Builders and Contractors Exchange
Weekly Bulletin: 5 dec 2006
Contracting on a "cost-plus" Basis
By: David W. Lannetti
Cost-plus contracts fix the amount to be paid to the contractor based on the cost of the material and labor, plus an agreed percentage thereof as profits. Such contracts are used when the costs of production or construction are unknown or difficult to ascertain in advance. It is important to understand that the relationship of trust plays an important part in these contracts. The owner must, to some extent, trust that the contractor will charge only reasonable costs. Stated another way, the contractor is expected to act in the best interests of the owner. Cost-plus contracts reduce the contractor’s risk of loss, but also decrease the contractor’s incentive to increase profit by working efficiently. This substantially increases the owner’s risk of loss should the owner’s trust be misplaced, because an unskillful, inefficient, or dishonest contractor could increase its profits by increasing the costs of materials and labor. Most courts have found that the contractor has a duty to ensure the efficient use of labor and materials, resulting in reasonable costs to the owner and reasonable profits for the contractor.
To prove that its costs were reasonable, a contractor must keep accurate and detailed records of its expenditures. To the extent that any expenditures are not supported by meticulous cost records, the expenses are non-reimbursable. If records are destroyed, or if cost records turn out to be estimates or approximations, all such inadequately supported costs may be disallowed. More importantly, the law requires the contractor performing under a cost-plus contract to use the same skill and ability in controlling costs as it would if the contractor were performing pursuant to a fixed-price contract. Additionally, when the contractor knows that actual costs are going to exceed the owner’s expectations, or exceed the estimate agreed upon, the contractor has the duty to fully apprise the owner of the excessive cost and to make that information available in a timely, understandable fashion.
In sum, a contractor on a cost-plus contract is entitled to costs together with the fee specified by the contract, provided that the contractor neither fraudulently inflated costs nor is guilty of malfeasance, wastefulness, or negligence in prosecution of the work and has proceeded with reasonable dispatch and due diligence to accomplish the provisions of the contract.
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This article is meant to bring awareness to this topic and is not intended to be used as legal advice.