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March 23, 2023
A cost-plus contract is a widely-used agreement in the construction industry. It allows the contractor to be reimbursed for all the direct costs incurred during a project, plus an additional fee to cover overhead and profit. This contract structure is often preferred for projects where the scope is uncertain or subject to change.
What is a Cost-Plus Contract?
In a cost-plus contract, the contractor is reimbursed for all direct costs, including labor, materials, equipment, and overhead. Unlike a fixed-price contract, the project cost is not predetermined. Instead, the actual cost of the project is based on the contractor’s expenses. Additionally, the contractor is paid a fee that’s typically a percentage of the total project cost. This fee covers overhead and profit, and it can vary based on the complexity and risk level of the project.
Key Benefits of Cost-Plus Contracts
Cost-plus contracts offer several advantages, both for the contractor and the owner. These benefits include:
1. Flexibility in Project Management
Cost-plus contracts allow for greater flexibility during the construction process. Since the contractor is reimbursed for all project expenses, changes or adjustments can be made without the need to renegotiate the contract price. This flexibility is especially valuable for projects that are subject to unexpected changes, such as design modifications or unforeseen challenges.
2. Accommodates Unforeseen Changes or Issues
One of the key reasons cost-plus contracts are advantageous is their ability to handle unforeseen circumstances. Unlike fixed-price contracts, which may require costly amendments if project scope changes, cost-plus contracts allow the contractor to address issues as they arise without delay.
Potential Risks of Cost-Plus Contracts
While cost-plus contracts are useful in certain circumstances, they can also present challenges, particularly for the project owner.
1. Increased Costs for Owners
One potential risk of a cost-plus contract is the potential for higher costs than initially anticipated. Since the total cost is determined by the contractor’s expenses, owners may end up paying more than expected, especially if there are unexpected or unplanned costs during the project.
2. Managing Contractor Profit Incentives
The contractor’s profit is typically tied to the total cost of the project. While this structure provides a fair return for contractors, it may reduce their incentive to control costs. As a result, owners must monitor expenses closely to ensure that costs do not spiral out of control.
How to Negotiate a Cost-Plus Contract
Negotiating a cost-plus contract requires a careful balance between ensuring the contractor is fairly compensated while protecting the owner from unnecessary expenses. Some key negotiation points include:
- Clear definitions of reimbursable costs: Specify which costs will be covered under the contract.
- Cap on overhead and profit fees: Establish a reasonable limit for the contractor’s fee to prevent excessive profit.
- Detailed reporting requirements: Implement regular reporting and documentation of costs to ensure transparency.
Comparing Cost-Plus Contracts to Fixed-Price Contracts
While cost-plus contracts provide flexibility, fixed-price contracts may be a better option in projects where the scope is well-defined. In a fixed-price contract, the contractor agrees to complete the project for a specific amount, regardless of the actual costs incurred. Fixed-price contracts can be beneficial for projects with a clear scope and timeline, as they provide price certainty. However, cost-plus contracts may be preferable when flexibility is needed, or when dealing with projects that are likely to encounter changes during the construction phase.
Best Use Cases for Cost-Plus Construction Contracts
Cost-plus contracts are particularly suited to projects with high uncertainty, such as:
- Complex or large-scale projects: Projects with many unknowns, such as renovations, large infrastructure projects, or custom builds.
- Design-build projects: When the design evolves throughout the project, and flexibility is necessary to adjust the scope as needed.
- Projects with high-risk factors: For example, projects that involve unusual site conditions or require new construction techniques.
Conclusion
Overall, cost-plus contracts offer flexibility and adaptability in construction projects, but they require careful management to ensure costs are controlled. Both the owner and contractor must be diligent in negotiating terms and tracking expenses to avoid unexpected financial burdens. By understanding the benefits and risks, and ensuring clear communication and documentation, cost-plus contracts can be an effective tool for handling complex and evolving construction projects.
AIA Contract Documents has provided this article for general informational purposes only. The information provided is not legal opinion or legal advice and does not create an attorney-client relationship of any kind. This article is also not intended to provide guidance as to how project parties should interpret their specific contracts or resolve contract disputes, as those decisions will need to be made in consultation with legal counsel, insurance counsel, and other professionals, and based upon a multitude of factors.