A cost plus contract is a contract where the builder is paid the cost of the works plus a margin over and above the cost.
Cost plus (CP) contracts are entered into where the contracting parties have formed a view that it will not be possible to generate a fixed price for the building works. Sometimes, people enter into CP contracts because they think that it may be cheaper than fixed price. Another paradigm is where a builder has gone into liquidation, the project is half completed and it is nigh on impossible to fix the price, absent a hefty risk buffer being factored into the fixed price.
It is ironic that consumer legislation like the Domestic Building Contracts Act in Victoria is heavily geared around regulations that stress the importance of fixed price, fixed term contracts. The consumer protection thesis that is supposed to underpin this Act of Parliament, however, is undermined by regulations that permit CP contracting.
One of our lawyers recalls a well-known tribunal mediator from a Domestic Building List opining that “she hated cost plus contracts.” Those are strong emotions, and it’s a pretty strong indictment, but I can understand the sentiments. These contracts neither provide cost certainty nor provide completion date certainty. In fact, they provide anything but certainty.
So is it any wonder CP contracts frequently go off the rails and end up in litigation because the costs have a tendency to blow out?
It is interesting to examine the restrictions on CP contracts under the DBCA, which states that a builder can’t enter into a CP contact unless “it is not possible to calculate the cost of a substantial part of the work without carrying out some domestic building work” or the value of the work is more than $500,000. The builder also can’t enter into a CP contract unless he or she provides a fair and reasonable estimate for the cost of the works.
Note the term “estimate,” which is a very distant cousin of a fixed price. An estimate typically provides wiggle room so that if the as-built spend exceeds the estimate, the builder will be entitled to the additional spend. Conversely, if the as-built spend comes in under the estimate, the owner won’t have to pay the estimate; he or she will only have to pay the cost.
CP contracts generally have provisions that dictate that the contractor has to justify and prove the spend. This means the owner is entitled to ask for, and indeed in a court of law, compel the builder to produce invoices that verify that that which has been spent has in fact been spent (and, I might add, legitimately spent.)
The process has to be transparent. One area that is always very very murky is proving how much labor was deployed on a job; it is one thing to contend that 1,000 of labor was clocked up, it is another thing to prove it. Furthermore, were a contractor to be inclined to inflate the hours in circumstances where there was some economy with the truth, it could prove to be very difficult to refute the figures evidentially. When put to the test, hours spent on the job don’t necessarily add up. It follows that if there is a disagreement about the spend, sometimes the only way one can extract the truth is via cross examination. The difficulty with this is that by the time a matter gets to trial, it will have cost owner and builder alike plenty, so it is best to ensure that the matter doesn’t get to trial and a deal is cut at mediation.
In CP disputes the process of discovery is critical
Builders operating under CP have to be fanatical about the records they keep for expenditure. If they don’t keep a record of all invoices and expenditures and there are expenditure holes, the owner will be entitled to ask the question. It follows that if a CP dispute is litigated, discovery is critical. Discovery is a process where all documents relating to the project have to be compiled and recorded in an affidavit of documents, after which the parties are at liberty to inspect them. Discovery is one of the most time consuming and costly litigation junctures.
Once discovery has been completed, a financial reckoning has to occur which entails marrying every invoice with the addition function in the calculator to generate a financial reconciliation.
We had one matter, a Canberra case where the builder’s solicitor refused to discover all of the builder’s documents and proceedings had to be issued to compel discovery in the Supreme Court. Once the information was discovered, transparency finally materialised and some nine days were then consumed in a negotiation where solicitors and clients tediously ferreted their way through literally hundreds of documents to prove the as-built spend. The case settled, but the road to settlement was cumbersome and very, very costly. Alas, that is the nature of cost plus disputes.
The take out is this: be loath to enter into a CP contract. Although they are stacked in favour of builders on account of the lack of price certainty, this ostensible benefit to the builder is the very thing that gives rise to disputes, and that’s in no one’s interest. Furthermore, CP contracting does not sit comfortably in building regulation that purports to protect consumers. Policy makers should give serious consideration to banning these contracts outright.