Contracts and Types of

Contracts
What Is a Contract?

A contract is an agreement between parties to do or not do certain things that is legally

binding (i.e., creates legal obligations for parties) and enforceable (i.e., parties can be
made to obey its terms).

So, in general, a contract serves two main functions:

1. clarifying the terms of an agreement and

2. ensuring there will be legal consequences for not adhering to them.

The main purpose of a contract is to formalize new relationships and outline the various legal
obligations each party owes to the other
For a contract to be legally binding, it needs to include the following elements:

 Offer & acceptance

 Mutual consent
 Consideration (i.e., value exchanged)
 Competence (i.e., parties’ capacity to sign a contract)
 Legal purpose

The absence of any of those elements means that a court can choose not to enforce a
contract, meaning a party will not be protected by law if the other party fails to fulfill its
contractual obligations. That’s why it is vital to consider the above elements when signing any
contract.
 Is signing a contract critical?

Absolutely, yes!

An agreement is simply the common intention of parties as to a certain course of actions.

On the other hand, a contract will serve as proof that you and the other party have rights

and are bound by obligations in respect to each other

 Why do you need a Contract

It’s great if a person or a company that entered into an agreement with you is reliable and

complies with all the obligations. But, unfortunately, that’s not always the case. You may need to

take legal action against the other party to force it to meet the terms you agreed upon. Without

a signed contract, it’ll be hard (or almost impossible) to prove to the court that your agreement

ever existed and that your rights were violated.

So, signing a contract is essential. But choosing the right type of contract is also a crucial step

in making everything work

Types of Contracts
Fixed-Price Contract

In a fixed-price contract, parties agree on the total payment in advance. This figure doesn’t depend on
how many resources a contractor actually spends to perform the work. Here are the key characteristics of
this contract type:

 A price estimate is made by the contractor based on assumed costs of material and labor needed to
perform the action under the contract.

 Usually, a contractor includes some unexpected costs in the estimation to mitigate the risks.

 The estimation plays a crucial role in contract creation, so the whole process may be a bit long

 May include penalties for missing deadlines and/or bonuses for completing obligations early.

This type of contract is considered risky:

if the estimation is wrong, either the buyer overpays or the contractor doesn’t cover the costs spent to
perform the actions. But if initial estimations are made carefully, this option may turn out profitable for
both parties.
Cost-Reimbursement Contract
In this type of contract or agreement, the final price is determined after a project or some of its stages are
completed. However, a contractor estimates the costs before the start of the project, and the parties set a
ceiling price. Without the buyer’s approval, this ‘ceiling’ can’t be exceeded. When it is reached, the parties
need to decide on the next step.

The key characteristics of cost-reimbursement contracts include:

 The buyer reimburses the contractor for all incurred costs.

 If a ceiling price specified in the contract is reached, a buyer must approve further action, or the contractor
can stop working on the project.

Construction is an area in which this contract is commonly used.

It is less risky than fixed-price contracts, but, in some cases, it may be less profitable for the contractor, as they
don’t get any extra payment, only being reimbursed for the labor and materials used.
 Cost-Plus Contract
This type of vendor contract is similar to the cost-reimbursement type, with one important difference. The
‘plus’ refers to the extra money (contractor’s profit and overhead expenses) the buyer agrees to pay.
Because the buyer is paying extra, they expect the project to be delivered on time.

Key characteristics of a cost-plus contract include the following:

 A contractor provides an estimation of all costs in advance.

 A buyer can review the list of all potential expenses and usually knows what the price of the most-
expensive scenario might be before the project starts.

 A buyer agrees to pay an extra fee on top of materials, labor, and time.

 A contractor is motivated to complete the project on time, not exceeding the ceiling price the parties
agreed upon.

