Cost-plus contracts: Considerations

Cost-plus contract considerations

The cost-plus form of contract has its own disadvantages and generally should be used only in unusual or very specific circumstances. For example, it may be suitable for a heritage renovation project where it is not reasonably practical to determine the extent of work that must be undertaken before the work commences. A cost-plus contract may be acceptable to a client-principal who is not concerned about the final cost of the project.

As the risk of the final price is allocated to the principal, a builder may be incentivised to propose a cost-plus arrangement by the reassurance that they will have their actual costs covered and will also achieve their desired profit on the project, or they want to avoid taking on the risk of the cost and cost increases in delivering the project.

In an economic environment where there is an elevated risk of insolvency of the builder, entering into a cost-plus contract presents higher project and financial risk to the principal.

Whether to use a cost-plus contract will depend on careful consideration and balancing the appropriate allocation of the risk of the final cost of the works. In considering whether to use a cost-plus contract, the architect and client should consider the following matters:

• There is no commonly-accepted standard form cost-plus contract for use in domestic/home building works. The client should get legal advice to prepare a suitable and compliant cost-plus contract.
• In some states and territories the cost-plus contract form does not comply with domestic building contracts legislation and special conditions must be included for domestic works. In others, the cost-plus contract may only be used on projects where the anticipated cost of works is above a legislated threshold—typically for high-value domestic projects. Your client must have these prepared by a lawyer.
• Architects should not recommend such a contract form for domestic work in jurisdictions where the cost-plus contract form is prohibited. If the architect recommends a non-compliant contract to their client, this may amount to professional negligence or improperly giving legal advice. In most domestic building legislation, the prohibitions on using cost-plus contracts falls on the builder to ensure they don’t offer a non-compliant contract to an owner-client.
• The client-as-principal takes on the risk of the final cost of the project and under a cost-plus contract this final price can be substantial and is typically not capped nor are there any contractual cost controls on the price.
• It can be more difficult to secure finance from leading Australian banks and lenders for domestic or home building works using a cost-plus contract. Some banks may decline to finance works to be built on a cost-plus basis.
• The contractor has no incentive to complete on time; though a well-written cost-plus contract will still obligate the contractor to bring the works to practical or final completion by a specified time.
• The contractor has no incentive to be efficient.
• The contract should secure a prudent level of financial security (cash retention or bank guarantee) from the contractor to the principal to ensure that the contractor has an incentive to perform the works and to rectify defects made by the contractor and to complete any incomplete work.
• There is no guarantee that the materials claimed to have been used have all been built into the works, or that all the wages for labour claimed have worked on the job.
• The client should engage a professional to either be on site most of the time to act as a clerk of works or otherwise superintend the works.
• Depending on the form of cost-plus contract, the architect may not have a role to administer the contract and the contractor takes on this role. This provides for weak accountability on the contractor to ensure that the costs plus margin that is claimed reflects actual costs of works actually carried out.
• Even if the architect administers the contract on behalf of the client-as-principal, the administration of the contract is much more arduous because of the need to closely examine large amounts of documentation which need to substantiate the actual costs claimed, as well as the various components of the margin (which are mostly documents internal to the contractor’s business). This typically increases the contract administration time above that required on an equivalent lump-sum contract, and your fees should include an allowance for this additional administrative work.
• Because the final cost for the project is not stated or quantified at the outset of the project, it is inevitable that the cost of works will increase during the project and the principal should assume that the cost of the completed project cost will greatly exceed the initial budget or any forecast or estimate that was made prior to the contract.
• Cost-plus contracts feature in negligence claims against architects related to project-cost overruns.

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ABIC Cost Plus Contract

If you have a non-domestic project which might be suitable for a cost-plus scope and payment arrangement, your client might consider using the ABIC Commercial Cost Plus (CP-2014 C) contract.

The Cost Plus CP-2014 C contract was not developed and is not warranted for use on domestic projects. State and territory legislation limits or prohibits the use of cost-plus contracts for domestic projects either outright, or if the estimated cost of the domestic project is below the threshold stated in the legislation.

As a practical consideration, these thresholds for using cost-plus contracts on domestic projects aren’t subject to indexing to reflect real-world cost increases. With recent rises in the cost of labour and materials, the cost of a typical domestic build or renovation project is more likely to come in above these thresholds. This may also explain the current trend of builders seeking to negotiate a cost-plus contract for domestic projects.

You should recommend that your client obtains legal advice about whether the cost-plus contract is suitable for their project. If your client intends to use this contract for a domestic project, they should get legal advice on whether and how they could adapt the CP-2014 C contract for that project.

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