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August 05, 2021

Project Management Contract - What is Contract in Project Management and it's types?

Project Management is the systematic management, control, and monitoring of projects to make them successful as per the customer's expectations.

Once a customer chooses a proposal, they can sign the contract to commence the project. In the initial vendor-customer relationship, contract signing is one of the last stages, after which the true project pipeline begins.

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Project Management Contract

What is a Contract in Project Management?

In project management, a contract is a framework of the agreement between the supplier/vendor and the customer for the project to be accomplished per customer expectations. This agreement can be between two or more parties who agree to market, reporting, and payments terms along with proposal and procurement initiatives.

The contract is quite comprehensive as it encompasses roles and responsibilities to be shared by both parties with project terms and conditions. Furthermore, in case of any changes in the contract, both parties need to conduct a meeting and agree upon the required changes. Lastly, the contract must be sealed by the legal professionals of both parties, so there’s no scope for misinterpretation or errors.

The legal contract has the offers and their acceptance, considerations with a legal objective and legal capacity. The entire contract is written in legal language to prevent the violation of clauses. It consists of penalties of violation, statement of work, privacy and security clause, confidentiality agreements, roles and responsibilities of both parties, etc.

Types of Contracts in Project Management: 

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Types of Contract in Project Management
  • Express and Implied Contracts :
    Express contract consists of terms defined openly or expressly when creating the contract, either orally or written. This is the most common type of contract used in businesses.
    On the other hand, implied contracts must state terms through facts, actions, and situations that suggest a mutual intent to create a contract.
  • Bilateral or Unilateral Contracts:
    Bilateral contracts consist of two parties who agree to exchange value. Also referred to as two-sided contracts, these types are the most common in the industry.
    On the other hand, unilateral contracts involve a single party agreeing to produce value or take action. One great example of such a one-sided contract is a reward assigned for a lost item. Another party is not obliged to find the item, but if they do, the offering party is under a contract to offer the said reward.
  • Unconscionable contracts:
    Unconscionable contracts are defined as unjust contracts that unfairly favor one party more as compared to the other. 
    Factors that can make a contract unconscionable are:
    Setting a limit on the rights of a party seeking justice in court.
    Setting a limit on the damages the party experiences for breaching the contract.
    Unable to honor a warranty
    Generally, courts interpret whether a contract is unconscionable or not.
  • Adhesion Contracts :
    Adhesion contracts are often termed as “take it or leave it” contracts. These are formed by a dominating party having more bargaining power than the opposite party. Hence, the weaker party may accept or reject the contract. However, a lack of bargaining power does not essentially imply that the contract terms will be unfair. 
  • Aleatory Contracts:
    Aleatory contracts are only instigated when an outside event occurs. A good example would be insurance policies. Such type contracts allow both parties to assume risks involved and act as per the terms stated.
  • Option contracts:
    Options contracts allow a party to go under another contract with a third party anytime later. Signing a second contract with another party is known as availing the option.
  • Fixed-price contracts :
    Fixed-price contracts are where a seller and a buyer agree on a fixed price to pay for the item or service. Often referred to as lump sum contracts, such types of contracts involve higher risks for sellers as in case of project extension or scaling more than agreed constraints, the seller will still receive the price that was initially agreed upon.

Types of Contracts in Procurement
A contract between two or more parties who agree to deliver goods or services is known as a procurement contract. Project Managers need to select a contract that satisfies the project requirements. You can divide procurement contracts into three main categories:

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Types of Contract in Procurement

1. Fixed-Price Contract :
Also known as a lump-sum contract, a fixed-price contract has a fixed scope of work. Meaning, once the seller signs the contract, they are bound to complete the task under the contract within the price and time that is agreed upon. Hence, in this type of contract, sellers face more risk. 

Besides, there cannot be price re-negotiation unless the scope of work in itself happens to change. Usually, fixed-price contracts are outsourcing and turnkey procurement contracts. These have a well-defined scope of work and are ideal for controlling costs, as the agreed cost cannot be changed. Moreover, changing the scope can be expensive.

The scope should be well-defined and detailed. Project managers need to monitor changes in scope closely.

The Fixed-Price contracts can be further divided into three categories:
  • Firm-Fixed-Price contract (FFP):
    It is the simplest type of procurement contract. The seller must complete the task within the price and time that is agreed upon. In case of an increase in cost, the seller will be held responsible. Seller is bound to complete the job within the constraints of the agreement. The scope of work needs to be defined in great detail here; otherwise, both parties may have disputes later on.
    Such type of cost-based contract is easy to receive bids, and the process is quite quick. Unfortunately, though, deviations in the originally stated scope may prove to be expensive.

  • Fixed-Price Incentive Fee Contract (FPIF):
    Here, the price is fixed, but the seller may get an incentive due to their excellent performance. This incentive reduces the risk of the seller, and it can be in the form of cost, time, or technical performance in a project.

  • Fixed-Price with Economic Price Adjustment Contracts (FP-EPA):
    This contract is used when the contract agreement is multi-year. It comprises exclusive provisions framed to protect sellers from inflation. 
2. Cost Reimbursable Contract:
In this type of contract, the buyer needs to pay the vendor for the actual cost of work. This could include equipment, materials, and other elements such as direct costs (e.g., salaries), indirect costs, etc. While the buyer covers all these expenses, the seller can benefit from a financial return of some kind. Such a contract will have a clause that allows the seller to claim a profit over cost price in incentive payment or a fixed percentage fee.

3. Time and Materials Contract:
This type of contract pays off the vendor for purchased materials along with a “per hour” or “per day” rate for time spent on work. Such contracts are generally used when you don’t know when to start and what resources you want for the project. If managed and monitored closely, time and materials contracts can be really cost-effective, as it allows you to add skills and resources to the project as per the needs.

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