Cost Plus contract

[rcginc]

We are a small home builder (6-10 homes/year) and for the most part have been building spec homes. We have a meeting tomorrow with a prospective new client and he was asking if we would do a cost plus contract. I've read some things in various forums but nothing consistent. Some positive and some negative.

Is there a "Cost + for Dummies" guideline to make sure we don't screw this up? What percentage should we try to get?

Thanks!

[Allan Edwards]

Re: Cost Plus contract

Our local home builders assoc has our own contracts for the custom builders, we have an excellent cost plus contract, which I am presently using. Our contract breaks out our fee to be paid monthly, separate from the reimbursement of hard costs. The important thing is to define costs (our contract does an excellent job of this). Also define things like what documentation you are furnishing the client and when (copies of invoices).

As far as fees, I charge cost plus 15%, although I do vary that depending on certain variables. I do not charge overhead to the job. I suggest you bury that in your fee.

[rcginc]

Re: Cost Plus contract

Our local home builders assoc has our own contracts for the custom builders, we have an excellent cost plus contract, which I am presently using. Our contract breaks out our fee to be paid monthly, separate from the reimbursement of hard costs. The important thing is to define costs (our contract does an excellent job of this). Also define things like what documentation you are furnishing the client and when (copies of invoices).

As far as fees, I charge cost plus 15%, although I do vary that depending on certain variables. I do not charge overhead to the job. I suggest you bury that in your fee.

Allen...thanks for the response. That is what I am looking for especially the monthly fee :)

Would you be willing to email me the contract to review? I don't believe our local HBA has services like that although I will be checking.

[Allan Edwards]

Re: Cost Plus contract

I really wish I could share our contracts but as you might expect both the attorney who wrote them and our association advise against us doing that, and it is a copyrighted contract on top of that. It's also not in an e-mail format. The best I can do is give you the attorney's contact information and speak in broad terms about the content. There's also a lot of legal languare that is required by our state statutes.

[Bob Kovacs]

Re: Cost Plus contract

RCG-

Be careful with using Allan's 15%- he runs an incredibly tight ship with virtually no overhead (I recall seeing around 2-3% quoted at some point), so the majority of that 15% is profit. If you're like most contractors and have a higher overhead, make sure you cover that first, and then I'd shoot for at least 10% on top of that.

Bob

[rcginc]

Re: Cost Plus contract

RCG-

Be careful with using Allan's 15%- he runs an incredibly tight ship with virtually no overhead (I recall seeing around 2-3% quoted at some point), so the majority of that 15% is profit. If you're like most contractors and have a higher overhead, make sure you cover that first, and then I'd shoot for at least 10% on top of that.

Bob

Bob...we subcontract 100% all our work and have very little overhead as well.

[Dick Seibert]

Re: Cost Plus contract

Michael Stone has a list of 22 reasons not to do cost plus work, and most of us have been burned at least once with Cost Plus contracts. That being said, I still do them, sometimes there is just no other way. I would read his list as warnings as what to look out for.

Here in the Bay Area what few new custom homes which do get through the approval process are being awarded on a negotiated fee basis, and paper contractors are bidding down as low as 3%, the secret is knowing how to work the General Conditions so the 3% really does flow through as net profit. They are subcontracting the supervision to another B licensed contractor along with everything else, and for liability reasons never set foot on the job. It's really morphed into a construction management contract rather than a construction contract.

[tgrahamcm]

Re: Cost Plus contract

Dick,

Thanks for the link. I think I must be living on a different planet though. Have you really had those kind of extreme situations come up on cost plus?

[Brad S]

Re: Cost Plus contract

Nothing wrong with cost-plus as long as you have a good contract and more importantly the client understands everything and how you are billing beforehand. Don't forget to add certain soft type costs as part of the cost of the work on top of the 15%, such as supervision on the job, insurance, etc. or that is going to eat at your profit.

