Are Cost-Plus Contracts ever a good idea?
By Emily Martins, Senior Associate of Lovegrove & Cotton Pty Ltd (Construction and Planning Lawyers)
Recently I was in a matter before the Victorian Civil and Administrative Tribunal (VCAT) regarding a million dollar Cost-Plus Contractual dispute.
The well known and well regarded Tribunal Member presiding over the Hearing, stated to the parties that aside from license-lending, the Member’s most disliked matter to preside before in the Building List, were matters involving Cost-Plus Contracts.
The Member was of the view that parties who entered into Cost-Plus Contracts often did so without receiving the necessary legal advice, and in turn at their own peril, making Cost-Plus Contracts troublesome for Owners and Builders alike.
The Member’s words were particularly poignant for all at the Hearing, particularly given that the parties were heavily invested financially and emotionally in a project that had not gone accordingly and considered the Member’s “pearl of wisdom” too little, too late.
The Member’s statement however, leaves us with an unanswered question, are Cost-Plus Contracts ever a good idea?
Fixed-Price Contract vs Cost Plus Contract
The most common type of building contracts entered into between parties are Fixed-Price Contracts for a set sum, which offer greater certainty to Owner’s on the overall cost of the building works to be performed.
Fixed-Price Contracts give Builders an incentive to finish the works on time and under budget, as they subject the Builder to the maximum risk and the full responsibility of costs escalating above the fixed price, Accordingly, Builders often overprice Fixed-Price Contracts to allow a margin for any variables throughout the construction process.
Alternatively, a Cost-Plus Contract in the building industry, is a Contract where a Builder is paid for all allowed expenses to get the job completed to a set limit, plus an additional margin to allow for a profit.
The Cost-Plus Contract price is not fixed and the Builder only has to give the Owner a reasonable estimate of the works. The estimate is ascertained by adding a profit margin to the actual cost of direct materials, labour and expenses. Essentially, in Cost-Plus Contracts, Builders get paid for all of the actual works completed and all the actual costs incurred without a fixed price.
Cost-Plus Contracts are also an “open book process” as Owners are entitled to receive Progress Payment Claims with all of the supporting invoices or satisfactory evidence for each item of expenditure/direct cost as charged by the Builder. With every single cost needing to be accounted for, Cost-Plus Contracts are naturally much more administrative in nature than Fixed-Price Contracts.
Laws and Regulations in Victoria
Pursuant to the Domestic Building Contracts Act (DBCA) and the Building Regulations 2006, all Domestic Building Contracts must be Fixed-Price except for certain circumstances. It follows that:
A Builder must not enter into a Cost- Plus Contract unless:
1) the reasonable estimate of the contract is over $500,000.00 or more;
2) the work to be carried out under the contract involves the renovation, restoration, refurbishment of an existing building and it is not possible to calculate the cost of a substantial part of the work without carrying out some domestic building work.
Further, should a Builder enter into a Cost-Plus Contract that does not contain a fair and reasonable estimate of the total money the Builder is likely to receive, the DBCA states that the Builder cannot enforce the Cost-Plus Contract against the Owner.
If it can be successfully proven that a Builder has not provided a fair and reasonable estimate, the VCAT has jurisdiction to award the Builder the cost of carrying out the work, plus a reasonable profit if the Tribunal considers that it would not be unfair to the Owner to do so.
What are the Advantages and Disadvantages of Cost Plus Contracts to the parties?
In theory, the Owner and Builder advantages and disadvantages are as follows:
-An Owner should be able to benefit financially from a Cost-Plus Contract as a Builder has no need to overprice a job to cover profit for any unknowns. Accordingly, the Builder’s profit margin can be less making it cheaper for the Owner.
-The Owner only pays for works that are undertaken by the Builder.
-The “open book process” of Cost-Plus Contracts is a regular monitoring system to ensure the Builder is keeping good records and is billing the Owner properly for works completed, materials purchased and direct labour costs.