Cost-plus construction contracts are common. Also known as cost-reimbursable or time-and-material contracts, they are often used when unknowns and uncertainties make it difficult to lock in a firm price upfront. The underlying notion is simple: rather than a fixed, predetermined price, the client pays the contractor’s actual costs for performing the work, as incurred, plus an agreed amount for overhead and profit. If the contractor spends a buck, he gets paid that buck plus some change.
When debating the merits of cost-plus contracts, shock, delight and befuddlement all take their turn. To some, this sounds like sending the contractor on a shopping spree, with the client picking up the tab. The more the contractor spends, the more he earns. Wheeee!
Whether stated in the contract or not, Canadian law accepts that a client should only pay the contractor’s reasonable costs.
To others, it’s a mature model for controlling contingencies and allocating risks, particularly where the design is evolving, the scope is unclear or the working conditions are uncertain. Rather than thick layers padding the bid to protect against potential problems (which may or may not happen), the parties deal with them only if and when they arise. Tight controls, good discipline and strong oversight keep things in line.
Depending on which side of the contract you are on, this might sound pretty darned terrific or downright terrifying. But regardless of where you stand, a cost-plus contract is not a blank cheque.
It starts with the contract itself. The contract sets out the scope and specifications, which define the work. It goes without saying that the contractor only gets paid for performing that work, and nothing else.
More importantly, the contract will likely set the standard the contractor must meet when performing the work. For example, it might say the contractor “is to exercise the standard of care, skill, judgement and diligence of a prudent contractor acting expeditiously.” Measured against this standard, the contractor won’t get paid for unskilled work, bad judgement or foot dragging.
Even more important, there is an overarching principle that a contractor must act reasonably. Whether stated in the contract or not, Canadian law accepts that a client should only pay the contractor’s reasonable costs. To quote from Halsbury’s Laws of Canada, a standard Canadian legal reference.
Since the contractor under such a regime benefits from higher costs, courts in Canada and elsewhere have implied a duty to prevent wasteful or uneconomic use of labour and/or materials in carrying out the work. Under a cost-plus contract the contractor may only recover the reasonable costs of carrying out the work as a result of reasonable competence and economy. The onus is on the contractor to prove the reasonableness of its costs and support some expenses with proper auditable records.
Putting it all together, there is an implied term in cost-plus contracts that the contractor will recover only those specified costs that he reasonably insures in performing the work to the standard specified in the contract. The client, on the other hand, need not pay costs that are unreasonable, or those that the contractor incurs because he failed to meet the specified standard of skill, judgement or diligence.
This sounds good in theory, but how do you tell if a contractor has been inefficient, unproductive or otherwise acted unreasonably?
Sometimes it’s glaringly obvious. If, for example, a contractor uses 20 men with shovels for a week to dig a hole, rather than a backhoe for an hour, the extra cost is likely unreasonable. Similarly, significant rework or repairs caused by unskillful or inattentive work will likely miss the mark.
More often, however, the analysis is more complex. While budgets and estimates don’t bind the parties (after all, that’s the whole point of a cost-plus contract), if a contractor blows through pre-construction budgets and comes in with final costs that are significantly higher, he will have some explaining to do.
The contractor will then have to justify the higher costs. It might be weather delays, unexpected winter work or interference by others. It could be unknown site conditions, scope growth or other factors outside the contractor’s control. But if not, poor performance and inefficiency might be the answer.
One might then dig into scheduling, sequencing and labour loading. Were critical path items executed in the right order in a timely fashion? Were enough workers, equipment and materials available at the right times? Was there high turnover and poor productivity?
Needless to say, arguing about whether costs are reasonable can get messy. But the principle remains: a cost-plus contract is not a blank cheque.