I’ll pay you ten dollars to mow my lawn. I’ll pay you $500,000 to build me a house.
The specific terms and conditions can take a contract in so many different directions. However, when the final agreement is made official, the contract, whether it be written or oral, will fall into a specific category.
As you maneuver your contract management strategy for your business, it’s important to pick out any and all types you might encounter to maximize contract performance, preparedness, organization, and compliance.
Types of contracts
The type of contract being used in an agreement can refer to the structure of the document, details of compensation, requirements to be legally enforceable, or the associated risks. The contracts listed below are not all comparable to one another and can’t all be used interchangeably.
As promised, here is a complete list of every type of contract you could ever possibly encounter.
Fixed-price contracts, also known as lump sum contracts, are used in situations where the payment doesn’t depend on the resources used or time expended. With fixed-price contracts, sellers will estimate the total allowable costs of labor and materials and perform the action specified by the contract regardless of the actual cost. Because of this, the fixed price presented in the contract usually includes some wiggle room in case unexpected costs occur.
The seller is assuming a certain amount of risk by using a fixed-price contract, so some will decide to present a range of prices instead of one dollar amount.
These types of contracts typically include benefits for early termination (meaning the duties were fulfilled) and penalties for missing deadlines. This common practice ensures that the agreement, or performance of action, or whatever the contract’s subject matter may be, is performed on time.
When entering a deal that will use a fixed-price contract, be prepared for the contract creation and approval process to take a bit longer than usual. To make sure they account for all time and resources accurately, sellers will be extra careful in determining the price.
Fixed-price contracts are most commonly used for construction contracts. Contractors will decide to use a fixed-price contract because the simplicity can result in buyers maybe paying a higher price up front to avoid the hassle of tallying up the actual cost. However, that initial estimate can be hard to reach accurately.
With a cost-reimbursement contract, the final total cost is determined when the project is completed or at another predetermined date within the contract’s time frame. Before the project is started, the contractor will create an estimated cost to give the buyer an idea of the budget. They will then provide payment for the incurred costs to the extent that has been described in the contract.
The purpose of setting this expectation with cost-reimbursement contracts is to establish a ceiling price that the contractor shouldn’t exceed without the approval of the buyer. At the same time, if that ceiling is reached, the contractor can stop work.
Also used for construction projects, a cost-plus contract is a type of cost-reimbursement contract for situations where the buyer agrees to pay the actual cost of the entire project, including labor, materials, and any unexpected expenses.
The word “plus” refers to the fee that covers the contractor’s profits and overhead. In these agreements, the buyer agrees to pay that extra amount and expects the contractor to deliver on their promise.
There are four types of cost-plus contracts and each one describes how the contractor is reimbursed to earn a profit:
Cost-plus award fee contract: the contractor is awarded for good performance
Cost-plus fixed fee contract: the contractor is reimbursed with a predetermined amount
Cost-plus incentive fee contract: the contractor is only given a reward if they exceed expectations
Cost-plus percent-of-cost contract: the contractor’s reimbursement is a percentage of the actual total cost of the project
When using a cost-plus contract, the buyer is usually able to see the entire list of expenses so they know what they’re paying for. They also will typically include a maximum price so they have an idea of what the most-expensive-case scenario might look like.
Contractors will use cost-plus contracts if the parties don’t have much wiggle room in the budget or if the cost of the entire project can’t be estimated properly beforehand. Some of these cost-plus contracts might limit the amount of reimbursement, so if the contractor makes an error or acts negligently, the buyer won’t have to pay for their mistakes.
Contractors will decide to use cost-plus contracts because they get flexibility to make changes throughout the project and the buyer gets the exact value they paid for. However, it can be frustrating to have the final price up in the air and getting that number requires extensive attention to detail.
Time and materials contract
A time and materials contract is like a cost-plus contract, but a little more straightforward. In these deals, the buyer pays the contractor for the time spent to complete the project and the materials used in the process.
Time and materials contracts are also used in situations where it’s not possible to estimate the size of the project or if the requirements for completion are expected to change.
