Cost plus contracts can be tricky. It requires a fair amount of documentation and detailed invoicing, to be sure the contractor isn’t taking advantage of the customer. Failing to do so can cause some serious difficulties in securing payment. Given that, a recent case from Iowa showed that proper invoicing is more important than ever, particularly when enforcing a mechanics lien claim.
What is a cost plus contract?
A cost plus contract is an agreement between the parties whereby the contractor will be paid for all of their construction related expenses and a fixed percentage of profit. The way these types of contracts are structured is relatively simple.
A cost-plus contract provides for reimbursement for three main items:
- Direct costs: Labor, materials, equipment, etc.
- Indirect costs: Business-related expenses
- Profits: A fixed percentage on direct costs
Cost-plus contracts are generally very favorable to contractors. They ensure the contractor’s expenses will be covered, essentially guaranteeing a profitable job while minimizing financial risk. However, there are inherent challenges that come with this. Most importantly is that the owner will likely monitor expenses closely to ensure the contractor isn’t inflating costs. After all, when the contractor is receiving a fixed profit for all direct costs, the more costs they bill for, the more profit they receive!
Olmstead Construction, Inc. v. Otter Creek Investments, LLC
One recent case in Iowa has emphasized the importance of proper accounting and record-keeping under cost plus contracts. In September of 2019, the Iowa Court of Appeals heard the case between Otter Creek Investments, LLC and Olmstead Construction, Inc. The issue came up when Olmstead filed an action to enforce a mechanics lien claim.
A tale of four different invoices
Otter Creek Investments hired Olmstead to build a gas station and convenience store under a cost plus contract. Although the project had other difficulties, the main dispute was in regards to the inconsistent invoices submitted by Olmstead. When nearing the end of the project, Olmstead sent multiple invoices within the same month for three different amounts.
Otter Creek, understandably, asked for supporting documents to verify the costs. Olmstead failed to provide additional evidence. Instead, they sent a fourth invoice with yet another different amount. Otter Creek refused to pay until the invoices until they received additional information about the costs. In response, Olmstead filed an action in court to enforce their mechanics lien.
The problem: Charging for owned equipment
The ultimate problem here was that Olmstead owned some of the equipment used on the project, such as a skid loader, forklift, and other equipment. So providing receipts or other types of evidence for costs was near impossible. Thus, Olmstead attempted to price it out using two different methods. In the first, the contractor estimated costs based on his 20 years of experience. Under the second method, Olmstead calculated costs based on the Iowa Department of Transportation rates of equipment rental.
Court: No foreclosure without proof of actual costs
The court eventually rejected both of these methods. The judge stated that these calculation were too speculative, and that Olmstead must prove actual costs. When a contractor agrees to a cost plus contract, they must justify all of the actual costs under the contract.
The judge’s rationale was that a contractor “should not be permitted to invoice for an unsubstantiated amount of money, and then subsequently foreclose on the property without providing proof the amount was actually valid.”
In such a situation, if the contractor foresees an issue with providing proof to back up their invoices, the contract should include a rate schedule for the use of their equipment. That way, the owner would have already agreed to the costs upfront.
Lessons learned: Keep detailed records
The biggest takeaway here is when working under a cost plus contract, or any contract for that matter, to keep meticulous records. Not only is this just good business practice, but it can save you a lot of hassle down the road. As with most construction payment disputes, what you can prove is more important than what actually happened. And under a cost plus contract, this is particularly important to protect against abuses. Under these contracts, owners have the right to request supporting documents, and contractors are under a duty to provide them.
As for this particular scenario, Olmstead learned another important lesson about being proactive. If you own equipment that’s to be used on the project, be sure to stipulate the costs in the contract ahead of time. That way, if there is any disagreement as to costs, the contractor has a written agreement that can substantiate them.