Holloway wants to provide attribution and thanks here to the staff of Under Construction, the newsletter of the ABA Forum on the Construction Industry, for publishing this article on Cost Plus Contracts for us in the March 2003 issue of Under Construction and providing the first two cites above on fiduciary duty.

CONSTRUCTION COST-PLUS CONTRACTS

CONTRACTOR DUTIES

AIA Documents A111 and A131/CMc are ostensibly the two most popular standard form contracts used on construction projects where the basis of payment to the general contractor is the cost of the work plus a fee (Cost-Plus). These AIA contract forms contain provisions that arguably could support a finding of a fiduciary duty on the part of the contractor. These provisions include:

  1. The contractor accepts a relationship of trust and confidence.
  2. The contractor covenants with the owner to cooperate with the architect and exercise the contractor’s best skill and judgment in furthering the interests of the owner.
  3. The contractor agrees to furnish efficient business administration and supervision.
  4. The contractor agrees to perform the work in an expeditious and economical manner consistent with the interests of the owner.

A fiduciary relationship carries a duty of good faith and loyalty and the obligation to make full disclosure of all known information that is significant and material to the affairs of the party reposing the trust. Such duty also can be imposed if the relationship is one where one of the parties is in a position to dominate the other party. In situations where the general contractor is experienced in construction cost-plus contracting and the owner is rarely in the construction market, it has been argued that the contractor is in a dominant position. Such a relationship, together with contractual provisions such as those above, would further support the argument that a contractor can have a fiduciary duty to the owner.

Nevertheless, courts have historically been reluctant to find that a general contractor has a fiduciary duty to the owner. See Eastover Ridge, L.L.C. v. Metric Const., Inc., 553 S.E.2d 827 (N.C. App. 2000); Avon Bros., Inc v. Tom Martin Const. Co., Docket Nos. A-740-99Tl, A812-99Tl, A-1681-99Tl (N.J. App. Div. Aug. 2000) (unreported). But, also see Jones v. J. H. Hiser Const. Co., 484 A.2d 302 (Md. Spec. App. 1984) where the contractor had a duty to be aware of the ongoing or escalating costs of construction and to communicate this information to the owner in a timely fashion. And, in A.A. and E. B. Jones Company v. Boucher, Colo. App. 530 P.2d 974, the court found that the contractor had not dealt in good faith with the owner regarding the cost of the work and had violated a relationship of trust and confidence.

Most experts agree that the typical construction owner’s key interests include the timely project completion; costs kept within budget; and quality consistent with the requirements of the contract specifications. Occasionally, however, the contractor’s operational and costing practices can be inconsistent with the typical owner’s interests and seemingly in contradiction to the relevant provisions of these AIA agreements. The remainder of this article explores potential pitfalls that arise under such contracts.

TRANSFERRING DIRECT COSTS TO INDIRECT COSTS

Contract values under cost-plus-a-fee agreements (with or without a guaranteed maximum price) are most often comprised of two major cost categories: (1) direct costs, such as concrete, mechanical, and electrical, and {2) indirect costs, such as field and home office overhead. Direct cost budgets are typically based on combinations of general contractor estimates and subcontractor cost proposals. Indirect cost budgets are usually based either on factored percentages or estimates prepared by the general contractor. When direct cost budgets are based on subcontractor lump sum, or fixed-price, bids there is relatively limited profit opportunity for the general contractor.

On the other hand, because indirect cost budgets are based on contractor estimates and include costs that might otherwise be charged to home office overhead, contractors will often instinctively look for opportunities to shift budgets from direct accounts to indirect accounts. A common example is where the general contractor executes, or “buys-out”, a subcontracted scope of work for less than the amount the owner/general contractor agreement. In this situation, it would not be uncommon for the general contractor to consider transferring some, or all of the under-run amount to the general conditions or field overhead line item. As discussed below, the buyout might also apply to a-cost savings provision.

CONTRACTOR SELF-PERFORMED WORK DISPUTES

As a general rule, direct cost budgets under these contracts are usually, but not always, based on subcontractor lump-sum proposals or fixed price bids that offer limited profit opportunity for the general contractor. One traditional and ever-popular practice that can be in contradiction to the owner’s interests arises when the general contractor elects to self-perform a certain scope of work such as foundations, structural concrete, tilt-up concrete, etc. The general contractor often tries to justify self-performing such work by reporting to the owner that it can perform the work for less than or equal to the prices of its competitors.