As a buyer, your money will be out toward the material costs and the rate you are paying the workers for their time. At the start of the process, you will likely have to come to a mutual agreement on the price of materials, including a markup rate and hourly rates for labor.
Time and material contracts require logging of everything happening on the work site, most importantly the hours being worked and materials being used. Paying close attention to those details will help the contractor and buyer come up with the most accurate estimate of the final total cost.
Contractors will use time and materials contracts because it simplifies the negotiation process and it’s easy to adjust if the requirements of the project change. A downside to this is that tracking time and materials is tedious work.
Unit price contract
With a unit price contract, the total price is based on all of the individual units that make up the entire project. When using this type of contract, the contractor will present the buyer with specific prices for each segment of the overall project and then they will agree to pay them for the amount of units needed to complete it.
The word “unit” in these contracts can refer to time, materials, or a combination of both. While the parties can estimate or make guesses, the actual number of units typically can’t be specified at the beginning of the project.
Say you are making a deal with someone to repave your driveway. It’s hard to tell how much cement you’ll need exactly, but the contractor says it costs $1,000 for each truckload of supplies and associated labor. So to redo your entire driveway, you would need to agree to pay $1,000 per unit. And if it took three units to complete the entire project, you would have to pay the contractor $3,000.
Unit price agreements make for easy-to-understand contracts, but on the side of the contractor, it can be easy for buyers to compare prices with their competitors and cause them to lose some business.
A bilateral contract is one in which both parties make an exchange of promises to perform a certain action. The promise of one party acts as the consideration for the promise of the other and vice versa.
With bilateral contracts, both parties assume the role of obligor and obligee, meaning they both have contractual duties to perform and they both are expecting something of value as well.
Bilateral contracts are most commonly used in sales deals, where one party promises to deliver a solution and the other party promises to pay for it. There is a reciprocal relationship here as the obligation to pay for a solution is correlated with the obligation to deliver the solution. If the buyer doesn’t pay or the seller doesn’t deliver, a breach of contract has occurred.
The key element of bilateral contracts lies in the exchange of something of value for another item of value, which is known as consideration. If only one party is offering something of value, this is known as a unilateral contract.
Unilateral contracts are agreements where a party promises to pay another after they have performed a specified act. These types of contracts are most often used when the offeror has an open request that someone can respond to, fulfill the act, and then receive the payment.
Unilateral contracts are legally binding, but legal issues usually don’t come up until the offeree claims they are eligible for money tied to certain actions they’ve performed and the offeror refuses to pay the offered amount of money. Courts will decide whether or not the contract was breached depending on how clear the contract terms were and if the offeree can prove they are eligible for payment based on the facts in the agreement.
Examples of situations where unilateral contracts are used include open requests where anyone can respond to a request, and in the case of insurance policies. In those contracts, the insurer promises to pay if something occurs that was included in the term of the contract. So essentially, the insurance company pays the client if they are covered for the situation they encountered.
An implied contract is an agreement that exists based on the actions of the involved parties. Implied contracts are not written down, and they might not even be spoken either. The agreement simply ensues once the parties take the designated action that kickstarts the contracts.
An example of an implied contract is a warranty on a product. Once you buy a product, a warranty goes into effect that it should work as expected and presented. This contract is implied because it went into effect when someone took a particular action (buying a product) and it might not have been written down anywhere.
There are two different types of implied contracts:
Implied-in-fact: contracts that create an obligation between two parties based on the circumstances of the situation.
Implied-in-law: contracts where the law imposes a responsibility on someone to uphold their end of an agreement.
An express contract is a category of contracts entirely. In these types of agreements, the exchange of promises includes both parties agreeing to be bound by the terms of the contract orally, in writing, or a combination of both.
Express contracts are often known to be the opposite of an implied contract, which, as a refresher, starts an agreement based on the actions of the parties involved. With express contracts, all terms, conditions, and details of the agreement are expressed (get it?) by writing them down, saying them out loud, or both.
Capacity: a person’s ability to enter a contract. People who are underage, mentally disabled, or intoxicated lack contractual capacity.
