In many businesses, contracts serve as vital documents. These mutual agreements between a seller (contractor, vendor, etc.) and buyer clarify various details such as what the seller will deliver and when, as well as how much the buyer will pay. In essence, they’re legally binding documents that outline the expectations of each party and the repercussions for not adhering to them.
The exact terms and conditions of an agreement can take many different directions, which can have an impact on the type of contract selected. Understanding the different types of contracts can help businesses choose the best one for given situations. It can also help them review contracts more effectively and ensure everything is in order before signing.
Contract Terms to Look for In Each Type of Contract
Contracts come in many forms, each with its own purpose and use. Here, we’ll go over some of the most common contract types and a few of the key details of each.
Fixed Price Contract
With a fixed-price contract — also called a lump sum contract — the buyer provides a detailed description of their desired outcome. The seller uses the information given to outline the cost of the project. They may also include billing milestones based on the product’s schedule.
The seller assumes the most risk with a fixed-price contract. They can’t go back and ask for more money if they go over budget. They have to estimate their total allowable costs of labor and materials and perform the actions specified within the contract regardless of their actual price. As such, they’ll often include a range of prices rather than a single set amount.
Fixed-price contracts may also include:
- Benefits for completing the project ahead of time
- Penalties or missing deadlines
These details protect the buyer and provide an incentive for the seller to fulfill their end.
Cost Plus Contract
A cost-plus contract is an agreement where the buyer agrees to pay the actual cost of the entire project as well as an additional fee. That’s the “plus” part of the contract. The buyer will pay the extra amount in exchange for the seller fulfilling their end of the agreement.
Generally, cost-plus contracts will outline the seller’s entire list of expenses. That allows the buyer to see what they’re paying for so they know what to expect. Sellers will often include a maximum price they can’t exceed (their most expensive case scenario) without the buyer’s approval. They may also provide a “reimbursement limit” that protects the buyer in case of a mistake or negligence.
There are a few different types of cost-plus contracts:
- Fixed fee: The buyer pays a set amount
- Percent-of-cost: The buyer pays a set percentage of the project’s total cost
- Award or incentive fee: Additional fees based on the performance of the seller
Unit Price Contract
With a unit price contract, the seller bases the total cost of their goods or services on a specific price per “unit.” That price typically includes:
- Taxes, permit costs, inspection fees, etc. (if applicable)
If the buyer agrees to pay the price per unit, they’ll pay for the number of units it takes for the seller to fulfill their end of the contract. So, if a seller states that their price per unit is $250 and it takes 15 units to complete the project, the buyer would pay $3,750.
Cost Reimbursement Contract
Where a fixed-price contract provides the buyer with the total cost of a project before they sign the agreement, a cost-reimbursement contract doesn’t give the final price until the seller fulfills their end. In some cases, they may provide the final price by a set date within the contract’s timeframe. The buyer then pays or “reimburses” the seller for all incurred costs.
Instead of providing a set price from the start, a cost-reimbursement contract allows the seller to offer an estimate. Both parties can also establish a “ceiling” or maximum cost that the seller can’t exceed. Should the seller reach that limit, the buyer would then need to approve the continuation of the project. Otherwise, the seller can stop working on it.
An aleatory contract, common in the insurance industry, is an agreement that states that the parties involved will only have to perform their agreed-upon actions if a specific, triggering event occurs. Neither party can have control over the event. Additionally, if the event never occurs, neither party needs to act.
For example, let’s say there’s a severe storm or a fire breaks out that causes damage to a person’s home. That storm or fire is the triggering event. The homeowner submits a claim and provides any required documentation, such as photographs and repair estimates. The insurance company would then pay the homeowner according to the homeowner’s insurance policy.
A lett or letter contract — also called an Undefinitized Contract Action (UCA) — is a type of contract that authorizes the seller to start delivering supplies or performing services before they and the buyer finalize the terms and conditions of their agreement.
These contracts have a few specific requirements, including:
- A statement of urgency to provide a reason for issuing the contract
- No other contract provides a suitable alternative for an agreement between the seller and buyer
- The contract must be definitized by 180 days or before the seller completes 40% of the work (both parties need to agree upon the contract terms, specifications, and price
Review Any Type of Contract With Contract Management Software
Contract review is a tedious component of the contract lifecycle. As involved as the process might be, neglecting this step could have serious implications. However, how are you supposed to give careful attention to every detail if you’re managing thousands of contracts?
With Lexion’s contract management software, managing and reviewing many contracts becomes much easier. The software streamlines the process, helping you to assign tasks (and see their status), collaborate with your team remotely, and share key metrics, all with one easy-to-use platform. Everyone involved in a given contract can view the document from their own devices and suggest changes until all individuals are satisfied with it.
Are you ready to streamline your contract review process and maximize workflow? Visit Lexion today to see just what our contract review software can do for you.