Avoiding Construction Claims through Guaranteed Maximum Contracts

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.

1062 Otter Circle (843) 470-0459

Beaufort, SC 29902 fax (520) 842-4175
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,

1062 Otter Circle (843) 470-0459

Beaufort, SC 29902 fax (520) 842-4175
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."

1062 Otter Circle (843) 470-0459

Beaufort, SC 29902 fax (520) 842-4175