Avoiding Construction Claims through Guaranteed Maximum Contracts
Submitted December, 2002
Guaranteed Maximum Contracts or G-Max are becoming more popular as a corporate vehicle to minimize risk, avoid claims and integrate the diverse interests of a complex project. Not to be confused with cost plus, the G-Max contract is bid exactly the same as lump sum. The contractor assumes the same risk, with a big stipulation: he's willing to share in the savings on the basis of the owner's guarantee of fee and prompt payment of net cost.
There's no difference in cost or risk between Lump Sum and Guaranteed Max, but a big difference in results, particularly on the owner's side of the fence. Don't let anyone tell you that G-Max cost more. They don't! In fact, Lump Sum contracts are sometimes converted to G-Max for the same price or less.
How do they work? In the following example, the best bid price received from a qualified general contractor for a major renovation is $2.5 million. The owner's budget is $2.2 million, but modifications and changes are anticipated for an additional $500,000 estimated construction costs. Time is of the essence. The project must start immediately. The owner wishes to cut $300,000 from the base contract without changing the scope of work and at the same time control cost of the additions without giving away the $500,000. The contractor already dropped his price on the first round of negotiations and won't budge off his $2.5 million. This project is an ideal candidate for G-Max conversion.
The Owner who awards the contract should ask the contractor: "How much fee (or profit) do you want in this project?" (Assume 6 percent). When the contractor states "$150,000," the owner says: "Then what you are saying is that this project's actual cost is $2.35 million. We'll guarantee your fee of $150,000, but we believe you can bring this project in for under $2 million by working with some of our people who know construction. Do you see that as a realistic possibility? " If the contractor answers "Yes," then the owner asks: "Would you then accept a Guaranteed Max contract with the understanding that all costs saved below the $2.35 million will be returned to the owner? " If the answer is "Yes," then you can establish the method of administration. If the answer is "No," then you negotiate a 75-25 or 50-50 split in the savings and ask: "If we guaranteed $500,000 of additional work to the base contract, will you agree to reduce your fee on extras for the first $250,000 of additional work?"
This is just the beginning, there are many possibilities. The yield at the end of the project often exceeds the original objective (in this case $300,000) because the atmosphere has changed from adversarial to partner. With proper controls, and by working with contractors as a team member, it is possible to obtain greater yields on the bottom line than by any other contracting method.
G-Max contracts best achieve the owner's objective because a partnership is formed between owner and contractor wherein the owner agrees to reimburse the contractor for actual cost as it occurs, not from a schedule of values. This eliminates the distrust between parties. It also eliminates the contractor's negligence to pay his suppliers and subcontractors because he gets audited monthly. In today's market, this one issue alone will solve a lot of problems and insure both savings and a smoothly running project.
The owner plays an active role throughout the entire process. The whole issue of cost is manageable when the savings are shared, rather than negotiated from an adversarial position. When the administration is properly set-up and organized, the benefits are truly amazing. Because every purchase order and invoice received from the contractor is submitted to the owner as backup, and because the owner agrees to cut the time for processing and pay promptly, a positive and successful relationship is assured. Front end loading disappears, so does the haggling with price.
There is another reason for using the G-Max contract system: It is the best vehicle for recovering cost when pricing on extras becomes unreasonable. The fact that owners have tremendous leverage on extras is not often mentioned among users, perhaps because it is a business advantage. Consider once again the outrageous cost for a new door. Assume that the contractor wants $1,500 to cut the hole and install a new door, plus another $50,000 to relocate the 4-inch gas pipe that nobody knew existed. Assume also that the true cost of the piping relocation is only $10,000, but the contractor will not back off his estimate. The work must start and he demands approval. Under lump sum contracts owner's haven't got much choice, but under the G Max system, even if you agree to the $50,000, all you've given away is the difference in fees, or $2,400 instead of $40,000. Once the work is complete and true cost is known, even this can be adjusted. There's a strong incentive here to be honest. Nothing like it exists with any other format. Cost plus contracts claim to be the same, but in reality they do not have any incentive for shared savings or efficiencies.
Still another advantage of G-Max occurs when work must start ahead of final drawings. There are often issues that delay completion of the drawings and therefore start of construction. The G-Max format allows owners to minimize risk when proceeding with work ahead of final drawings. It has been my experience to start work on 30 percent completed drawings while obtaining a G-Max price for the entire project based on preliminary drawings and outline specifications. That's an extreme example, but it does happen.
The downside also needs stating. G-Max contracts require more work on the owner's part to administer. The main effort involves defining what is cost. And if you are not interested in collecting discounts, obtaining credits for small tools, establishing realistic labor rates, monitoring rentals, and are not really prepared to act as a partner with your contractor in the project, then this program is not for you. Don't try this if you don't have a strong administrator experienced in general contracting. Contractors resent inexperienced owners questioning their decisions, and they certainly aren't eager to have their books audited by anyone they don't trust. Properly set-up and administered however, G-Max contracts are a win-win situation."
Copyright © 2002 Paul Gogulski.All rights reserved. No portion of this article may be reproduced without the express written permission of the copyright holder. If you believe you may lawfully use a quotation, excerpt or paraphrase of this article under the Fair Use exception to copyright law, except as otherwise authorized by the author of the article, you must cite this article as a source for your work and include a link back to the original article from any online materials that incorporate or are derived from the content of this article.