Articles

Cost Plus Contracts – What are they and when should they be used?

Cost plus contracts are a popular form of construction contract across the residential, commercial and civil sectors. However, they should be approached with caution.
There is continuing debate on the efficiency of cost plus contracts and their implications, including as to what projects they best fit. We have prepared a brief oversight as to what to consider before entering into a cost plus contract.

What is a cost price contract?

A cost plus contract is a contract where a contractor obtains material and services throughout the stages of the building process and costs are passed to the owners, with an agreed margin to cover overheads and profits. The hourly rates of the contractor’s labour are usually agreed upon. The contractor may make claims, inclusive of its margins at intervals that are agreed between parties and could provide supplied invoices. These claims are often monthly or linked to milestones.

Fixed price contracts vs cost price contracts – what’s the difference?

Construction contracts are often fixed price contracts. This means the amount to be paid to the contractor is a lump sum. This form of contract offers owners certainty on the overall projections of the costs for the works to be performed. Fixed prices contracts provides incentives for parties, mainly builders, to finish the proposed works on time as the responsibility and risk of costs above fixed price are borne by the builder, except in circumstance where those costs arise from changes to the scope of works.

Benefits of a cost plus contract

• It is an “open- book process” as it allows owners to receive progress payments claims with invoices for each expense/direct cost for the Works
• More administrative in nature in comparisons to fixed-price contracts
• Less incentive for builders to ‘cut costs’
• Allows for more flexibility to owners with the constant monitoring of costs and expenditures

Risks of a cost plus contracts

• If a finance is required, it is difficult to obtain appropriate loans without a fixed costs
• If records for costs are not supported, despite being valid, the owners may refuse payment
• Lack of bargaining and less incentive for competitive quotations for principals
• Greater risk for principals around time, cost and delivery

When should cost plus contracts be used?

Cost plus contracts should be used for designated purposes where it is difficult to assess an overall project and cost, but the budget has flexibility. It would be beneficial to enter into a cost plus contract where there is mutual trust between owners and builders who are able to have meticulous record keeping. Without a fixed cost, it is paramount for builders and owners to have a well-executed and defined plus contracts. Special conditions are often necessary when working from a standard form contract.

Examples of projects where cost plus contracts could be appropriate is when the budget is being restricted or when there is a high probability that the actual costs might be reduced. The cost plus contracts can be suitable where there is not enough information to perform a detailed estimate of the works or when the design is not complete and there is limited concern around financing the project.

Residential cost plus contracts

Cost plus contracts often are not suitable for residential building works, except when it is a larger project with significant complexity. This has been supported by the Courts. For example, Member Member Lohrisch of the (then) Commercial and Consumer Tribunal in Versace vs Lavis [2005] QCCTC stated:

“… the use of a Cost Plus Contract in residential construction is to be very specifically confined to instances of absolute necessity, that is, where the condition of the physical premises is, in substantial respects, in doubt.”

It’s important to be aware of the jurisdictional requirements and hurdles with entering into these contracts.

If you have any questions around cost price contracts or wish to discuss your options, contact Michael Morrissey at m.morrissey@morrisseylaw.com.au and Hamish Geddes at h.geddes@morrisseylaw.com.au or on 02 8077 0668.
This article was prepared by Mary Ann Wen.

Disclaimer: This publication by Morrissey Law & Advisory is for general information and commentary only and should not be considered or relied upon as legal advice. Formal legal advice should be sought in relation to any matters or transactions that may arise in relation with communication.

2018-07-30T11:10:12+00:00 July 30th, 2018|Construction Contracts, Construction Law, Home Building|