By Janeia L. Brounson and Carl R. Pebworth of Faegre Drinker Biddle & Reath LLP
Published June 24, 2020
With the uncertainty of COVID-19 impacting construction projects in new and unfamiliar ways, choosing the right construction contract format has never been more important. A cost-plus contract—also known as a cost-reimbursement contract—can offer an attractive project format in the current construction environment. Defining project costs and expense using projected and agreed upon costs can be particularly attractive for both owners and contractors in roiling social and economic circumstances.
A cost-plus contract requires the owner’s consent to pay the complete cost for material and labor in addition to the amount for contractor overhead and profit. Cost-plus contracts fall in two basic categories: cost-plus fixed fee contracts and cost-plus fixed fee agreements with guaranteed maximum price. In a cost-plus fixed fee contract, compensation is based on a fixed sum independent of the final project cost. The owner agrees to reimburse the contractor's actual costs, regardless of amount, and, in addition, pay a negotiated fee independent of the amount of the actual costs. In a cost-plus fixed fee with guaranteed maximum price contract, compensation is based on a fix sum of money and the total project cost will not exceed an agreed upon upper limit.
Cost-plus contracts allow the contractor to be reimbursed for almost every expense incurred in a project. The cost-plus contract pays the contractor for direct costs (such as labor, materials, supplies and equipment) and overhead costs or indirect costs (such as business-related expenses) that are necessary to perform the contract. The contractor is also entitled to a pre-negotiated amount above the reimbursed amount considered a fee or profit.
Cost-plus contracts present several advantages on a construction project. Generally speaking, the contractor can focus on the quality of the project instead of the overall cost. Contractors can be less likely to cut corners or to use less expensive materials because the costs will be reimbursed. Cost-plus contracts also cover all expenses related to the project so there are no surprises. With this in mind, the risk is shifted from the contractor to the owner because all expenses are likely to be covered.
There are also disadvantages with a cost-plus contract format. Final costs cannot always be determined. Cost-plus contracts require that contractors reproduce and justify all related costs, which can be burdensome and time consuming. Disputes regarding expenses can also arise where a contractor feels a cost is justified while owner does not.
With stay-at-home orders, infection risks at job-sites, and project delays in the age of COVID-19, owners may want to negotiate a project cost cap or limit, and a contractor may find comfort in knowing that expenses will be covered. Under those circumstances, cost-plus contracts offer a comparatively safe and assuring construction format.
This article summarizes content from Bruner & O'Connor on Construction Law. For more information on this topic, or for additional citations, see § 2.23
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Janeia L. Brounson is an Associate with Faegre Drinker. She is a strategic adviser to businesses eyeing ambitious construction and real estate projects. She primarily supports clients on the contract side, working to draft and negotiate legally and financially sound agreements. She can be reached at janeia.brounson@faegredrinker.com or 317.237.1356.
Carl R. Pebworth is a Partner with Faegre Drinker. He represents clients in disputes and risk management involving real property and construction. A skilled litigator, he is adept at proactive risk management, early case assessment, motions practice, negotiating settlements, and successfully winning trials and appeals on behalf of clients. He can be reached at carl.pebworth@faegredrinker.com or 317.237.1267.