[Dick Seibert]

Re: Cost Plus contract

Ted:

Yes, one in '84. I had done several over the years with minimal problems, mostly an uncomfortable feeling that they were always looking over our shoulders, some questioning breaks and things like that. I was high of three bidders, but after checking out all three of us he decided upon me, and after talking to the owner of one I had just completed cost plus he decided to fire the architect and hire me cost plus so he could change many of the things the architect had done. He was very upset with the architect for making him pick fixtures out of catalogs, he wanted to sit on every toilet, lay in every bathtub, and see every light fixture, etc. He wanted nothing from catalogs. He wanted to upgrade from aluminum windows to wood, 2x4 walls to all 2x6, $30,000 custom made front doors created by an artist in copper, etc. etc. etc.

When we started we found the topographical survey was off by as much as 20' in places because he refused to pay the surveyor to do a survey and used an aerial topo, he had limited the soils engineer to 2 tests rather than take tests at all perimeter points. We hit granite and couldn't get a permit to blast, the piers had to go down 40' in places (cut and fill) rather than the 5' shown. No electrical engineer and we ended up having to install an 1100 amp service with an underground transformer, sewer lateral became a main because he wanted to subdivide his 10 acre lot into two lots in the future. Before we drove our first foundation stake we were in $400,000. Here is a picture of the house, and here is another so you know what I am talking about, both pictures are from the expert's report in the litigation.

He started demanding that I spend 8 hours a day on the project, even though I had a superintendent on the job 8 hours a day who had worked for me for over 15 years. I refused and spent my usual 2 to 4 hours per day on the job. I kept a crew of a minimum of 5 carpenters on the job at all times, and there were subcontractors crawling all over the place, but he was never happy with the progress (the house took 1 year and two months and cost $1.2 million, 6,000 feet, 8,000 under roof including garages and other covered areas [that was over 20 years ago]) even though he hadn't sold his existing house and had just made $6 million selling an instrument corporation). One day when he and I were standing in front of the house he said to me: "Dick, if only I could hire your carpenters, and knew the names of your subcontractors and suppliers, I could build the house myself and wouldn't have to pay your exorbitant fee, you don't do anything around here but talk to the men, I could do that, you're nothing but a paper contractor!" (first time I heard the phrase)

Eventually he said: "I've paid you over a million dollars, that should be enough to build any house, I'm not paying you any more". Because the house was almost done I decided to finish it knowing that I would have a stronger position in court if it went there. He terminated me when everything was done (including all painting and wallpapering) except the finishing of the hardwood floors, installation of the driveway, and final utility hookup (the panel was jumped from underground power pole). The Building department called wanting to know if they should honor his request to final the house since I wasn't on the job anymore, I told them to go ahead and final it because the longer it was incomplete the greater his damages would be in court, and he was burning $750 a month off my power account! He paid my concrete guy and hardwood floor guy to come back and finish.

He even filed a complaint with the District Attorney claiming I had taken kickbacks from subcontractors and taken more money from him than I had put in the house, diverting the funds to other projects. I opened my books to the DA, he audited me and found that I had never taken more than I had expended on his house, and there was no evidence of kickbacks. He filed a complaint with the license board requesting my license be revoked for taking more money than I had expended on his house, they audited me and found that I always had expended more than I had received. The lead came from a realtor, and I gave her a piece of jewelry I had my jeweler custom make for her and had it delivered to her office, I stupidly posted the two charges ($1,140) to his job (I viewed it as a job cost) but never billed him for it, it was clearly excluded when I gave him the monthly billing which included the charge and wasn't in the total when added up. For years I kept hearing in depositions and arbitration that I was giving jewelery and flowers to girlfriends and charging them to him, no matter how many times it was explained and proved not to be true, it would come back under another context later. She even had to testify and she was a little old 80 year old lady! I had to fight to stay out of bankruptcy and sell my house when no financing was available, but I'm a stubborn Kraut and my honor meant more than giving him the pleasure of bringing me down completely. The fact that I was a lawyer clearly hurt me in arbitration (the three arbitrators' fees came to an even $100,000 which we split), the arbitrators looked at me as a guy who used to be a good hard-working builder, but had gone to law school to learn how to screw people, they didn't like me invading their territory and thought that contractors should be dumb hard-working carpenters. The only defect I lost on was Marvin Windows, one of the arbitrators said that any contractor who had been building houses as long as I had should have know better than to have put crap like Marvin windows in a house, even though he had chosen them.

