Lump sums: the essentials

With lump-sum contracts the contractor agrees to complete defined building works for a given price. There are a number of ways of arriving at the price, some of which make the term “lump sum” something of a misnomer. A lump-sum contract does not provide for the contractor to carry out design and it says little about how the contractor is to manage the procurement of works. Some would include design-and-build contracts in the definition but I have dealt with these separately. The lump sum to be paid to the contractor is unrelated to the actual cost to the contractor of completing the works.

Lump-sum contracts, excluding design and build, accounted for 60% of the value and 85% of the number of contracts in the RICS’ 1995 Contracts in Use survey.

Lump-sum or “traditional” contracting dates from the late 18th century, when the government decided that each job had to be controlled by a single contractor. This contractor – usually a bricklayer – entered into a contract with the architect and subcontracted the other craftsmen. Architects employed “measurers” to produce a bill of quantities from which competing contractors could prepare their tenders. And so quantity surveying was born.

How to arrive at the lump sum

In common law, the contractor is entitled to be paid the lump sum as and when it completes the works, although the Construction Act gives contractors the right to payment by instalments. There is a bewildering array of methods for calculating the lump sum. The traditional practice of preparing bills of quantities describing the work on an item-by-item basis is in decline. Lump-sum contracts can cover contracts that arrive at the price by remeasuring the works on completion, so the lump sum is no more than an indicative estimate. The total price is then adjusted for overheads and profit.

The lump sum is itself then subject to adjustment. The obvious cause of an adjustment is the addition or omission of work by the employer, but, without an express contractual provision, the employer has no right to instruct variations. Other standard contractual provisions allow for fluctuations in the price of labour and materials during the contract, the adjustment of prime cost and provisional sums and the payment of loss and expense to compensate the contractor for acts or defaults of the employer or architect. The result is that the lump sum is rarely, if ever, the sum paid to the contractor by the employer on completion.

• There is a bewildering array of methods for calculating the lump sum
• Experienced contractors can manage risk by a form of arbitration

Time for completion

The contractor is obliged to complete the works in an agreed period and must compensate the employer if it fails to do so through its own fault. Time for completion can be extended (but not reduced) if the employer or architect instructs extra work, or is in default. If the contractor is delayed by a neutral event such as bad weather, losses lie where they fall so that the time for completion will be extended but additional costs are borne by the contractor.

Managing the risk

Experienced contractors can manage the risk in pricing lump-sum contracts by a sort of arbitration. They build up the lump-sum price from market knowledge and then manage their cash flow by not paying subcontractors and suppliers before receiving payment from the employer. Contractors therefore require minimal working capital. But profit margins are low. A return of 2% on turnover before tax is commonly regarded as nirvana for this type of work.