Guaranteed Maximum Price (GMP) contracts are popular in the construction industry, especially for projects where the scope is not entirely defined at the outset. This is a construction contract that provides a financial safety net for the client while incentivizing efficiency from the contractor. Below is an in-depth guide to understanding GMP contracts.
How Do GMP Contracts Work?
A GMP contract sets a maximum price that a client would pay a project owner for a construction project – helping manage working capital. The guaranteed maximum price is the utmost amount that the client agrees to pay for the project, covering all costs and the contractor’s fee.
If the project costs exceed the GMP due to unforeseen factors, the contractor bears the excess unless the scope of work changes, at which point the GMP can be adjusted. If the project comes in under budget, the savings can be shared between the contractor and the client based on terms negotiated beforehand.
What’s Covered in a GMP Contract?
| GMP Contract Component | Coverage Details |
| Direct Costs | Labor, materials, equipment, and services directly related to construction |
| Indirect Costs | Supervision, temporary facilities, utilities, and other site management expenses |
| Contractor’s Fee | Predetermined fixed fee for the contractor’s profit and overhead |
| Contingency Allowance | Set amount to cover unforeseen expenses without altering the GMP |
| Change Orders | Additional costs due to changes in scope approved by the client |
Clauses in a GMP Contract
In Guaranteed Maximum Price (GMP) contracts, negotiated clauses play a pivotal role in aligning the interests of the client and contractor, ensuring that both parties share risks and responsibilities appropriately to meet KPIs. These clauses are designed to set clear expectations and boundaries for project costs, scope adjustments, and risk management. Here’s a detailed look at some common negotiated clauses found in GMP contracts:
Scope of Work Adjustments
This clause defines the process for managing changes in the project’s scope. It specifies how adjustments to the scope will affect the GMP and outlines the procedure for approving these changes. This is crucial for maintaining transparency and avoiding disputes over unauthorized changes or misunderstandings regarding the scope.
Cost Savings Sharing
To incentivize cost-effective management of the project, many GMP contracts include a cost savings sharing clause. This arrangement allows any under-budget savings to be divided between the client and the contractor according to a predetermined formula. This encourages the contractor to find efficient ways to complete the project without compromising quality.
Audit Rights
Giving the client the right to audit the contractor’s records related to the project expenditures ensures that all claimed costs are justified and within the contractual agreements. This clause is integral for maintaining financial transparency and building trust between the client and the contractor.
Price Escalation
Considering the variability in material and labor costs, a price escalation clause is often negotiated into GMP contracts. This clause addresses how unexpected increases in costs, beyond the control of the contractor, will be handled. It helps protect the contractor from significant financial losses due to fluctuating market conditions.
Dispute Resolution
As with any contract, it’s crucial to establish a method for resolving disputes. This clause outlines the steps to be taken if
Advantages and Disadvantages of GMP Contracts
Guaranteed Maximum Price (GMP) contracts are frequently used in construction projects where both clients and contractors seek to manage risks while maintaining flexibility. These contracts have distinct advantages and challenges that need to be considered by both parties involved.
Advantages:
Cost Certainty
One of the most significant benefits of a GMP contract is the financial predictability it offers. Clients can budget more effectively knowing that the project costs will not exceed a predetermined ceiling, unless scope changes are mutually agreed upon.
Efficiency Incentive
Contractors are motivated to control costs and manage the project efficiently since any cost savings below the guaranteed maximum price can potentially result in additional profit, depending on the cost-sharing terms outlined in the contract.
Flexibility in Scope
GMP contracts allow for adjustments in the project’s scope without the need to renegotiate the entire agreement. This flexibility is particularly useful in complex projects where not all details are known at the outset.
Collaborative Relationship
The structure of GMP contracts encourages a collaborative relationship between the client and the contractor. Since the financial interests are aligned towards completing the project within the budget, both parties work cooperatively to achieve common goals.
Disadvantages:
Complexity in Contract Management
The nature of GMP contracts can lead to complexity in administration. Tracking costs, managing change orders, and auditing expenses require meticulous attention to detail and can be resource-intensive to avoid mistakes.
Contractor Risk
Contractors bear a significant amount of risk since they are responsible for covering any cost overruns that exceed the maximum price, unless those overruns result from changes initiated by the client. This can place substantial financial pressure on the contractor.
Potential for Scope Creep
While flexibility is a benefit, it can also be a drawback if not managed properly. Scope creep can occur if the boundaries of what is covered under the GMP are not clearly defined or enforced, leading to disputes and potential overruns.
Limited Contractor Bidding
Some contractors may be hesitant to enter into GMP contracts due to the risks associated with potentially underestimating costs. This can limit the pool of potential bidders, possibly increasing the overall project costs or affecting the quality of the work if fewer contractors are willing to accept the terms.
Example of a GMP Contract
An example could be a community center renovation where the GMP is set at $2 million. The contract includes costs for all materials, labor, design revisions, and permits, with a fixed contractor’s fee of $200,000. If the actual cost is $1.8 million, the remaining $200,000 under the GMP could be shared between the client and the contractor as negotiated.
How To Mitigate Risk on GMP Contracts
Mitigating risks in Guaranteed Maximum Price (GMP) contracts involves careful planning, transparent communication, and strategic management practices. Here are some effective strategies for both clients and contractors to minimize risks and ensure a successful project delivery within the agreed-upon budget.
Provide Detailed Scope and Specifications
Start with clear, detailed project specifications to minimize misunderstandings and discrepancies regarding what is included in the project and what is not.
Stay on Top Of Regular Monitoring and Reporting
Implement strict monitoring and regular financial reporting to catch and address issues early. This helps in maintaining control over the project’s budget and timeline.
Practice Strong Collaboration
Maintain open lines of communication between all parties involved in the project. This proactive communication helps in addressing potential issues quickly and efficiently, fostering a cooperative approach to project management.
Use Contingencies
Ensure that the contract includes a well-sized contingency allowance. This is crucial for covering unexpected costs without the need to renegotiate the guaranteed maximum price.
GMP Contracts Can Be a Valuable For Some – But Use With Caution
Guaranteed Maximum Price (GMP) contracts are valuable in the construction industry for their ability to balance cost control with flexibility. They cap expenses for clients while motivating contractors to work efficiently, making these contracts particularly suitable for projects where the full scope isn’t defined upfront. However, their success hinges on clear agreements, ongoing communication, and meticulous oversight to manage complexities and risks effectively. When executed well, GMP contracts facilitate a collaborative approach, aligning the interests of all parties towards the successful completion of the project.
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Michael P.
Michael P. is a seasoned construction estimating expert with over two decades of experience in the industry. As the voice behind Master Estimators Ltd., he shares insightful tips and strategies on material takeoff and project bidding. His blogs aim to equip construction professionals with the knowledge to enhance accuracy and efficiency in their estimates.