We litigated for 15 years, he won in arbitration, I had it overturned in court, he appealed that, etc, etc, he finally gave up when a court told his attorney if he came back one more time they were going to sanction him. The litigation cost me $750,000 and he admits to $1.25 million, I ran into him in a store a year ago, and he came up to me and said: "Hey Dick, good to see you, you know I should have paid you for the house, those damn attorneys ended up getting $1.25 million from me, they ripped me off for a lot more than you ever did."

After all of this, I still do cost plus on occasions, sometimes it's the only way because the plans and specs are not complete enough to give a firm bid, but I understand why architects can't always get everything on the plans, people in the upper ranges want to be able to make constant changes, and cost plus is better than standing around writing up constant change orders.

The real problem with cost plus is that it gives the attorneys a field day to run the litigation costs up, with a fixed price they are limited to quality issues as well as what you were supposed to do for the price. With cost plus they can go into your books for years and challenge ever nickel you have spent for anything. They can go into your personal life and look for any traffic ticket you have had and try to tie it into the case. A lot of this stuff wouldn't be allowed in court, but they can do anything they want in depositions and that's where the attorneys make their money. Attorneys will run the costs up as high as they can as long as the litigants have the resources to pay, and cost plus gives them the ability to do just that. They had a CPA do nothing but work my books over and over for more than a year trying to find something. If you do cost plus, you would be well advised to get out if you even sense a problem, try to settle up and get out, or convert to a fixed price contract. Contractors seldom win when going up against poor homeowners, even if those poor homeowners are millionaires, so get out when trouble starts, don't be stubborn like I was. When I do one now, I plan to get out if problems arise no matter how much money I have to leave on the table to get out.

[Allan Edwards]

Re: Cost Plus contract

Well Dick, that’s an interesting story but what relevancy does it have to cost plus contracts? It’s like me saying in 1983, one day before closing a new house I built for a couple, the man gassed himself in my garage and committed suicide (true story), therefore I should not have used the contract I used. It’s anecdotal, like my mother saying she didn’t want to wear a seatbelt because she heard of a woman who got trapped in a burning car wearing one, you cannot extrapolate out a definitive course of action from one story.

From your story, would I now say cost plus contracts are bad? No. First, there are always facts that aren’t told in these kind of stories, and of course there’s the other side. I agree with you that posting to the job a piece of jewelry was stupid, but then I’ve done stupid things too. That really looks bad, even though I’m sure you didn’t mean harm.

The most important thing to remember in a cost plus arrangement is that money from a client is considered “trust” funds, that money really don’t belong to the contractor. What’s left after completing the improvements does belong to the contractor, but the actual funds paid by the client to the contractor does not belong to you and should be treated as such. I’m sure you know this.

In Texas, we are required to deposit those funds into an account separate from our operating account. My attorney goes one step further and suggests that on cost plus jobs I open an account for each job and do not commingle with other jobs

I think a really good contract, which I believe we have one of the best, with arbitration-mediation clauses would have helped too. Most contracts have those these days, but back then I’m sure you didn’t.

Undoubtedly you had a bad client, he probably would have sued anyway.

Cost plus can be a really good way to build houses for the right people.

[Dick Seibert]

Re: Cost Plus contract

Allan:

I agree with what you say, and continue to use them, but the basis of his suit was that I went overtime and over-budget (plus the defective Marvin Windows) on the cost plus contract! So what good is cost plus if you can be hit for going over budget? I had an arbitration clause, and that was much of the problem, I am an arbitrator and I no longer put arbitration clauses in my contracts. Had this gone to court I think I would have come out a lot better. About a year later one of the arbitrators was a state bar party and after a few drinks told my attorney that they ruled the way the did to get some money to the owner from my insurance company so he could pay me (they figured he did what he did because he was out of money), of course my insurance wasn't about to pay an award like that, I even sued them to force them to pay with no luck after a few appeals. Arbitration can be a lot more expensive than litigation anyway as my case proves (all the discovery costs plus the $100,000 arbitration fees, many retired judges are getting $500 an hour to arbitrate cases).

