Legal Definitions - cost-plus contract

A cost-plus contract is a type of agreement where the price a buyer pays for goods or services is determined by calculating the seller's actual, verifiable costs incurred in completing the project, and then adding a predetermined amount or percentage for profit. This means the buyer covers all the seller's legitimate expenses related to the project, plus an agreed-upon profit margin, which can be a fixed fee or a percentage of the total costs.

This type of contract is often used when the scope of work or the exact costs are difficult to estimate accurately at the outset, such as for highly customized projects, emergency repairs, or innovative research and development.

• Example 1: Custom Home Construction

  Imagine a couple commissioning an architecturally complex, custom-built home. Due to the unique design, specialized materials, and potential for unforeseen challenges during construction, the exact costs of labor and materials are difficult to predict precisely at the start. The couple enters into a cost-plus contract with a builder. The agreement states that the builder will meticulously track and provide receipts for all expenses, including materials, subcontractor fees, permits, and labor hours. On top of these documented costs, the builder will add a fixed fee of $150,000 as their profit and overhead.

  How it illustrates the term: This is a cost-plus contract because the final price the couple pays is the sum of the builder's actual, verified expenses (the "cost") *plus* the agreed-upon fixed profit margin of $150,000 (the "plus"). This structure ensures the builder is compensated for all their efforts and expenses, even if costs fluctuate, while the couple gets their unique home built to specification.

• Example 2: Specialized Software Development

  A technology startup needs to develop a groundbreaking new software platform, but the exact technical challenges and the number of development hours required are uncertain. The project's scope might evolve significantly as new features are conceptualized and tested. The startup hires a software development firm under a cost-plus contract. The firm agrees to bill for all developer hours at a specified hourly rate, plus the cost of any necessary third-party software licenses or cloud computing services. Additionally, the firm will add a 20% markup on these total costs as their profit.

  How it illustrates the term: This scenario exemplifies a cost-plus contract because the startup pays for the development firm's direct expenses (developer salaries, software licenses, cloud services) *plus* an additional 20% of those costs as the firm's profit. This arrangement provides flexibility for the project's evolving scope and duration, ensuring the firm is fairly compensated for its actual efforts and resources without having to absorb unforeseen expenses.

• Example 3: Emergency Infrastructure Repair

  Following a severe hurricane, a coastal city needs urgent repairs to a damaged municipal pier. The full extent of the underwater structural damage is not immediately clear, and specialized materials and equipment might be difficult to source quickly, leading to unpredictable costs. The city contracts with an engineering and construction company on a cost-plus basis. The company agrees to document all expenses for labor, materials, equipment rental, and subcontractor services. On top of these verified costs, the company will receive a 12% profit margin.

  How it illustrates the term: This is a cost-plus contract because the city agrees to pay for all the construction company's actual, documented expenses for the emergency repair work (the "cost") *plus* an additional 12% of those costs as the company's profit (the "plus"). This structure is often used in emergencies when time is critical and precise upfront cost estimation is impossible, ensuring the company is incentivized to begin work immediately without fear of absorbing unforeseen expenses.