Potential Liability With Cost-Plus Construction Contracts

What is a cost-plus construction contract? A cost-plus construction contract is a contract in which a contractor agrees to be paid for all of his costs including a certain percentage for his expenses and profit. The pros vs. the cons of cost-plus construction contract format are a business decision, but cost-plus construction contract also raises legal issues contractors should be aware of before agreeing.

One of the most commonly litigated issues with cost-plus construction contracts is that of contractors inflating their costs in order to increase their profits. In the recent case of Stern v. H. Dimarzo, Inc., a pair of homeowners agreed to pay their contractor its costs plus 15% for expenses and 10% for profit, but the contractor allegedly overcharged them and failed to perform in a workman-like manner.[1] They committed both breach of contract and fraud, and, although the court stated that minor overbilling would only constitute breach of contract, it maintained that the homeowners’ allegations that the contractor used the funds for its own purposes and for other projects might amount to a claim for fraud against the contractor.[2]

In another similar case, Mora v. RGB, Inc. involved an alleged agreement by a plaintiff with a corporate contractor to construct a new home, with change orders to be paid at the contractor’s actual costs plus 22%.[3] An issue arose when the plaintiff became suspicious in regards to the price changes, and the plaintiff ultimately filed a lawsuit alleging, among other things, that the corporate contractor’s president committed fraud against the plaintiff by convincing him to sign off on change orders containing raised prices.[4]

Ultimately, the court stated that, if the plaintiff could prove his allegations at trial, he would have a claim for fraud against the contractor’s president, so that cause of action could not be dismissed.[5] This is highly unusual because, as a general rule, corporate officers cannot be liable to parties who deal with the corporation, but the specific wrongdoing of the corporate president in this case justified a departure from the general rule as an exception.

Therefore, the biggest concern with cost-plus construction contracts has been and continues to be the propriety of the costs from which operational expenses and profit are calculated. Because of the potential exposure to personal liability for corporate officers if they should submit intentionally increased or incorrect estimates of costs. Conscientious calculation and good record-keeping are a must for your corporate and individual protection when you work under a cost-plus agreement.

Meanwhile, the cost-plus construction contract raises practical issues as well, with respect to filing mechanics’ liens. The Lien Law requires a notice of mechanic’s lien to state, among other things, the agreed price of the project.[6] In the recent case of Sullivan Contracting, Inc. v. Turner

Construction Co., this was at issue because the plaintiff subcontractor had failed to state the agreed price of its work in its notice of mechanic’s lien, evidently having been confused as to how to describe the agreed price of its cost-plus contract.[7] The court refused to overlook the omission, finding the notice of mechanic’s lien to be defective, and observed that “the requirement that a notice of mechanic’s lien state the price agreed upon or value may be satisfied by the inclusion of an agreed-upon cost plus percentage if there is no specific dollar amount indicated in the contract”.[8] Therefore, when filing a mechanic’s lien with respect to a cost-plus construction contract, the proper course is to be very specific with the language of your contract regarding the agreed price.[9] It is always a good idea to seek advice of an experienced construction law attorney when preparing a notice of mechanic’s lien for filing so as to avoid this and similar problems.

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John Caravella Esq., is a construction attorney and formerly practicing project architect at The Law Office of John Caravella, P.C., representing architects, engineers, contractors, subcontractors, and owners in all phases of contract preparation, litigation, and arbitration across New York and Florida. He also serves as an arbitrator to the American Arbitration Association Construction Industry Panel. Mr. Caravella can be reached by email: [email protected] or (631) 608-1346.

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[1] 19 Misc. 3d 1144(A), 867 N.Y.S.2d 20 (Sup. Ct. Westchester Co. 2008).

[2] Id.

[3] 17 A.D.3d 849, 850, 794 N.Y.S.2d 134, 136 (3rd Dep’t 2005).

[4] Id.

[5] Id. at 852, 794 N.Y.S.2d at 137.

[6] Lien Law § 9.

[7] 60 A.D.3d 1315, 1316, 875 N.Y.S.2d 695, 697 (4th Dep’t 2009).

[8] Id.

[9] See also, Fyfe v. Sound Dev. Co., 235 N.Y. 266, 269, 139 N.E. 263 (1923).