Unless the general contractor had previously disclosed to the owner that it planned to self-perform the work, a conflict of interest may arise. The owner’s interests probably have not been advanced if the general contractor established an inflated budget based on an in-house estimate, knowing that it would perform the work at a profit, for less than the budget. Moreover, a general contractor in this situation may argue that it is entitled to self-perform such work and that it should be treated like the other direct cost subcontractors working under fixed-price subcontracts. Therefore, consistent with lump-sum subcontracting principles, it is not uncommon for a general contractor to object to disclosing its actual costs for self-performed work.

ESTIMATED VERSUS ACTUAL CONTRACTOR PAYROLL BURDENS

Contractors are responsible for paying various state and federal employee payroll taxes and insurance (“payroll burdens”) that can include: FICA; federal and state unemployment insurance; Workers Compensation; CGL Insurance; and E&O Insurance. The amount of payroll burdens paid by the general contractor will depend upon a number of variable factors, including the company’s safety record, statutory adjustments, the state in which the contractor is based, and the location in which the work is performed. Due to these uncertainties and other factors, some contractors will include a provision in the contract that allows them to bill an estimated, predetermined percentage of direct payroll labor as “burden.” In this regard, some general contractors use payroll burden billings as a “profit center.” Some contractors will use payroll burden estimates in the GMP estimate that are higher than their anticipated payroll burdens. When actual burden expenses are less than the estimates, the contractor pockets the difference. This practice would be more understandable in circumstances where the contractor was at-risk if actual labor burdens exceeded the estimate. However, this is rarely the case under GMP contracts.

COST SAVINGS PROVISIONS

Some GMP contracts contain cost savings provisions that prescribe how any cost savings, or GMP under-runs, will be shared by the parties after the completion of the work. To the inexperienced owner, this provision may seem like a good idea, because on its face it may serve to motivate the contractor to minimize costs. However, experienced owners understand that a cost saving provision can serve as either a disincentive or incentive, depending upon the circumstances of the project and the integrity of the contractor. The experienced owner also realizes that the contractor can often control whether it realizes “savings” during or after the project. A simple example occurs where the contractor buys-out a scope of work early in the project for less than the GMP budget for the item. At that point, the contractor has several options from which to choose:

A. Execute a change order to reduce the GMP;

B. Move the savings, or under-run, to a contingency account;

C. Move the under-run to an account that has or may experience an overrun;

D. Let the under-run apply to the end-at-job cost savings provision.

Option A is least likely to be favored by the contractor, particularly where the design is incomplete. The contractor tends to benefit immediately under Options B and C, while delayed gratification would be better served under Option C. Some contractors spurn and endeavor to avoid Option D.

The potential relationship between subcontract buy-out savings and a GMP cost savings/sharing provision merits further comment. General contractors tend to do business with a relatively small group of subcontractors in each trade. Consequently, these subcontractors become accustomed to the general contractor’s bidding and subcontracting practices. It is not unusual for a general contractor to base its GMP budget on the low bid for a trade knowing that it will or should be able to buy-out that trade for less than the bid price.

Subcontractors tend to anticipate this practice by including some “give-back” money in their bid price. These practices often results in GMP line-item under-runs that best apply to the end-of-job cost savings provision:

FEE ON DEDUCTIVE CHANGE ORDERS

The dollar amount of the contractor’s fee under a GMP contract is typically calculated by multiplying an agreed-to fee percentage (often 4 to 5 percent) times the total (direct plus indirect) budgeted cost of the work. When scope and cost are added to the work through a change order, the contractor will add fee to the cost of the work. However, when base scope and cost are removed from project through deductive change orders, the contractor will often be reluctant to reduce or give back fee. In anticipation of avoiding disputes over this provision, the parties should address how fee on deductive changes in handled the contract.

CLOSING

The debate about whether a general contractor has a fiduciary duty under the A111 contract form will undoubtedly continue into the distant future. But there seems to be much less disagreement amongst legal experts as to whether or not the general contractor has a “higher duty” under this form.

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