What is a Cost Plus Contract? Learn About Its Features, Benefits, Disadvantages, and More!

The cost plus contract is a written instrument used in construction to secure reimbursement for construction project costs after completion, along with the contractor’s profit margin. Cost refers to the price of completing a build, while plus accounts for the fee charged by the service provider to do the construction. 

To learn about other crucial aspects of this specific construction agreement, continue to read the article below. From how it works, negotiation techniques, terminology, features, benefits, and disadvantages to the importance of a contract management platform, learn everything you must know to make an informed decision.  

How Does a Cost Plus Contract Work?

Talking about how it works, the contractor first communicates the expenses with the project owner by providing bills, invoices, and other evidence of expenditure. Second, the project owner cross-checks such receipts. Third, the reimbursement is made to the contractor along with service charges (profits). The following is a brief elaboration of each of the key components.    

Cost Determination

There are two primary types of costs associated with the construction process: direct costs and indirect costs. Direct costs include expenses associated with labor, equipment, materials, etc. Indirect costs account for the other aspects of expenditure, such as administration, maintenance, insurance, permits, legal compliance, utilities, etc. All such costs are calculated and determined with payment receipts.   

Fee Determination

Fees or the profit margin of a contractor can be determined by any of the following methods: fixed fee, percentage of cost, and incentive fee. In the first technique, a fixed amount of money is paid. Secondly, a percentage of the total actual cost of construction is paid as the profit margin. Finally, in the third method, a fixed amount of money is paid as the fee, along with extra incentives for quality work or efficient management.    

Payment

In order to get the actual cost of a construction project reimbursed, the contractor has to provide all the bills and invoices as evidence. The markup can be paid along with the cost reimbursement or separately.    

Note: Contingency is a crucial part of the construction process. Thus, a cost plus construction contract might provide for the same. However, it is subject to the inclusion of a specific clause, dedicated to the same, in the contract. If no section accounts for unforeseen events and consequent increases in financial needs, a contractor must talk to the project owner instantly. 

Learn More: What is RFI in Construction? A Naive-Friendly Guide

How to Negotiate a Cost Plus Contract?

While negotiating a cost plus contractor agreement in construction, the concerned parties must take care of certain key aspects carefully. The process requires active and intelligent participation from each stakeholder equally. Some points to facilitate effective interactions are mentioned below.  

1. Be specific when it comes to what costs are to be covered and what aren’t. However, there will always be scope for overruns. 

2. Establish change orders, as they help deal with changes to the project scope effectively throughout the actual construction.

3. Maintain detailed documentation to keep track of all expenses with legitimate receipts or invoices. 

4. Determine a fee payment method after adequate consideration. Don’t rush, as it will be impossible to change this part once the agreement has been reduced to writing, set up, and signed.

5. Create a dispute resolution system in advance for a proactive approach to fix potential issues.   

6. Factor in likely risks and emergencies, so as to avoid future hassle and speed up the construction of the project.  

Negotiating a cost reimbursement agreement is an art as much as it is a scientific approach. Hence, mastering it requires time and consistent effort. If you find it overwhelming to go about bargaining, connect with an expert and get real insights. 

Crucial Terms Used in a Cost Plus Contract

The major terms used in cost plus contracts are contractor, project owner, scope of work, costs, direct costs, indirect costs, reimbursement, fee structure, payment terms, completion timeline, change orders, quality control, risk management, termination clauses, and dispute resolution. Consider the following, as each term is described briefly. 

1. Contractor: The professional who provides construction services is referred to as a contractor or a developer. 

2. Project Owner: The one who hires a general contractor to complete the site construction is called the project or property owner. 

3. Scope of work: This term refers to a breakdown of the project into actionable and viable steps or tasks by a contractor. 

4. Costs: A cost, also known as a construction cost, is an expense incurred during a build. 

5. Direct Costs: Expenses related to items that are directly connected with the actual construction process, such as labor, materials, equipment, etc., are put under the head of direct costs. 

6. Indirect Costs: Costs related to things such as permits, legal compliance, safety measures, utilities, insurance, risk management, etc., are called indirect costs. 

7. Reimbursement: The payment of all the costs incurred by the contractor after the completion of a construction project. 

8. Fee Structure: It specifies how much fee is to be paid to the contractor for construction-related services. 

9. Payment Terms: Rules related to when and how the fee and incurred costs are to be paid by the project owner to a contractor are specified under this head. 