This option is appropriate to use when the exact cost estimates are difficult to make beforehand. It also
gives the contractor flexibility to make changes after the start of the project.
The contractors may also be rewarded for exceeding expectations, showing good performance, or
with a fixed amount when the project is done.
Time and Materials Contract
As the name suggests, the buyer pays the contractor for the materials used and the time spent on the
project. With this contract, it is crucial to track everything happening within the project accurately;
otherwise, a contractor can miss the chance to get paid for some resources spent.
Here are key characteristics of time and materials contracts:

 Materials and labor need to be paid for by the buyer.

 The parties agree on the price of the materials, the markup rate, and hourly rates when creating the
contract.

 The contractor has a high level of flexibility if changes need to be made during the project.

These contracts work well in situations where it’s hard or impossible to estimate the scale of the
project and the final costs in advance.

Time and materials is also a common type of consultant contracts. Although they rarely imply the ‘material’
part, it’s convenient to determine a final price based on the number of hours a consultant actually spent
to provide the services.
Unit Price Contract
In unit price contracts, the contractor provides the buyer with the cost of one unit required
to complete the project. The units can refer to time or materials, but usually, one unit
combines both elements.
Unit Price Contract
For example, the buyer agrees to pay $300 for building one section of the floor in the house
(materials plus associated labor). This creates one unit. It takes 20 sections to complete building the
floor in the entire house. In this case, the buyer will end up paying $6,000 when the project ends.
The key characteristics of unit price contracts are the following:

 The price per unit is specified in the contract.

 The buyer reimburses the contractor for the number of units spent on the project.

 The final price is determined upon the project’s completion.

This type of contract is easy to understand, so it’s a convenient option in many cases where work of
some kind is performed.
 Party 1
Party 2 offers Difficulties Advantages Typical application
offers

A service + Covering the costs Possibly bigger profit for Party 1 Construction,
Accurately estimating final
Fixed-price estimate of (the entire fixed (a contractor), less hassle for Manufacturing,
costs
total costs price) Party 2 (a buyer) Engineering

A service +
Covering the costs The project may not be Construction,
Cost- approximate Can be cheaper than fixed-price
(until the ceiling finished if costs exceed the Manufacturing,
reimbursement estimate of contracts, offers more flexibility
price is reached) limit Engineering
total costs

Covering the costs +

A service + Gives Party 1 (a contractor) more
additional fee It may turn out to be more Construction,
approximate wiggle room and incentive; Party
Cost-plus (contractor’s profit expensive for a buyer than Manufacturing,
estimate of 2 (a buyer) gets exactly what they
and overhead other contracts Engineering
total costs paid for
expenses)

A service +
Construction, Software
Time and hourly rates, Recording hours and Flexibility and simplified
Covering the costs development,
materials price of materials negotiation process
consultancy services
materials
 Typical
Party 1 offers Party 2 offers Difficulties Advantages
application

Estimating the number of Construction,

A service + the Covering the costs
Unit price units, unexpected unit price Simple contract with clear terms manufacturing,
cost of one unit of all units
changes repair services

Services or goods Services or goods

Both parties are the obligor Both parties receive something of
Bilateral that are of value that are of value Sales, procurement
and obligee at once value to them
to the other party to the other party
Services or goods
that the other
Unilateral party requested, Compensation No room for negotiation Simple contract with clear terms Insurance
usually in an open
request
Performing an No need to write them down or sign;
Implied Services or goods action such as Can create misunderstanding goes into action after a task is Product warranties
buying a product performed
Most areas,
including sales of
Needs to contain the six main No room for misunderstandings;
Express Anything Anything goods,
elements of a contract parties get what they expect
procurement,
providing services
 Party 1 Typical
Party 2 offers Difficulties Advantages
offers application
Something of Something of Agreement can be implied,
Simple contract that is legally
Simple value to the value to the which may create Employment
binding
other party other party misunderstanding

The contract is unfair to

Unconscionable Anything Anything one party and will not be None Any area
accepted in court

Services or Lack of room for Contracts are standard, clear, Insurance, real
Adhesion Payment
goods negotiations and easy to create estate

An event can’t be
Services or predicted by either party; a Legally binding contract with
Aleatory Usually payment Insurance
goods contract might never be clear terms
executed
Thank You