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The Fixed Rate Contract With Allowances: a Stealthy Cost-Plus?

As a practicing construction law attorney in North Carolina, I have occasion to review all kinds of construction contracts. Typically, there are two main types: The first is the cost-plus contract, also known as “time and materials.” This contract requires the owner to pay the contractor for all labor and materials costs incurred on the project, plus a fee (typically 15%). It’s easy to see why contractors like this structure--if costs go up during the build, the contractor still makes a profit and the fluctuating costs fall on the owner.

By contrast the flat rate fee structure, which is also very common, is very simple: You simply have a single price for the entire work package. In this situation, the risk of rising prices falls on the contractor. It’s easy to see why owners will generally prefer this contract, as it gives them a high degree of certainty as to how much they are likely to spend.

Lately though, I’ve observed a major uptick in contracts that purport to be a flat rate contract, but then also contain what’s called an “allowance” provision. And these “allowances” can affect the contract price in a number of different ways, depending on how the contract is drafted. The allowances usually detail a series of work packages which supposedly make up the total project price; however, there may be a provision that declares that the “flat rate price” is to be adjusted upward if any of the given “allowances” are exceeded.

The problem with this is, depending on how the contract is drafted, and how the contractor came up with the “allowance” totals, this contractual provision can cleverly disguise a time and materials-style contract as a flat rate contract. You need to be sure that it’s abundantly clear how the allowance provision is supposed to apply. For example, if the “allowance” for cabinetry is exceeded because the contractor underestimated or the prices went up, and then the owner is responsible for the excess costs above the allowance, then you don’t really have a strict flat rate contract. Owners who thought they signed up for a flat rate price contract can become very surprised to find this to be the case when they start seeing these upcharges listed on their invoices.

At a minimum, it should be abundantly clear in the signed contract exactly how the allowances interact with the quoted price total, and you need to be certain that you are okay with the risk allocation, as stated in the contract. All too often I see contracts that have an “allowances” provision, but that completely fail to make it clear how the allowances interact with the contract price. This creates a fertile ground for disputes between the owner and contractor--and resolving these disputes can become extraordinarily expensive and time consuming.

If you’re a property owner considering hiring a contractor to build a home or major structure, the construction lawyers here at Asheville Legal are very well situated to make sure that you have a contract that everyone understands and will help prevent, rather than foment, disputes during the build. Similarly, if you’re a contractor and you have any doubts about whether your written contracts operate the way they should, we can review them and help refine and make them clear. At Asheville Legal, we pride ourselves on drafting clear contracts that laypeople can understand and digest. Give us a call today to find out if we can help.


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