“CH-CH-CH-CH-CHANGES”: THE BIG ISSUE WITH FIXED-PRICE CONSTRUCTION CONTRACTS
For most home owners considering a renovation or new build, price is one of the most important factors in determining the scope of their project, the finishing’s to select and what contractor to choose. For contractors, providing a client with budget certainty can be a significant selling point; thus, the appeal of fixed price construction contracts.
With a fixed price contract, the owner knows the price at the outset of the project, they can budget and arrange financing accordingly and they’re protected in the event the project goes over budget. The contractor assumes the risk of bringing the project in at a cost that will cover its expenses, overhead and profit. If the project is over budget, the contractor absorbs all of the losses.
In addition to being a good marketing tool for contractors, fixed price contracts can also reduce their administrative burden. Unlike cost-plus contracts, contractors are not required to disclose proof of actual costs, including labour hours, in order to justify their fees. The owner has to pay the fixed contract price regardless of what the contractor’s actual costs are.
However, the big issue with fixed price contracts is dealing with and accounting for changes to the scope and cost of the project through an owner’s request for extras, deletions or unexpected site conditions.
Unless effective terms are included in the contract to deal with changes, they can become a significant headache for both contractors and homeowners.
A recent court decision out of Ontario provides one example of how contractors can effectively manage changes to a fixed-price project. In Balmoral v. Biggar, the plaintiff contractor, Balmoral, brought an action for unpaid services and materials to renovate and build an addition onto the defendant owner’s house. The owner claimed set-offs and counterclaimed for approximately $70,000. In issue was the nature of the contract for the original scope of work and for extras.
The contractor argued the parties agreed to a fixed price for the original scope of work, with extras to be priced either on a cost plus basis or else fixed by agreement on an extra-by-extra basis. Deletions from the original scope of work were to be calculated based on the contractual formula of the line item cost in the quote less 25 percent.
The court found the Contract was clear: the parties agreed to a fixed price for the specified scope of work. Whether the contractor made a profit or lost money was irrelevant. The contractor had no obligation to disclose actual costs.
The Contract contemplated the possibility of the owner adding or deleting items from the scope of work and specified the method of calculating the price of extras and deducting the price of items deleted from the fixed price contract. The Contract specifically stated:
Extras to be calculated on a cost plus 17% basis or on a lump sum basis to be agreed upon in advance by both parties and to be payable upon completion less 10% holdback.
Deletions to be calculated on a cost, less 25% basis and to be reduced from the relevant or next scheduled payment.
Two of the extras in question were charged at the cost plus 17% basis rather than a lump sum basis because the contractor could not determine the scope of work in advance. One of these extras concerned excavation of a hidden foundation. The extent of the required excavation was unknown because the size of the hidden foundation was unknown.
Interestingly, the Contract also required the owner to pay 25% of the original amount allocated to any items removed from the scope of work. The Contractor’s explanation for this clause was to recognize that while an owner may change their mind or decide to hire a different contractor for specific item or items, at some point, if too many items are removed, it may not be worth the contractor’s time to undertake the project. This clause was upheld and binding on the owner.
Fixed price construction contracts can be effective tools for contractors in marketing their services to budgetconscious home owners looking for price certainty. However, the changing nature of most projects can create significant hurdles for contractors to jump through in order to satisfy their clients and maintain profitability.
In his famous song “Changes”, the late, great David Bowie penned the line “ch-ch-ch-ch-changes, turn and face the strange”. By including specific mechanisms in a fixed price contract to deal with additions or deletions from the scope of work, contractors can effectively face the sometimes strange and often unforeseen changes that occur during a project.
This article was written by Ian Moes and Jay Spiro, lawyers who practice construction law with Kuhn LLP. This article is only intended as a guide and cannot cover every situation. It is important to get legal advice for specific situations. If you have any questions or comments about this case or other construction or commercial law matters, please contact us at 604-684-8668.