Avoid Common Mistakes in Cost-Plus Contracts

Cost-Plus contracts have gained popularity following the COVID-19 pandemic. In a Cost-Plus contract, the Owner pays for the total Cost of the Work, plus the Contractor’s Fee (typically, a percentage of the total Cost of the Work, but sometimes priced as a lump sum amount). The Contractor is responsible for documenting the Cost of the Work and, therefore, must track and document all costs incurred in performing the Work. Because there is no fixed price or Guaranteed Maximum Price (GMP), there is no cap on the total Cost of the Work to be paid and, because the Contractor’s Fee is typically a cost percentage, there is also no cap on the Contractor’s Fee amount. 

Owners are generally wary of Cost-Plus contracts because, unlike its more popular cousins (the lump sum and GMP contracts), the Cost-Plus contract shifts the risk of cost overruns to the Owner, including overruns for price escalation (a contract risk heavily negotiated during and after the COVID-19 pandemic). For their part, most contractors will prefer to use a Cost-Plus contract whenever possible because it helps to reduce their risk during performance. However, many contractors are dissuaded from using the Cost-Plus contract because of the record-keeping and documentation requirements. 

Regardless of its pros and cons, it is important for parties entering into Cost-Plus contracts to understand the contract form and to avoid common mistakes.  Here are a few and how to fix them: 

Clearly Define the Cost of the Work

Most industry forms define the “Cost of the Work” as including all costs reasonably and actually incurred by the Contractor in performing the Work. This means the Contractor is entitled to reimbursement of all costs directly incurred in the proper performance of the Work and typically includes costs that “are reasonably inferable from the Contract Documents as necessary to produce the intended results.” This is a broad and vague definition. Therefore, it is important for parties to clearly define what specific cost items are reimbursable and what items are reimbursable only with Owner’s approval. Most industry forms include a sample list, but the list should be tailored to address project and deal specifics. Just as important, the parties must clearly define what costs are not reimbursable (the typical example is any cost resulting from the fault or negligence of the Contractor or of its Subcontractors).

Stop Using the Wrong Application for Payment and Schedule of Values Forms

In a Cost-Plus contract, price fluctuation is expected, and the Contractor is responsible for tracking changes to the initial Control Estimate (or budget) in the schedule of values. Unfortunately, when billing Cost-Plus contracts, most contractors use the standard AIA G702 Application and Certificate for Payment and G703 continuation sheet as their schedule of values (or similar forms), which do not allow the Contractor to track price fluctuation. Even after the AIA’s 2021 release of new application for payment forms specifically tailored for Cost-Plus contracts (with and without a GMP), many parties continue to use forms set up for fixed price contracts. (For the new AIA forms, see AIA Documents G702CW-2021, G702GMP-2021, and G703CW-2021.) Therefore, it is important for contractors to review their applications for payment and schedule of values forms. If the correct forms are not being used, then this is the perfect time for contractors to update those forms and update their standard billing practices for Cost-Plus contracts. For owners and lenders, it is important to require the correct forms from their contractors.

Understand the Role of Change Orders

In a Cost-Plus contract, the Contractor is generally entitled to reimbursement for increases to the Cost of the Work. For example, unless the contract states otherwise, the Contractor is entitled to invoice for items like increased cost of materials due to supply chain disruptions without an executed change order (compared to lump sum and GMP contracts, which do require a change order), and the Contractor must simply track the price increase in the schedule of values (using the correct SOV form!). However, change orders are still required to effectuate any changes in the Work (e.g., a change in scope or a change in schedule). Therefore, in addition to clearly defining the “Cost of the Work,” it is important for parties to clearly define what constitutes a “change” in the Work, and, perhaps more important, what changes are compensable and what changes are not compensable.

For parties choosing to enter into Cost-Plus contracts, taking some time to clearly define key contract terms and provisions and to ensure the correct forms are used to administer the contract and manage the project will help to avoid confusion and potential disputes.