Offer: the statement of terms and conditions of an agreement by which the offeror is willing to be bound.
Acceptance: the offeree’s acceptance of those terms and willingness to abide by the agreement.
Legality: whether or not the subject matter of the agreement is legal.
Consideration: the exchange of one thing of value for another.
Mutuality: both parties must be bound to the contract or neither can be bound to the contract.
When two types of contracts are compared, it often means that the parties involved in the agreement can decide which one to use. This is not the case for express and implied contracts. The nature of the agreement determines that for you.
A simple contract is a contract made orally or in writing that requires consideration to be valid. Again, consideration is the exchange of one thing for another and can be anything of value, including time, money, or an item.
Simple contracts are the opposite of contracts under seal, which do not require any consideration and have the seal of the signer included, meaning they have to be in writing. These contracts are officially executed once they are signed, sealed, and delivered.
While simple contracts require consideration, they don’t have to be express contracts to be legally binding. The agreement in a simple contract can be implied as well.
An unconscionable contract refers to an agreement that is so obviously one-sided and unfair to one of the parties involved that it can’t be enforceable by law. If a lawsuit is filed regarding an unconscionable contract, the court will likely rule it to be void. No damages are paid, but the parties are relieved of their contractual obligations.
There are a few things that make a contract unconscionable:
Undue influence: when one party puts unreasonable pressure on another or to enter a contract, or when someone takes advantage of the other party to get them to enter a contract
Duress: when one party threatens another to get them to enter a contract
Unequal bargaining power: when one party has an unfair advantage over the other party, especially when one of the parties doesn’t fully understand the contract terms
Unfair surprise: when the party who wrote the contract included an element within it that was not in the original agreement or expected by the other party
Limiting warranty: when one party tries to limit their liability in the event of a breach of contract
If one or multiple of those events occurs when making an agreement, the contract is null and void and neither party is responsible for their end of the deal.
An adhesion contract, also known as a standard form contract, is sort of a “take it or leave it” situation. In these agreements, one party typically has more bargaining power than the other. When the offeror presents the contract, the offeree has little to no power to negotiate the terms and conditions included. This is contrasted from situations where the offeree can return a counteroffer to the original offeror in hopes of starting negotiations and reaching an agreement they both find suitable.
This lack of negotiation isn’t done with bad intentions. In the case of adhesion contracts, the offeror is typically someone who offers the same standard terms and conditions to all of their offerees. Every contract is identical.
For example, if you were buying insurance, the agent would draw up the contract, the way they do with every other client, and you would either accept or deny the terms. It’s not likely you’ll be able to negotiate a new contract that you prefer more.
Adhesion contracts must be presented as take it or leave it to be enforceable. Because if one party holds more bargaining power in any other situation, that could potentially be seen as an unconscionable contract. It’s easy for that line to be blurred, causing adhesion contracts to be placed under scrutiny quite often.
Aleatory contracts explain agreements where parties don’t have to perform their designated action until a triggering event occurs. Essentially, aleatory contracts state that if something happens, then the action is taken.
Again, this type of contract is typically used in insurance policies. For example, your provider doesn’t have to pay you until something happens, like a fire that causes damage to your property.
The events that demand action described in an aleatory contract are ones that can’t be controlled by either party. Risk assessment is an important part of creating aleatory contracts so both parties know the likelihood of that event occurring.
Be ready for anything
Your business might not encounter each and every one of those contract types, but it’s your responsibility to be prepared for any that might come your way. After reviewing all of those examples, familiarize yourself with the contracts that your business is likely to encounter. An extra layer of preparedness never hurt.
With all of the different types of contracts, compliance can take many forms. Follow these seven tips for contract compliance that will keep you in line no matter the circumstances.
Mary Clare Novak is a Content Marketing Specialist at G2 in Chicago, where she is currently exploring topics related to sales and customer relationship management. In her free time, you can find her doing a crossword puzzle, listening to cover bands, or eating fish tacos. (she/her/hers)
Management for all contract types
No matter the types of contracts your business uses, you'll need some help managing them.