Our owner/developer clients often retain contractors on a “GMP” basis. The term “GMP”, which stands for “Guaranteed Maximum Price”, can mean different things to different people. This article will clarify what is meant by a GMP, how it can protect an owner and some of the exclusions and clarifications that can undercut those protections.
What is a GMP? A GMP is a cap on the total price that a contractor can charge an owner on a construction project. A GMP is NOT a price. Rather, it is the maximum price that the contractor could be paid for the project. So your contract should never state that the contract price is the GMP amount – the contract price may actually be less than the GMP.
If the GMP is not the price, then how is the price calculated? In general terms, the contract price will be the actual overall costs to the contractor to perform the work, including labor and materials, general conditions, bonds and insurance, plus a fee, which is usually a percentage of those overall costs. Those costs are generally referred to as the cost of the work. Certain kinds of costs and expenses will be excluded entirely from the cost of the work and the contractor will not be permitted to seek payment for those.
How does the GMP relate to the contract price? There are many risks and unknowns on a construction contract that could affect the price. The purpose of the GMP is to protect the owner from those risks and unknowns by providing for a cap that the contract price cannot exceed, regardless of the contractor’s actual costs and anticipated profit. In addition to an overall GMP for the entire contract price, a contract may provide for sub-GMPs for individual categories of the contract price. Each month, the contractor will submit a payment application to the owner showing the cost of the work and other charges as incurred so that the owner may verify that all items are properly payable to the contractor as set forth in the contract, and do not exceed the GMP. The contract should state that the contractor is not entitled to payment in excess of the GMP.
How is a GMP different from a lump sum contract? The most common alternative to a GMP contract is a lump sum contract. In a lump sum contract, the owner and the contractor agree on a firm price to be paid to the contractor. The owner will pay that amount regardless of the actual cost of the work. One advantage of a lump sum contract is simplicity – the owner knows what it will pay for the work and will not need to dedicate resources to reviewing the minute details of the cost of the work and other components of the contract price in each payment application. The disadvantage is that the owner has no transparency into the actual costs and profits of the contractor.
What’s a Cost-Plus contract? A cost-plus contract has all the disadvantages of a GMP with none of the advantages. The owner simply pays the cost of the work plus a fee, just as in a GMP contract, but with no cap. Therefore cost overruns will be at the owner’s risk and the contractor’s profit margin is protected.
How are GMPs undermined? An owner can undermine a GMP by agreeing to language in the GMP contract that is not consistent with the concept of a cap. An owner needs to be very careful in examining the “exclusions”, “clarifications” and “assumptions” that a contractor may include as part of the contract. For example, a contractor may attempt to exclude from the GMP increases in labor costs from the time of signing of the GMP contract until the time subcontractors are actually retained (i.e., “escalation costs”). The contract may also provide for numerous allowances that can be adjusted based on actual costs irrespective of the GMP. Or it may provide that refinements to the construction documents are treated as change orders that increase the GMP. These risks can be addressed in the contract in a variety of ways so that the integrity of the GMP is preserved as much as possible.
What is a contingency? One way to address those risks, without losing the benefit of the GMP concept, is by including a contingency in the GMP. In other words, if the parties estimate that the contract price will be $100, but they know circumstances exist that are likely to cause the contract price to exceed $100, they may agree that the GMP should be $100 plus some fixed amount. This additional amount is an additional component of the GMP and is referred to as a contingency. Simply put, a “contingency” is a shorthand way of describing a limited source of funds to pay for costs that cannot yet be quantified. Sometimes a contingency may be eliminated after those unknowns are determined – e.g., after all subcontractors are retained.
Who controls the contingency? That can vary. Sometimes, the contingency is simply included in the GMP without being specifically allocated to any particular line item. Other times, the contingency can only be used to pay for certain items or under certain circumstances. It is possible that the contingency may be used for costs that the owner would otherwise not be obligated to pay for under the terms of the contract. Sometimes the owner’s prior approval is required for use of the contingency and other times, not. In any event, a contingency can help bridge an impasse in the negotiation of the GMP amount.
Does the GMP ever change? Yes, it is appropriate for the GMP to be increased if the scope of the project is increased, and decreased if the scope of the project is decreased. Changes to the GMP should be memorialized in a written change order along with the change in scope in question and related modifications such as schedule impact.
What happens if the final price is less than the GMP? Traditionally, if the contract price turns out to be less than the GMP, the owner would simply pay the contract price to the contractor and no more. Alternatively, owners and contractors may agree that if the final contract price is less than the GMP, a portion of the “savings”, or the difference between the final contract price and the GMP, is paid to the contractor. This savings split may have its own cap, or a deductible. The same arrangement may apply to unused portions of the contingency. These concepts can incentivize the contractor to save the owner money.
For more information about what we might be able to do for you on your next transaction, please visit our website at www.zeidellaw.com or contact our offices directly.