10. Timeline and Completion: Clauses under this part of the contract specify various stages of a project’s completion and ultimately by when it is expected to be completed in its entirety. 

11. Change Orders: These are rules agreed upon mutually between both parties to the cost plus contract with respect to handling possible changes in the project scope later, anytime after the pre-construction phase.  

12. Quality Control: Part of this head, certain clauses ensure in the agreement that the project is completed as per the terms of the construction documents. 

13. Risk Management: All the rules and coping mechanisms with respect to unforeseen events during construction and the related rise in costs are discussed here. 

14. Termination Clauses: Such sections account for events upon whose realisation, the terms of the contract become ineffective and no longer bind the parties. For example, not ensuring compliance and thus causing unwanted delays might cause such efforts. 

15. Dispute Resolution: Agreed-upon ways to handle potential disputes in construction are called dispute resolution. 

This has been a very flexible and brief explanation of crucial components of a cost plus contract. For more, you can conduct your own research independently of this article. Or, to build a strong base, read this resource: General Conditions of Contract: Complete Guide with Meaning, Types & Examples. 

What are the Key Features of a Cost Plus Contract? 

Being part of the cost reimbursement mechanism, the cost plus construction contract exhibits various features. Major ones are highlighted below to facilitate better understanding. 

1. Payment of Incurred Costs: With the help of this written statement, reimbursement of construction costs is done on time, saving both parties to the contract time, money, and effort. 

2. Profit: The contractor’s markup is paid along with the reimbursement or separately. 

3. Cost Bifurcation: Cost plus construction contracts also include the cost bifurcation, dividing all the expenses into direct, indirect, and contingency/emergency/unexpected. 

4. Transparency & Documentation: Cost plus agreements promote transparency by ensuring detailed documentation of expenses throughout the building of a project. 

5. Flexibility: When a project’s scope cannot be well-defined before the actual start of the construction, it is best to set up a written promise that all the costs will be paid upon the conclusion of the construction. 

6. Risk Allocation: It is very common in construction to encounter an unexpected increase in the need for finance and resources. Thus, this contract helps a developer shift such burdens to the client, as they are responsible for covering cost overruns, if not stated otherwise. 

Conflict management, alternatively known as dispute resolution, is also a major part of such liability contracts. This section contains provisions for coping with all the issues that might crop up while building.  

What are the Different Types of Cost Plus Contracts? 

The four major types of cost plus construction contracts are cost-plus fixed pricing (CPFF), cost-plus incentive fee (CPIF), cost-plus award fee (CPAF), and cost plus percentage of cost (CPPC). Let’s understand what these are: 

1. Cost-Plus Fixed Fee (CPFF): All project costs are paid along with a fixed fee as determined before the start of the building. 

2. Cost-Plus Incentive Fee (CPIF): The reimbursement doesn’t just account for all expenses and service charges, but incentives as well that are offered to a contractor in response to quality work or extra value added.   

3. Cost-Plus Award Fee (CPAF): Getting exceptionally inspired by the work of a contractor, the owner of the property might offer an award to the developer, based on subject analysis, giving rise to this particular variation. 

4. Cost-Plus Percentage of Cost (CPPC): All the allowable costs are reimbursed to the contractor along with a fee that is calculated as a certain percentage of such costs in totality. 

Contractors and owners can negotiate and decide on any of these available variations to maximize their results and profits. 

What are the Major Benefits of a Cost Plus Contract? 

The cost plus building contract is important for the timely payment of all costs that have already been incurred in construction. As a result, it is a great tool for a builder to manage risks inherent in every type of development, especially projects with no fixed scope.   

For project owners, cost plus contracts help ensure advantages such as lower bids, early start, and transparency in the process. And, for contractors, there are benefits like reduced risk, high flexibility, and quality focus. Consider the table below.   

Advantages of Cost Plus Contracts

For Project Owners	For Contractors
Lower Bids: With reimbursement guaranteed, contractors offer competitive bids, leading to reduced cost of development in the end.	Reduced Risk: Clients are also responsible for the reimbursement of cost overruns.
Early start: Contractors can begin construction without worry, as all costs are contracted to be covered later after the build.	High Flexibility: Contractors can better manage projects with evolving scopes and changing requirements.
Transparency: Before paying back, the owner is informed of all the expenses with proof, which results in authenticity and collaboration.	Quality Focus: Now, a builder doesn’t have to work on maximizing the profit margin by cutting down on costs, ultimately shifting the focus from minimizing costs to ensuring quality work.

