All About Cost-Plus Contracts
A cost-plus contract is a construction contract under which the contractor gets paid for all construction-related expenses plus an agreed-upon profit. The term plus refers to the profit allowed to be earned by the contractor. A cost-plus contract usually represents a win-win situation for the contractor because all risks are essentially covered and all expenses are likely to be paid.
What to Charge on a Cost-Plus Contract
A cost-plus contract is a tool that the contractor uses to get paid for almost every expense related to the construction job. However, the contractor must justify and present evidence for the costs related to the job. Furthermore, the contractor could be denied recovery of associated costs if a negligent act or other relevant error is attributable to the contractor's responsibility. Some cost-plus contracts can be drafted to set a limit that restrains the contractor with a "not to exceed" amount for construction costs.
There are three main components of a cost-plus-contract:
- Direct costs: Labor, materials, supplies, equipment, and professional consultants being used by the general contractor
- Overhead costs (or indirect costs): Business-related expenses that are necessary to perform the contract; typically a percentage of labor costs and can include office rent, insurance, office supply, communication expenses, mileage, and printing or reproduction of construction drawings
- Fee (or profit): Typically a fixed percentage based on the labor costs directly associated with the work
When to Use a Cost-Plus Contract
A cost-plus contract might be used when the budget is being restricted or when there is a high probability that actual costs might be reduced. This type of contract is preferred when there is not enough data to perform a detailed estimate of the work or when the design is not completed. It is also a preferred by governmental agencies because they can select the contractor based on their qualification instead of the low bidder. Cost-plus is widely used to perform research and development works because the risk can be controlled by the contracting officer.
Pros and Cons of Cost-Plus
A cost-plus contract has advantages and some drawbacks for both the contractor and project owner. Some of the advantages of a cost-plus contract include:
- The contractor will not be able to reduce workmanship.
- It can focus on quality instead of cost.
- It could cover all related expenses.
- The contractor's risk is minimized.
On the downside, cost-plus contracts:
- Present uncertainty to the project owners because the final cost cannot always be easily determined
- Require additional resources and management to reproduce and justify all related costs
- Might lead to disputes when trying to recover construction-related expenses
- Can lead to projects running longer than expected
How to Protect Your Business When Using Cost-Plus Contracts
A cost-plus-contract presents a great opportunity for the contractor to recover all construction-related expenses. However, if a good record keeping is not enforced, some costs might be unrecoverable. A few basic tips can help contractors stay out of trouble:
- Read the cost-plus contract provisions carefully.
- Negotiate critical items that could lead to disputes, such as overhead expenses and costs associated with the main office.
- Control the material usage. A cost-plus contract can lead to misuse of construction material, so you might end up acquiring more material than reasonably expected.
- Do not take advantage of the project owner. Be honest but beware of exorbitant costs.
- Control your 'hard' and 'soft' costs.
Variations of Cost-Plus Contracts
Cost-plus contracts can include variations or features to serve the needs or special circumstances of specific construction projects.
- Cost-plus incentive fee: Incentive fees are based on the contractor's performance and are set under the contract provisions. The amount and type of incentive may be based on the project goals or schedule deadlines.
- Cost-plus award fee: A cost-plus award fee provides for award fees, predetermined and set forth in contract documents. The fee can be a penalty or a gratitude fee.
- Cost-plus fixed rate: A fixed rate contract sets predetermined labor rates based on the contractor's history and labor costs. It is a contract used by specialized contractors who really know their actual costs, but it provides little flexibility for contingencies.
- Cost-plus fixed fee: A cost-plus contract that covers direct and indirect costs plus a pre-determined fixed fee.