I agree that the client would have sued anyway, at one point I had a skylight leak and it damaged some sheetrock, he showed up that morning and asked: "When are we going to start filing insurance claims around here?" I told him that I don't file insurance claims, I fix them myself. He said he had a little stove fire in his existing house and got enough insurance money to add a whole second floor to it. If I had a fixed price contract the litigation would have been much simpler. An example: I bought the bulk of my lumber direct from the mills in Canada, getting wholesale prices by buying full units in truck and trailer load quantities (I paid the same as the lumberyards). When my trucks would arrive I would offload what I needed at another job and take the balance to his job. I personally was at the first job to take down the number of units which were offloaded before proceeding to his job with the balance (no units were broken). Of course he accused me of falsifying the quantities I offloaded at my other contract job to pad my pocket by making him pay for the lumber going into the other house. In court the Rules of Evidence accept journals kept on a daily as indisputable evidence, but in arbitration the arbitrators aren't bound by the Rules of Evidence, he didn't win this one, but I bet my attorneys fees ran 10s of thousands of dollars over the issue.

One of the biggest problems was that I wrote my own contract rather than using an industry standard contract. I put an attorneys' fees clause and an arbitration clause in the contract. The arbitrators determined that he prevailed and I was responsible for his attorneys' fees. If a client sues you for $1,000,000 and the court (or arbitrator) awards only him nominal damages (always $1) they can (if they want) designate him as the prevailing party, and he can get an award of $1 plus whatever the attorneys' fees run to. In this case I challenged his attorneys' fees in court (Motion to Tax Costs), hired a state bar expert to pour through his attorneys' records like they poured through mine, and was successful in reducing his attorneys' fees from $750,000 (at that point) to around $300,000 by finding all kinds of duplications and charges not authorized by statute. I don't believe in attorneys' fees' clauses after this, you can win 99% and still end up paying the other side's attorneys' fees if the court (or arbitrator) thinks he wants to stick your insurance company. Courts and arbitrators love to hit contractors who are insured, thinking that they aren't hurting either party if they hit a faceless insurance company. The biggest thing that hurt me was the fact that I wrote the contract, they found that it was one-sided and gave all advantages on disputes to him! If he hadn't fired his architect and I was on an AIA contract I would have fared much better.

For those who don't know, under the English system the loser pays the winner's attorneys' fees and costs. Under the American system each pays his own attorneys' fees and costs, unless there is an Attorneys' Fees clause which states that the loser is to pay. My feeling is that litigants won't pursue a bogus claim if they don't think they can recoup enough to recover their attorneys' fees. Attorneys love to put Attorneys' Fees clauses in contracts, because they can encourage their clients to pursue litigation a lot further if they figure they can recover their fees and costs.

BTW, I like the Texas statute requiring separate accounts, had I deposited his monies in a separate account it would have made the accounting much simpler and cheaper.

[Brad S]

Re: Cost Plus contract

Dick, it sounds like you had the client from hell, he would have screwed you cost-plus or not. Perhaps a better discussion would be how to avoid this type of client, not burn cost-plus because of one bad experience.

[tgrahamcm]

Re: Cost Plus contract

Boy! I'd say Owner from the bowels of hell!

I think a fear of this sort of thing is why I expend so much effort in waving big red flags in the owner's face when they attempt to exceed any budget line item.

Dick, I'm glad you survived the experience.

[Dick Seibert]

Re: Cost Plus contract

What were the red flags I should have seen?

1) He wanted me too much with no concern about price, said he had just sold his corporation for $16 million and was making more interest in a year than the house would cost (interest rates were over 20% in those days).

2) Wanted a contract in writing when he just talked to a customer whom I'd just built a similar house for on a handshake (actually a much more difficult house to build). He came over to my house one day and demanded a written contract, said that he wanted to make sure I didn't start somebody else's house rather than his.

3) After reading the contract he crossed out my non-interference clause, saying he wanted to work with me to get the best house possible, he wanted to help by talking to the workmen and subcontractors (I should have refused to let him do that, that was the biggest red flag -- I think).

4) Firing the architect.

5) New money, when we had the dot-com explosion later many contractors had problems with new money. Old money is much better to work with.

5) Being in a hurry to get the house started and wanting to know how fast I could build it.

In retrospect, I think those were red flags, I can't think of any others.