With large-scale construction projects, it’s clear: the stakes are high. Cost overruns can make or break budgets. But Guaranteed Maximum Price (GMP) contracts can create a structured way to manage costs and provide both owners and contractors with a sense of financial predictability.

Imagine setting a financial boundary on a project—one that protects your budget while giving you transparency into each expense along the way. GMP contracts have become mainstream in construction because they establish a clear limit on costs. But like any contractual approach, they come with nuances.

This article covers the essentials of GMP construction contracts: key clauses, benefits, and potential pitfalls. Last but not least, we’ll walk you through scenarios where GMP contracts have been effective and discuss how you can manage risks when using this contract structure. By the end, you’ll have a better sense of whether a GMP contract is right for your next project and how to implement it.

What is a Guaranteed Maximum Price contract?

A Guaranteed Maximum Price (GMP) contract is exactly what it sounds like: a contract that sets a defined cost limit for a construction project. Basically, a GMP contract assures the project owner that the final cost won’t exceed an agreed-upon ceiling price. This maximum price includes all project expenses, capping the financial exposure for the owner while giving contractors flexibility to manage costs.

To establish a guaranteed maximum price, both parties work together to define the project scope in exact detail. This involves itemizing costs line by line, allowing for greater transparency and predictability.

Unlike lump-sum or time-and-materials contracts, a GMP contract offers a unique blend of cost control and accountability, which makes it a favored choice for projects where budget management is critical.

For the contractor, the ceiling price incentivizes efficiency. Any cost savings achieved through effective planning and execution can also translate into added value or profit for the contractor. On the other hand, for the project owner, the transparency of a GMP contract is invaluable. It breaks down each cost component upfront and clarifies contractual obligations regarding fees, materials, and contingencies.

How does a GMP contract work?

A GMP contract functions through a few components that collectively set a price ceiling. Here’s how these components work together to safeguard the project scope and overall financial boundaries:

Itemized cost breakdown. The foundation of any GMP contract lies in its detailed breakdown of costs. Each line item is meticulously defined, creating a roadmap for spending that must align with the project’s total budget. If the contractor manages to complete the project under this cap, any remaining funds can‌ be shared with the project owner or retained as profit, depending on the contract terms.

Contractor fees and profit margins. Your contractor’s fees are generally negotiated and included in the guaranteed maximum price contract to avoid any surprises. These fees also cover overhead and profit margins and are structured to encourage contractors to manage resources efficiently without compromising on quality. Any additional savings achieved on expenses often go directly to you.

Contingency funds for unexpected costs. A GMP contract also accounts for the unexpected by including a contingency fund. This fund serves as a financial buffer for unanticipated expenses or minor scope adjustments, protecting both the project owner and contractor from cost overruns. Spending from this fund usually requires approval to stay aligned on costs and contingency funds only when necessary.

Key clauses in a GMP contract

In a GMP contract, certain clauses are a must for maintaining clarity, managing costs, and protecting the interests of both the project owner and the contractor. The following two clauses define the scope, control mechanisms, and flexibility needed to keep the project on track financially and operationally.

1. Scope of work and cost control

This section lays out the project’s goals, specifications, and required tasks in meticulous detail. The scope-of-work clause clearly defines each element of the work—from the materials used to the completion timeline. It also helps ensure that both the contractor and the project owner share the same vision.

In GMP contracts, the scope directly influences the budget. If you or the other party add new tasks or extra features after the contract is signed, they must be carefully considered and, if agreed upon, added to the contract. Without a solid scope, you may find yourself stretching resources to meet unstated demands, and project owners risk financial surprises that weren’t accounted for.

2. Change order provisions

No matter how detailed the planning might be, some degree of change is inevitable in construction projects. This is where “change order provisions” come into play in a GMP contract. Change orders allow for flexibility when unforeseen circumstances arise or when the project owner requests modifications.

A change order clause is meant to outline the process for requesting and approving these modifications.

For example, if a project owner decides mid-project to add a new feature or alter the design, the change order clause dictates that the contractor can assess the impact on the budget and timeline. Both parties must agree on these adjustments, safeguarding the financial parameters of the original GMP agreement.