In addition, clear documentation of all incurred costs promotes transparency, trust, and collaboration so that there are no disputes and all the claims and liabilities are settled by the project owner as soon as possible. 

Also Read: Get a General Construction License in California

What are the Disadvantages of a Cost Plus Contract? 

Although the cost plus contract construction has several important advantages, there are some drawbacks as well. Consider the following negatives associated with the drafting of this contract.  

Downsides of Cost Plus Contracts

Owners	Contractors
Uncertainty: The actual amount of construction cost is never known, even though pre-construction estimates are made.	Reimbursable Criterion: Not all expenses are to be reimbursed.
Need for a Trustworthy Contractor: Otherwise, a builder might want to increase actual costs on paper so as to boost profit markup.	Vast Documentation: It might turn out to be an unmanageable task to keep track of and maintain a record in writing of all incurred costs.
Audit Requirement: Overwhelming, tedious, and even impossible, but checking receipts for authenticity is a must before making payments to a contractor.

Provisions dealing with change orders might cause disputes in cases of extreme cost overruns and the owner’s inability or unwillingness to manage reimbursement. 

Who Pays for Mistakes in a Cost Plus Contract? 

It depends, as if the mistakes are caused by poor work or negligence, no client will pay for the same, and thus, the contractor has to suffer the liabilities. However, it is not true when mistakes are deemed reasonable by the property owner. 

Moreover, a confluence of personal trust, collaboration, and amicable relationships has a say in it, too. A client might sum up all such mistakes under the unforeseen emergency before reimbursement if they share a personal connection with the contractor. Thus, this is a complicated process.  

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How Do You Protect Yourself in a Cost Plus Contract? 

Various rules and techniques can be considered for the protection of both parties in such a contract. The significant ones are laid down below for a quick glance. 

For Clients:

1. Define reimbursable costs, as it helps cut back on the ultimate liability of the project owner.  

2. Set a guaranteed maximum price (GMP), so as to provide a financial outline to a contractor to operate within and minimize the chances of cost increases. 

3. Establish a change order process so as to manage the evolving needs of a project better without inefficiencies during construction. 

4. Implement detailed documentation requirements for all the costs paid by the contractor for the construction. This helps authenticate each reimbursable expense.  

For Contractors:

1. Define the project’s scope, because it enables a contractor to manage expectations, estimations, and costs better. 

2. Establish a GMP, guaranteed maximum price, so that a developer at least has a fixed amount as a predetermined ceiling, secured in advance. 

3. Keep a detailed cost documentation for the validation of each transaction during construction, and at the end for the client for reimbursement. 

4. Define the fee structure clearly, so that there are no issues related to the payment of a contractor’s service charges or profit margin. 

Both parties must be careful in their interactions, bargaining, and dealings if they meet for the first time. It is often advisable to hire a contractor, if possible, with whom an owner has already worked before.  

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What is a Cost Plus Example? 

Talking about the cost plus fee contract’s formulation and subject-matter, it is drafted under the presence of both parties, i.e., an owner and a contractor and usually contains provisions protecting each party’s interests. 

Consider the following example to have a better understanding of the same.

ABC Pvt. Ltd. offers construction services, having been a general contractor in the marketplace for years. Now, a project owner approaches the company and discusses their project details. 

The company brainstorms and creates a detailed scope of the work that the construction site requires and then offers a bid or an estimation, the potential cost to complete the development. 

Let’s imagine the bid is 10 million dollars, and 20% of the bid is the markup or service charges. Now, the project owner will analyze the same proposal and accept if agreeable. Afterwards, a contract will be signed that all the incurred costs, including the fee, will be paid back after the construction.

The actual cost may be higher due to cost overruns, which are also payable by the client if there are justifiable reasons.  

Also Learn: What is a Submittal in Construction? Learn How Submittals Work and Why You Need to Focus on Them

Should You Use a Contract Management Platform? Let’s Wind Up! 

If you are a contractor, it would benefit you immensely to use a contract management platform to handle all your essential legal documents used in construction, including cost plus contracts. 

Use of software reduces time, effort, and cost, streamlining major aspects of the work. However, before you buy a subscription to any software, never forget to conduct thorough research, as it will enable you to make an informed decision.  

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