beware cost plus contracts

Beware cost plus contracts.

A builder’s favorite contract is cost plus contract but property owners should beware cost plus contracts due to unabated profits.  Cost plus permits builders to be reimbursed for construction costs incurred during a project plus overhead and profit. Builders entice clients into the contract where the scope is uncertain or subject to change; however, beware cost plus contracts.

A recent architectural brief meeting with a new client for an institutional building conveyed an all too familiar story.  The client had signed a cost plus contract with a builder without an architect for a new $10M building.  At practical completion of the building; the cost plus contract had blown out a staggering 200% to approximately $30M.

What is a cost plus contract?

In the cost plus scenario, the contractor’s costs are reimbursed (labor, materials, equipment) and an agreed overhead markup or percentage.  Cost plus contracts have no contractual role for a superintendent/architect for builder honesty and accountability.  Unlike lump sum or fixed price contracts, the project cost is not known prior to the client executing the contract.  The client cost is based on the builder’s expenses in addition to the builder’s margin percentage of the project cost.  This builder’s fee covers preliminaries overhead and profit,  varies between companies and is based on project complexity.

Cost plus contract disadvantages. 

1. Absence of cost controls   Cost plus contracts eliminate the most strategic mechanism of controlling costs: architect superintendence.  The contractor has no economic incentive to control client cost as his profits increase proportionally with costs.  Cost control is always a difficult task on construction sites but it’s impossible without the architect as contract umpire.
2. Perverse incentives  The contractor has a perverse incentive to increase costs and job duration – especially on a cost plus-percentage job.  A cost-plus contract is the direct opposite for positive, economic client cost outcomes.  The longer the contract duration is directly proportional to the builder’s larger profit.
3. Non-binding estimates  Beware cost plus contracts when the ‘estimates’ are non-binding.  There is little incentive to no incentive for the builder to put a lot of hours into preparing accurate estimates.  Without contractual compliance to a guaranteed maximum price by the builder, the estimate should be badged guesstimate.
4. No bid process  The builder has no incentive to manage a bid process with sub-contractors.  The builder’s profit deteriorates by negotiating and tendering for the best prices from suppliers and subcontractors.  Beware cost plus contracts that create lazy builders who pass through the cost to you.  Exasperating the client risk of cost overruns; subcontractors may also be working cost-plus.

Cost plus contract problems.

1. Pay for builder mistakes The client pays for the builder’s mistakes.  If there are problems with materials or installation; the contract permits builders to charge clients to make good defects.
2. Planning and building permits  The builder is entitled to more monies if there are problems with planning or building permits or engineering.  Contractually, the client will absorb all the additional costs for any unforeseen approval anomalies missed by the city.
3. Double dipping  Some contractors charge hourly for supervision, office expenses, customer meetings, and other administrative costs that should be covered by the markup.
4. Lack of cost information  Without an architect superintending the contract, there are no change orders.  Clients will learn about cost over-runs after the cost is expended and when it’s too late to make adjustments.  Clients may get large surprise bills at practical completion of the project.
5. Defects list costs  Without retention sums of bank guarantees; clients don’t have leverage after practical completion.  Cost plus contracts don’t require money’s to be withheld from the builder for substandard or incomplete, unfinished work.  If there is anyone compiling a defects list; the list will come with an additional client charge. Either you pay more to have the loose ends tied up, or you will end up doing them yourself.
6. Defects liability period  Cost plus contracts typically don’t include defects liability period clauses for a client’s peace of mind.  If builder warranty claims are identified after practical completion, the builder will often charge to come back and make good. Beware cost plus contracts where defects lists are unaddressed, unattended or an additional building cost.  AIA lump sum building contracts typically have twelve month defects periods where defect costs are borne by the builder.