Plus, adhering to contract compliance standards within these change order provisions reduces misunderstandings. Overall, keeping these processes in check supports a transparent relationship.

Advantages and disadvantages of GMP contracts

While GMP construction contracts are popular for cost controls and clear structure, they come with benefits and drawbacks that influence a project’s performance. Here’s a look at the main pros and cons.

Advantages

  • Cost certainty. One of the biggest pros of a guaranteed maximum price contract is contract cost certainty. When the project’s expenses are capped at a specific amount, the project owner can be confident that costs won’t exceed the agreed ceiling. This financial predictability is particularly valuable in large-scale GMP construction projects, where budgets can be at risk without clear boundaries.
  • Transparency. A GMP contract requires a breakdown of costs, letting you as the contractor and the project owner see where you allocate funds. This transparency fosters trust and open communication. With an itemized budget in place, any potential for contract disputes is minimized, as both parties have a shared understanding of the contract’s financial framework.
  • Risk management and cost-saving incentives. Structured GMP contracts promote efficient cost management, incentivizing contractors to complete the project under budget. When contractors save money within the guaranteed maximum price framework, they may be able to retain part of the savings as profit. It’s a win-win arrangement for the project owner and you, the contractor.

Disadvantages

  • Complexity and preparation time. While GMP construction contracts provide cost certainty, they require pre-planning and detailed estimations. Creating an accurate budget and scope of work demands time from both parties, so all elements are accounted for. This can add upfront costs and extend the project’s start date, which may not be ideal for projects with tight schedules.
  • Potential for disputes on changes or overages. Although a GPM contract caps costs, changes to the scope of work may result in legal risks and disputes if project owners and contractors don’t see eye to eye. If unexpected site conditions or requested additions push the project closer to the guaranteed maximum price, disagreements may arise over which costs should be absorbed. 

Example of a GMP contract in construction

To see how a GMP contract works in practice, let’s look at a real-world example where this type of contract structure helped manage costs, scope, and timelines on a large-scale project.

What would happen if a city planned the construction of a new community center? For one, they’d have to establish a project with a strict budget and a fixed completion date to align with upcoming public events. In this case, the city chose a GMP construction contract to control expenses and ensure that the project wouldn’t exceed its funds.

The contractor and project owner collaborated closely in the pre-construction phase, using detailed estimations and scope definitions to establish a guaranteed maximum price for the entire project.

As construction progressed, the city requested modifications to enhance the center’s facilities, such as adding a library and some meeting spaces. Thanks to the change order provisions in the GMP contract, both parties were able to review the cost and timeline impact of these changes before proceeding.

Each modification was documented, and any adjustments to the GMP were agreed upon and approved.

Although unexpected site conditions arose, the GMP contract’s contingency fund allowed the contractor to address these issues without jeopardizing the budget. The contractor’s incentive to manage costs efficiently played a key role as well. In this context, adhering to the scope and smartly managing resources benefited both the contractor and the city in finishing the project under budget.

Mitigating risks in GMP contracts

GMP contracts offer a high level of cost control, but they also come with certain risks that need careful management. To prevent unexpected expenses and minimize disputes, project owners and contractors alike should adopt proactive strategies to keep projects within the guaranteed maximum price.

AI for contract review and risk mitigation

Advanced AI contract review software, such as Superlegal’s, can reduce the time and effort required to analyze contracts. It also helps identify potential risks and compliance issues before construction begins.

For instance, AI contract review software can streamline the process of evaluating scope-of-work definitions, change order provisions, and other essential clauses. This precision reduces the risk of misinterpretations that could lead to costly disputes or scope misalignments. With AI tools, everyone involved will better understand the contract’s expectations fully as well as potential pitfalls.

Is a GMP contract right for your project?

No doubt, GMP contracts offer a reliable way to control costs and clarify expectations from day one. While these contracts speed up financial planning to some extent, they require thorough contract review. Luckily, with AI-driven contract review tools, it’s easier than ever to navigate the complexities of GMP contracts, making them viable for those seeking cost control, transparency, and predictability.