What is a Cost-Plus Contract?
Sometimes called a cost reimbursement contract, the cost-plus contract is a legal agreement that allows a contractor to be paid in full for all expenses allowed by the terms of the contract, up to a set limit that is defined in the terms and conditions. In addition, the contractor may also receive additional compensation that will ensure that a profit is made on the job. There are several variations on this type of contract in common use today.
The provisions of the cost-plus contract are different from those associated with the fixed-price contract. With the latter, the contractor commits to only charging a specific amount for the job covered by the terms and conditions outlined in the agreement. Should the actual expenses exceed the costs associated with fulfilling the obligation made in the agreement, the contractor cannot pass those costs on to the client. Instead, the contractor must absorb those costs, which may result in a net loss on the project.
Four common variations of the cost-plus contract are used today. The cost plus fixed fee contract allows the contractor to collect a fixed amount of compensation at a specified time during the project. Additional expenses and fees are billed at a later date.
The cost-plus-incentive fee contract is another form of the cost-plus contract that can sometimes be to the advantage of the client. With this arrangement, the contractor receives a higher fee for saving money on materials or labor associated with fulfilling the terms of the agreement. However, the larger fee can sometimes offset the savings.
A cost plus award fee arrangement is a type of cost-plus contract that will award a bonus if the contractor demonstrates performance that is considered to be above the terms of the contract. The awarding of this fee is usually left to a third party, such as a review board. Cost-plus contract arrangements of this type are much more common when contracting work for companies and government agencies, but rarely used for residential construction, such as home building or renovations.
One final variation of the cost-plus contract is known as the cost-plus-percentage of cost agreement. Essentially, this type of contract makes it possible for the contractor to adjust charges for materials upward in the event that the market price for those materials increases. This is one of the least favorable forms of the cost-plus agreement, since it provides no incentive at all for the contractor to keep expenses within the range originally defined in the agreement.
Many individuals and businesses prefer to go with a fixed-price contract, simply because there is more control on the part of the client. Cost-plus contracts generally do not provide any motivation for the contractor to monitor costs closely. However, if quality rather than price is the main objective of the client, a cost-plus construction contract is likely to be the best option.
@CaithnessCC - I don't think the second payment of expenses would be much of a surprise. Rather it is a way of splitting the plus part of the fee, essentially the profit, into two stages. This is useful for the contractor because they get some cashflow, and for the client as they can stagger outlay.
Are there any particular advantages to using the cost plus fixed fee option? It sounds as if there wouldn't be much control over the second wave of expenses a builder could present you with.
From my experience of cost plus contracts in the construction industry I'd say they can be as tricky for the contractors as for the client.
Inexperienced folk may see them as potential money makers but not put enough thought into what percentage they need to add to the basic costs. It's easy to overlook something and then find the profit you expected has dwindled.
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