A cost-plus contract arrangement can be a sweet deal for a construction company, be it general contractor or subcontractor. For the contractor who might have otherwise miscalculated total costs for a project, there is no lump-sum dead end waiting ahead.

And for owners, it offers a chance for transparency and the opportunity to see all the receipts and invoices for material, equipment labor and overhead charged to their projects. However, as with most contracts, success relies greatly on the experience and intention of the two parties.

Inside a cost-plus contract approach

When a contractor performs under a cost-plus contract, the owner pays the contractor all the costs of construction plus a fee. That fee typically is either a percentage of construction costs or a fixed fee, the latter of which can be used by the owner when there are fears that the contractor will try to drive up costs. Cost-plus contracts also come with either a guaranteed maximum price or no cap on spending.  

However, there are are also variations on these major forms of cost-plus arrangements that can further aid in tweaking the owner-contractor relationship. For example, there might be a cap on costs for a main structure but none on the excavation work if there are unknowns regarding soil or questions as to whether there is rock below the surface.

Benefits of cost-plus for contractors

There are clear advantages to a cost-plus arrangement for contractors, particularly when the job isn’t clearly defined at the outset, according to legal experts. Steven B. Lesser, shareholder and chair of the construction law and litigation practice at Becker & Poliakoff in Florida, said the big upside for contractors is the fact that cost-plus eliminates many of the potential liabilities created by "what if" scenarios.

"If (the contractor) makes a mistake and gives (the owner) a stipulated sum price and then can't meet it, the contractor could incur a loss," Lesser said. The costs are built into a fixed-price contract, so if material prices go up or there are other unforeseen expenses, barring a change order, the contractor has "no place to go" in an effort to recoup overruns, he noted. Therefore, Lesser said a cost-plus contract keeps the contractor from getting "boxed into a position where he's going to lose money."

Advantages for owners

A cost-plus contract can also provide the owner with opportunities for savings, even though the bidding process involved with lump-sum contracts typically results in lower costs to the owner, according to attorney Margaret Greene, partner and leader of the construction planning practice group at Honigman Miller Schwartz and Cohn in Detroit.

So if the owner can get the project done for less with a fixed-price contract, why bother with cost-plus at all? Greene said one reason that owners might not want to go through the process of getting competitive bids is because they might have a good prior working relationship with a contractor and trust that company to successfully manage the project. 

Owners might also opt for a cost-plus contract when they want the contractor to be a part of the design process, often as the cost-aware "silent partner." The contractor, Greene said, can lend a professional eye, complete with cost estimates, to proposed design features as soon as the architect generates them. For this service, she said, the owner might be willing to pay a little more for the overall project.

"The price will be higher," Greene said, "but the owner can say, 'Give me the worst case as a guaranteed maximum price,' knowing he will only pay (a lesser) cost." With a knowledgeable contractor at their side, owners can even gain valuable insight regarding whether to move forward with the project at all.

In addition, Lesser said cost-plus contracts come in handy when — because of potential deadlines with permits or financing — the project needs to get underway immediately without a full set of plans and specifications. "If there's a rush to get something done, it's the only feasible way to go," he said.

Potential downsides to the cost-plus approach

Of course, there are drawbacks to any type of contract, and the cost-plus relationship is no exception. For owners, there is the danger of out-of-control spending if they don't have knowledgeable staff to monitor construction. For contractors, the potential negatives include the interference of an owner who doesn't understand the construction process and the possibility of that person taking a peek into their books with an uneducated eye.

"For the unsophisticated owner, (a cost-plus contract) can be a disaster," Lesser said. "If the owner doesn't have the staff to view every sheet of paper, he's going to get killed." Lesser added that the cost-plus concept can yield positive results for the owner, particularly if the owner was involved in negotiating subcontractor or other prices.

Lesser emphasized that one contract item the owner needs to pay special attention to is audit rights. A standard American Institute of Architects cost-plus contract establishes that the contractor has a fiduciary duty and that the owner has some rights of audit, Lesser said.

An owner needs to expand those contractual rights because sometimes even the threat of an audit might be enough to keep the contractor and subs on the straight and narrow. A smart and reasonable owner, Lesser said, will hire someone knowledgeable about construction to handle the project and its accompanying paperwork. 

The owner of a one-time or first commercial project might think that because they built their own house and dealt with an architect in the past, they can achieve the same results in an office building or some other nonresidential endeavor. "They think it all should be logical," Lesser said.

And a savvy owner, or at least owner's representative, benefits the contractor as well, according to Anthony Sierra, president of construction company JP Sierra in Tampa, FL. "A novice owner can complicate the job very easily," he said. In the worst-case scenario, someone who is as aggressive in questioning the contractors, subcontractors and vendors about expenditures and methods when they are inexperienced can "create a war" on the job site with contractors feeling harassed, Sierra said.

How to create a 'beneficial process'

Sierra said the solution is for the owner and contractor to pitch in and split the cost for a neutral third party to review billings, track costs and make sure the job runs smoothly. "Any other way, and there's too many places on the owner's side where he can beat you up, and the general contractor can inflate his costs as well," Sierra said.

Lesser added that a cost-plus contract in which the owner and contractor work together in the "spirit of collaboration" is always the best-case scenario. Parties that are able to enter into an agreement, sit at the table together, negotiate with subs, conduct value engineering and then split savings can enjoy a "very beneficial process," he said.

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