Cost-of-the-work agreements (aka “cost-plus” contracts) are commonly used in commercial construction contracting to establish the terms and conditions for a project based on the cost of the work performed.[i] The major families of standard construction contracts include a cost-of-the-work plus overhead and profit in their product offerings. Material supplies from China are already facing new increased tariffs and tariffs on products from Mexico and Canada which were announced are currently on pause (not withdrawn).
In light of the disruptive nature and uncertainty tariffs cause, cost-of-work agreements are a great solution to combat this uncertainty. Cost-plus contracts help address price uncertainty. Today’s hot-button topic, tariffs, is the subject of an upcoming AGC webinar that will take a deep dive into tariffs on February 27 (more info here), and ConsensusDocs has a tariffs and price escalation center, which you can find here.
Cost-of-the-Work Agreements
In a cost-of-the-work agreement, the owner pays for project costs, including labor, equipment, and materials, plus a fee to the builder. Some call these agreements “cost-plus” contracts. The fee can be fixed/predetermined, based upon the estimated cost of the work or a percentage of the total project cost actually incurred during construction. The fee typically includes the builder’s profit, and sometimes the fee delineates how much is for overhead and how much is for profit. Other times, the fee is just one amount. The advantage of a fixed/predetermined fee in cost-plus contracts is that there is no incentive (or appearance of incentive) to increase the overall project costs during construction to correspondingly increase a builder’s fee and profit.
ConsensusDocs offers cost-of-the-work agreements without a GMP: ConsensusDocs 235 and 510 and cost-of-the-work agreements with a GMP: ConsensusDocs 230 and 500.
Determining the Cost-of-the-Work
Determining what is included as a cost-of-the-work might seem straightforward, but often some costs fall into grey areas that are difficult to define. Choosing a cost-of-the-work agreement causes additional record-keeping and administrative burdens on the builder that can be burdensome for smaller construction projects.[ii] The owner is more likely to have auditing rights to protect themselves. It is important to contractually define what is and is not included in cost-of-the-work items. A contract should define direct and indirect costs for a project. Generally, specific project costs, including home office personnel assigned directly to the project, are considered direct costs. Within direct costs, some costs are fixed and not time-sensitive, and other direct costs are variable and time-sensitive. For instance, rental items are variable costs because the longer a project uses them, the more cost a project will incur. An owner will want to ensure that rental costs don’t exceed the fair market price of the equipment being rented. Subsection 8.2.8 of the ConsensusDocs 500 caps rental charges up to 85% of the fair market value of the equipment, and the Bluebook is the source to determine fair market value.
Advantages of A Cost-of-the-Work
Projects utilizing a cost-of-the-work payment better address unpredictable price fluctuations than lump sum agreements. If material prices increase or decrease, costs and payments adjust accordingly using a cost-of-the-work approach. Considering price escalation caused by tariffs, inflation, as well as supply chain disruptions, owners and builders and owners are more likely to purchase supplies earlier and seek early buy-out of subcontracting packages as soon as feasible so that prices and the availability of materials are locked in. When suppliers or specialty contractors are prepurchasing and storing materials, consider using the ConsensusDocs 750.1 Rider for Material Storage at Subcontractor’s Site.
Setting the GMP (To GMP or Not to GMP?)
Many cost-of-the-work agreements set a guaranteed maximum price (GMP) on a project. Without a GMP, the risk for cost a project cost overrun falls on the owner. Conversely, once actual costs exceed the GMP, the builder absorbs those additional costs. The risk in CM at-risk is typically viewed as the risk of meeting the GMP. When and how aggressively to set the GMP is hotly debated. The risk profile of a project with a GMP is higher than a project without a GMP. To this end, the amount of fees and contingency a builder seeks under a GMP contract should account for that risk. Cost-of-the-work agreements without a GMP have experienced greater acceptance in markets and projects with the greatest amount of uncertainty.
Conclusion
Cost-of-the-work agreements offer an effective contracting tactic to address uncertainty in construction caused by tariffs, Covid-19, and whatever unpredictable event might be coming next. When and whether a GMP is set will depend on project-specific facts and the parties’ preferences. Carefully defining and determining cost-of-the-work items in your contacts is critical, and there are standard construction contracts that can help you do so. The more uncertainty and earlier a GMP is set, the more it will increase builders’ pricing.
If you have questions or comments about this article, contact Brian Perlberg, ConsensusDocs Executive Director & Senior Counsel at brian.perlberg@agc.org.
[i] https://constructionexec.com/article/lump-sum-general-conditions-in-cost-plus-commercial-construction-contracting.
[ii] https://www.americanbar.org/groups/construction_industry/publications/under_construction/2018/spring/cost-plus-contract-agreement/.