The construction industry uses three distinct terms to offer their services to customers. Estimates, bids and proposals are terms used to present a dollar value associated with construction work. For less sophisticated contractors, the terms are interchangeable. The reality is far different. Each term has an historical context and legal meaning. Thus, it is prudent for any contractor to understand the differences and use the correct term in an accurate way when offering their respective services.
This article will explain and elaborate the differences between estimates, bids and proposals. In addition, some legal issues are explained; specifically, as they relate to contract law. As a contractor, it is your responsibility to understand the respective terms and when and how to use them. This knowledge greatly reduces your risks, especially risks associated with lawsuits. It all starts with understanding the most commonly used term in the industry – estimates.
Estimates
An estimate is the most broadly used term in the construction industry. However, it actually has two separate meanings. Estimates are divided into internal and external definitions. Internally, the term refers to the process of identifying the hard costs of construction. External use of the term refers to a verbal communication of how much the contractor will charge for their services. Take note, external use is a ‘VERBAL’ conveyance of value.
The following subsections explain these differences in more detail.
Estimates as an Internal Term
Internally, the term alludes to the process of calculating the financial hard costs of construction for a project. With almost every small business construction company, there is a single person assigned this responsibility. This individual is commonly called the ‘Estimator’. The estimator calculates the actual direct costs of construction to build or complete the respective task. Estimators use take-offs, worksheets and proposals from subcontractors to determine the final expected hard cost of construction.
With the known hard costs, the company adds a mark-up to determine the final price that will be delivered to the customer. This is where the confusion about the term estimate starts.
Estimates as an External Term
The core problem with the term estimate is the public’s perception of its definition. Webster’s dictionary defines an estimate as “an approximate calculation or judgment of the value, number, quantity, or extent of something”. However, for the average person, the term estimate is more in line with an exact value or calculation of the price to perform services. Some customers will allow some deviation from the quoted dollar amount; in general, many customers will allow and understand a 3% deviation from the estimated amount as the final price. The key point here is that customers interpret the term ‘estimate’ to mean an exact dollar amount to perform services including materials, labor and all other costs the contractor must absorb.
To add to the confusion, many contractors state on their websites, marketing and advertising materials that the contractor provides free estimates. Thus, contractors have allowed the term to be perceived by the public as a definitive value to perform services.
With most states, under contract law there are four key elements with the creation of a binding contract. First there is an offer, some form of a statement from the contractor stipulating they will perform services. The second key element under contract law is acceptance by the customer. In effect, whether verbally or in written format, the customer must accept the offer. A contract does not exist under these two conditions. There are still two more required elements. The third element is called consideration. This refers to the dollar value related to the exchange. The final element is called performance. This means that when either party puts some form of value in the other party’s hand, consideration is achieved. For the customer, this means some form of financial transfer to the contractor. For the contractor it means they must deliver materials or do some form of labor work at the job site.
Many states further define a contract to include mutuality, i.e. a meeting of the minds. Both parties must understand the parameters and what the contract entails. Another common requirement is a date and or timeline for the contract to exist. Overall, for the reader, there are four required elements – 1) Offer, 2) Acceptance, 3) Consideration and 4) Performance.
The conveyance of an estimate to a customer is often interpreted as an offer and consideration. This starts the process with the creation of a contract. A contract doesn’t exist yet; but this meets the technical definition of an offer along with consideration. It gets a tad more confusing because in most states, the law requires that any form of contract related to real estate MUST be in written format. Thus, if a contractor provides a written estimate, this begins the first stage of creating a written contract.
Thus, technically and legally speaking, written estimates to customers, if accepted and the customer provides some form of deposit or initial payment, is then considered a legally binding contract. It meets all four elements of a contract. An offer: ‘I’ll perform this work contingent on you paying me’; acceptance: the customer states ‘I agree’; consideration: ‘this is the set dollar value’ and finally; performance: ‘customer makes a payment’.
Obviously, the above illustration is very common with smaller forms of construction work. Think of the small contractors that perform small jobs such as building decks, sealing driveways, performing landscaping services, and even conducting traditional trade repair work. All of these are customarily done with this sub standard method of creating a contract.
However, the best construction definition for an external estimate is:
A verbal communication of dollar value to perform services with stipulations that it is nonbinding and the value is plus or minus a set % (recommend no less than 20%) of the actual cost to the customer.
Take note of the three important elements of an external estimate.
- It is VERBALLY communicated, never in written format. Go back to the definition of a contract, especially contracts related to real estate; if in writing, there is no doubt of meeting the elements of an offer and consideration. Therefore, to prevent the creation of a contract, provide the estimate verbally.
- NONBINDING: every estimate conveyed to a customer must include the words: ‘Nonbinding’, or a statement to the effect that the company will not honor the price provided without a formal process of determining a set price with conditions and a written contract. In effect, the customer must be made aware and acknowledge the understanding that the proposed dollar value is not a legal agreement between the parties.
- An APPROXIMATE value of exchange between the parties: the verbal conveyance of dollar value should also include the words ‘approximate’ and/or ‘an initial judgment’.
So why even have external estimates? The answer is: customer expectations. Every contractor gets the common phone call asking ‘Can you give me an estimate to do such and such?’. Many contractors advertise free estimates. Thus, there must be a tool to differentiate presenting value without being formally obligated to perform the services. The answer is: provide an estimate with several levels of protection in order to alleviate the perception of a formalized arrangement.
The more professional contractors always start the conversation with the customer or client with the definition of an estimate prior to stating the price. Having the customer or client acknowledge the definition is critical to gaining an understanding between the parties. A good starting sentence is the following:
Mrs. Smith, an estimate is a nonbinding approximation of the price our company would charge to do this work. Please understand, the final price is often plus or minus 20% of this verbal price and is influenced by many factors including scope of work, job site conditions, weather and time frames. Do you understand that this estimate is not an agreement between us? Do you acknowledge that this price will deviate substantially due to multiple issues?
The customer must state ‘YES’ to both questions prior to providing a dollar value.
The key to an external estimate is that it is created as a nonbinding understanding between the two parties. It must be delivered verbally with at least two additional elements of 1) nonbinding, and 2) it is an approximation of value. The customer or client should acknowledge their understanding of this exchange.
