Contract Types

It should be noted that while there are similarities, all incentive contracts weren’t created equal. Let’s have a look.

Fixed Price Incentive Contracts allow the contractor to forecast their total quote and submit it for consideration. An owner will typically review all the proposals and choose the lowest priced and this is where things get interesting.

Negotiations ensue and a cost ceiling is determined, and from there it’s simple. If the contractor delivers the project under the amount of the ceiling, they’re due a profit. On the other hand, if they exceed the amount of the ceiling, they, not the owner, incur a loss. It’s that simple.

A Cost Reimbursement Contract is different, but it’s still driven by incentives. These types of agreements come with risks. Under this contract, the owner promises to reimburse the contractor for the total costs of the project. This means the contractor, not the owner, is paying for the project. There are no draws, milestone, or scheduled payments.

The contractor only receives payment once the job is complete with an additional amount tacked on to what’s due. For contractors thinking about taking this route, it’s important to know whether they can support these risks. Unforeseen expenses that impact funding, pay lags once a job is complete, and a host of other variables should be evaluated.

Things to Consider

As shown above, these contracts can go either way. A contractor can win big financially, benefiting from hard work and planning. On the other hand, they can also find themselves on the losing end if they don’t have a grasp on their operations. With that, any contractor considering entering either of these should do a careful review of business prior to executing this agreement.

Conclusion

At some point, everyone needs a push, a challenge that keeps them fresh, or a new goal to make the monotonous interesting. This includes construction professionals. Incentive contracts help create the environment where those variables are found.

In closing, there are risks involved. Contractors who understand where they are with regards to risks, can determine if the rewards found in these agreements are worth it.

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.