Making Sure the Price is Right The Importance of Distinguishing Between Cost-Plus and Fixed Price Contracts

Frequently, an important step before work begins is to determine what the price will be or how it will be calculated. The case of Kareway Homes Ltd. v. 37889 Yukon Inc. is a good example of how failing to clearly address this issue in a written contract can result in serious financial consequences for the contractor.

FACTS

This case involved a dispute between a property owner (the "Owner") and a builder (the "Builder") over the total amount owing for the construction of a two-building condominium complex in Whitehorse (the "Project"). Construction began based on the Builder's original estimate of $4,268,000 (the "First Estimate"), which was accepted by the Owner but never set down in a written agreement. After construction began, the Owner insisted that a written agreement be finalized. As a result, the Owner and the Builder signed a formal Development Agreement (the "Agreement"), which, in part, determined how the costs for the Project would be accounted for. However, the Agreement never clearly stated which party would be responsible for costs exceeding the amounts identified in the First Estimate.

It later became apparent that the total cost of the Project would exceed the amount of the Owner's investment capital, and that additional bank financing would be required. In order to obtain this necessary financing, the Owner prepared an increased total estimate for the Project of $4,541,000 (the "Second Estimate"), based on information provided to him by the Builder. However, the Project continued to incur significant cost overruns over and above the amounts identified in the Second Estimate. A dispute then arose between the parties over who was responsible to pay these additional costs. The Builder terminated the Agreement and sued the Owner for approximately $600,000 allegedly owed in cost-plus fees. The Owner maintained that the Agreement, along with the two written estimates, created a fixed priced contract. As a result, the Owner claimed that the Builder should pay back approximately $750,000 in overpayments already made in excess of this fixed price.

ISSUE

Was the price under the Agreement to be a fixed price or cost-plus?

COURT DECISION

Although the Builder conceded that the Agreement was not a "typical cost plus contract," he maintained that significant cost-plus elements were present. Specifically, the Builder suggested that the fact that he was entitled to a share of the profits under the Agreement was inconsistent with a fixed price contract. Moreover, the Builder pointed to the fact that the Owner was provided with weekly invoices and closely monitored the Project's costs as further evidence that the parties had reached a cost-plus agreement.

The court rejected the Builder's arguments. A choice had to be made in interpreting the Agreement, and in this case the majority of factors pointed towards a fixed price contract. For example, the creation of the First and Second Estimates was considered evidence that the parties intended to create a comprehensive fixed budget for the Project.  In the end, the court ruled that the Owner was entitled to recover from the Builder additional overpayments in excess of the fixed price reflected in the estimates, with some deductions being made for legitimate extras.

LESSONS LEARNED

  1. Make it clear in a written contract whether the price will be a fixed price, or calculated on a cost-plus basis.
  2. Always prepare estimates as completely and accurately as possible. Although it may be tempting to give an originally low estimate to secure a job in the hope that the owner will pick up any additional costs as they arise, a court may consider the estimate a fixed price and hold a contractor responsible for costs in excess of the estimated amount.

 

This article was written by Ian Moes and Andrew Delmonico, lawyers with the law firm of Kuhn LLP. It is only intended as a guide and it is important to get legal advice for specific situations. If you have questions or comments about this case or other construction law matters, please contact Ian or Andrew at 1-888-704-8877