Hybrid Cost-Plus Contracting With Lump-Sum General Conditions Offers Advantages for Contractors and Owners

The most common method of contracting for private commercial construction is reimbursement of the contractor’s construction costs plus a fee, with a guaranteed maximum price. Cost-plus contracting offers the allure of “open-book” contracting and provides the opportunity to return all or part of the savings when the costs come in below the guaranteed maximum price. All of the major form contract families have cost-plus contract templates.

Drawbacks of cost-plus contracting include the increased administrative costs involved in keeping and presenting costs on a monthly basis, completion audit costs, and additional disputes over whether “grey area” costs are compensable. Some contractors have attempted to ameliorate these drawbacks by marketing a hybrid cost-plus/lump-sum arrangement where the contractor’s direct overhead costs are estimated, negotiated, and billed to the project as a lump sum. This lump sum then becomes the basis for an agreed percentage or daily rate addition to change orders for time and price.

General Conditions Costs—Defining Terms

A contractor’s overhead costs traditionally have been segregated into indirect costs (such as home office overhead costs) that are allocable among the company’s multiple projects and direct costs that are incurred specifically on account of a particular project. Indirect costs usually are reimbursed as part of the contractor’s fee.

Direct project overhead costs—often referred to as “general conditions”—include costs incurred at the jobsite for the supervision and administration of the overall contract that are not ascribable to any particular onsite construction activity. General conditions costs typically include

• a jobsite trailer;
• jobsite utilities;
• small tool charges;
• superintendent salaries and costs;
• safety costs;
• site administrative costs;
• project accounting;
• field computer and building information modeling (BIM) services;
• a dumpster;
• cleanup;
• job signs;
• photographs;
• site security personnel and cameras;
• webpage and web camera;
• critical path method (CPM) scheduling;
• mobilization;
• street cleaning;
• temporary toilets; and
• water.

These general conditions costs can be further divided into fixed and variable costs. Fixed costs, such as job signage and mobilization, do not change with changes in job duration.

Variable general conditions costs vary when the job duration or value of construction changes. Job trailer rental costs, for example, increase if the job’s duration is extended, but not if the amount of the construction changes. In standard cost-plus contract regimes, all of these indirect costs are accounted for, reported, and reimbursed as part of the periodic and final payment process, the change-order pricing exercise, and the claims process.

Standard Form Cost-Plus Contracts

Each of the American Institute of Architects (AIA), ConsensusDocs, and Engineers Joint Contract Documents Committee (EJCDC) families of standard form contracts has a cost-plus contract form which defines the types of costs that are includable within the definition of the cost of work. AIA A102 identifies project general conditions costs in several places within Article 7. Similarly, the ConsensusDocs 500 lists typical project general conditions costs in various places throughout Article 8.2.

A contractor must track these costs and present support to the owner on its monthly and final pay applications. The contractor must similarly estimate, track, and support such costs during the change order and claims processes. The owner must conduct an audit of the contractor’s costs at the end of the project. This practice of supporting all general conditions costs results in greater precision, but it also requires an administrative effort throughout the project and presents opportunities for disputes over whether certain “grey area” costs are compensable and whether such costs have been adequately supported. In the claims and changes processes, the practice of paying only specifically enumerated, incurred, and documented project general conditions costs creates a fertile ground for disputing cost estimates, causation claims, and cost allocations.

The problem is one of scale. Project general conditions costs may range between 6 and 12 percent on typical commercial construction jobs. On large construction projects, the value of these project general conditions costs can be large enough to justify detailed contract definitions and the administrative expense of tracking, maintaining, presenting, and auditing these costs.

The added administrative expense becomes less justifiable on smaller projects. This administrative burden affects contractors and owners alike. As a result, many contractors and owners are now routinely negotiating, or attempting to negotiate, lump-sum general conditions programs in all of their cost-plus contracts below about $50 million.

The Lump-Sum General Conditions Alternative

“Lump-sum general conditions” refers to a hybrid cost-plus contract in which all costs other than the defined project general conditions costs are handled in the usual method where costs are disclosed and supported throughout the job and audited at the end. The project general conditions costs are defined, estimated, and negotiated at the outset and are billed either as a percentage of the direct job costs or in proportion to the construction schedule.

The first step is to identify all the project general conditions costs that will be included within the lump sum. Next, the contractor determines which are fixed and which are variable based on the time and value of the construction. The contractor estimates the total of these costs from preconstruction through completion to reach a lump-sum number. The estimates can range from simple straight-line calculations to extremely complex models.

Once the lump sum is established, the parties determine how these costs will be paid over the course of the project. Most contracts divide the lump sum by the number of months in the project to make a straight-line monthly billing rate. The parties should then address how to deal with changes and claims. Usually, fixed costs are stripped from the lump-sum general conditions, leaving only variable costs (any costs that are not time-variable should be stripped as well) from which a periodic rate (usually daily) is developed for the purposes of compensating for schedule extensions due to compensable delays and changed work.

The main benefit of lump-sum general conditions is simplicity. The parties do not track, maintain, present, or dispute individual general conditions costs during the interim and final payment processes or in the changes and claims processes. Disputes as to causation, inclusion, and documentation of these costs should be eliminated. And, since general conditions costs usually represent a relatively small part of overall job costs (but are typically one of the largest areas for dispute), the lump-sum general conditions strategy should lessen the probability of distrust and disputes.

The primary risks of the lump-sum general conditions strategy are errors in estimating and planning. Precise control over these costs is sacrificed in favor of efficiency, reduction of administrative burden, and ease of closeout. In trading certainty for precision, the contractor and the owner bear similar risks.

Attention must be paid to the types of costs included in the lump-sum definition. Some costs, which are usually thought of as general conditions costs but are not certain to occur, should be expressly eliminated from the definition and handled in the traditional manner. Winter conditions, insurance deductibles, and concrete-floor leveling compound are often dependent on variables other than time and may be excluded from the definition. These costs can be carried as separate cost items or handled through allowances. Listing the types of costs specifically included in the lump sum can help to avoid disputes about unlisted costs.

AIA Contract Changes Needed

Implementing the lump-sum general conditions regime requires three general changes to the AIA A102 form. First, a paragraph must be added to Article 5 (Contract Sum) to introduce the general conditions lump sum, identify the list of included costs, and establish the periodic billing rate. Next, a paragraph should be added to Article 5 to address the agreed rate of general conditions costs for changes and extensions of the contract time. Finally, the general conditions costs must be removed from the Article 7 definition of Cost of the Work.

Delays and Extensions of Time

The above formulation would award general conditions costs at the daily rate for all extensions of the contract time no matter whether the extension resulted from a noncompensable event. Therefore, the formulation might be overinclusive. The law of most jurisdictions provides that some delay events that are not caused by the owner or do not result from risks assumed by the owner, such as force majeure events, may entitle the contractor to an extension of time but not to additional compensation. If noncompensable extensions of contract time are part of the contract scheme, then section 5.1.7 of the A102 should be adjusted accordingly.

Conclusion

Hybrid cost-plus contracting with a lump-sum general conditions component can have administrative advantages for both contractors and owners. The parties trade precision cost control for a best-estimate method that is intended to reduce administrative expense and disputes for the 6 to 12 percent of total job costs represented by general conditions costs. The effectiveness of this strategy depends on the scale of the project and the ability of the parties to accurately estimate and describe the costs included within the lump sum. 

A version of this article was published in the April issue of Construction Executive magazine.