Cost Plus Contracts a curse for homeowners and lenders
Before 1 July 2015, the use of cost plus contracts for home builds was extremely limited. In fact, cost plus contracts could not be used for new builds at all. But after the repeal of the Domestic Building Contracts Act 2000 (DBCA) on 1 July 2015, the flood gates have been opened and cost plus contracts can be used for everything and anything. But homeowners and lenders have more to fear from cost plus than just cost overruns.
What is a cost plus contract?
A cost plus contract is a contract that does not have a fixed price and instead the value of the work is worked out as the sum of:
the time spent by the builder (the builder usually gives an hourly rate);
the cost of the materials purchased to carry out the work; plus
the builder’s margin.
Under Schedule 1B Queensland Building and Construction Commission Act 1991, which replaced the DBCA, a cost plus contract is defined as:
“cost plus contract means a domestic building contract under which the amount the building contractor is to receive under the contract cannot be accurately calculated when the contract is entered into, even if prime cost items and provisional sums are ignored.”
There is no penalty for:
giving a cost plus contract when the contract price can be accurately calculated; or
giving an estimate that is well below a reasonable estimate for the work.
We are now seeing cost plus contracts for new domestic builds where the contract price can be accurately calculated. And if you are a builder and you can get away with it – why wouldn’t you?
Why is a cost plus contract risky?
There are two major reasons why cost plus contracts are so risky:
cost overruns; and
There is absolutely no incentive for a builder with a cost plus contract to carry out the work with due diligence. In fact, there is more reason to take as long as the builder wishes. This is because the builder is getting paid per hour. The more hours it takes to build the more money the builder makes.
This also flows down to the subcontractors. The builder is incentivised to encourage the subcontractors to take their time. As the builder is paid a margin on top of whatever the subcontractor will charge, the larger the fee the larger the builder’s margin.
So not only do the costs ramp up, but the time blows out as well.
In addition, the homeowner, with no construction background, will have no ability to check or identify whether materials claimed for have actually been used on that home building project.
Cost plus can work on commercial sites, where both parties are commercially and construction savvy and the owner has an ability to assess every bolt and screw that has been claimed for. But for homeowners, the use of cost plus contracts is an absolute disaster waiting to happen.
But wait there is more …. the risk QBCC won’t explicitly or openly tell you about
The QBCC Statutory Home Warranty Insurance does not insure for non-completion for cost plus contracts. However, the cost of the compulsory statutory warranty insurance is exactly the same for cost plus contracts as fixed price contracts. Further, the only place that this exclusion is mentioned is the QBCC Statutory Home Warranty Insurance policy. It is not mentioned in the QBCC information statement or on any general advice or warnings on cost plus contracts by QBCC.
It is understandable that as cost plus contracts do not have a fixed price, it would be difficult for QBCC to assess how much the value of the build is. However, it is somewhat ironic that the homeowner is left to rely on the QBCC licenced builder’s reasonable estimate for the build, but QBCC will not rely on the same purported reasonable estimate from its own licensees.
The irony continues, as the QBCC was born out of a Commission of Inquiry into the old Building Services Authority. That same commission made numerous recommendations for further and more stringent protections for consumers. However, the changes that were made to domestic building in July 2015, including the deregulation of Cost Plus contracts has actually depleted the rights of consumers and passed more risk on to consumers in domestic building contracts.
How does this affect lenders?
It is extremely easy to over-capitalise on a domestic home building project, even when the contract is not a cost plus contract.
If a consumer entered into a cost plus contract, it would be easy to imagine:
The consumer running out of money before the cost of the home build had matched the value spent or secured;
The Lender being left with its security over an asset that is worth less than the amount secured and with no ability to:
Rely on the consumer’s right (under a non-cost plus contract) to terminate the home building contract; and
Use the QBCC Home Warranty Insurance to complete the home build and restore the asset to the value that is secured.
Therefore, cost plus contracts loom over domestic home building projects as a curse for homeowners and lenders alike.
Contact Us - Your Building Lawyers
Worried about a domestic home building contract? At Aitchison Reid, we deal with domestic home building contracts on a daily basis. We understand the legislation, the contracts and the policy behind them. Who better to give advice on one of your biggest investments – your home?
We provide a set home building contract review that gives a written report on the builder’s licensing record, a commentary on the clauses in the home building contract that you need to know about and our recommended amendments. We also include a one hour phone call to go through all of your questions.
Call our friendly building lawyer team at 07 3128 0120 or contact us here.