Using a Cost-Plus Contract? Here’s How to Avoid Litigation

There are a number of different  construction contracts used by general contractors. The differences in the contract are usually predicated on the type of project and the obligations of the parties. One construction contract that has become popular is the cost-plus contract.

In a cost-plus contract, the buyer pays the contractor for the cost of the materials and labor used to complete the project. A contractor’s fee is also charged to the buyer or developer on top of the costs and is usually calculated as a percentage of the total amount of the labor and materials. For example, if a home cost $100,000.00 to build. The general contractor may elect to charge a fee of 10% of cost and bring the total price of the project to $110,000.00.

As you can see, in a typical cost-plus contract, the more expensive the project the more money the general contractor makes.  It is for this reason that buyers and developers are becoming less comfortable with these agreements and more cost-plus contracts are becoming the subject of litigation. Contractors using these contracts needs to be prepared to litigate them and this is not always an easy task.

In cost-plus contract litigation, the developer typically alleges that the contractor reported inflated costs to inflate its fee or the contractor failed to act as a reasonable contractor in controlling cost on the project. A contractor can place themselves in a position to contest these allegations by following a few simple rules.

Get Approval

One way to be proactive and create a defense to allegations of cost inflation or failure to control costs is to require written approval from the developer or buyer for anything on the project that is more expensive than originally estimated. Make sure that the developer acknowledges that there is an increase in cost; that they have seen reasonable documentation confirming the increase in costs; that they do not want the contractor to seek a less expensive alternative; and they approve the work to be performed despite the increase in cost. This will make it very difficult for a developer or buyer to allege a lack of effort in controlling costs.

Explain Your Actions In Detail

It is important that contractors remember that buyers, developers, and contractors are sometimes on different frequencies. The buyer is simply looking to keep costs down so that they can get a good deal on the property and the developer is looking to keep costs down to increase profit margins when the property is sold.  Meanwhile, the contractor must concern its self with warranties and the meeting of certain statutory regulations because ultimately it is the contractor that will be liable for violating the law. Due to the need to comply with certain regulations and provide the best overall product, sometimes the contractor may elect to take an action that increases costs. In this scenario the costs should been agreed to by the developer. It is also important to explain to the developer why costs are increasing.

For example, assume a residential property is being built in an area and the price of the project is estimated at $5,000,000.00 with $500,000.00 allocated to the foundation. After running some tests, the general contractor realizes that the soil makes the home more prone foundational problems and as a result, it wishes to use the best foundation firm in town at a price of $250,000.00 more than the original foundation estimate. A simple written explanation to the owner and a written acknowledgment of the owner’s understanding would be very helpful in a litigation situation.

Be Diligent In Your Accounting

In a claim of fraud against a contractor due to an allegation of falsely reporting costs on a project, the easiest way to defeat the claim is to keep accurate accounting figures and maintain strict documentation to support the numbers. When working on a cost-plus contract, all receipts, check copies, invoices, and related documents should be filed and well maintained. Your ability to be completely transparent with the buyer or developer will help keep you from being a party to a fraud claim.

Nothing here is intended to be legal advice. If you are facing a construction issue and need representation information, visit our website http://www.StephensBell.com; call 832 930 0529; or email us at info@stephensbell.com

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