Choosing Between Fixed Price and Cost Plus Contracts for Safer Builds

Introduction

When embarking on a construction project, one of the most critical early decisions is selecting the right type of building contract. Construction contracts provide the essential legal framework for a project, outlining payment terms, responsibilities, and the process for changes, which is vital for mitigating risks and preventing misunderstandings between parties. The specific type of contract used significantly impacts costs, incentives, and the allocation of financial risk for both the project owner and the builder.

This guide will explore the key differences between the two most common types of construction contracts: the fixed price contract and the cost plus contract. Understanding the distinct benefits, drawbacks, and ideal use cases for each is fundamental to choosing the right option for your project’s unique circumstances. Making an informed decision between a fixed-price vs cost-plus agreement helps ensure your project runs smoothly and stays within budget, leading to a safer and more successful build.

Understanding a Fixed Price Building Contract

Key Benefits of a Fixed Price Contract for Developers

A fixed price contract, often called a lump sum contract, establishes a single, predetermined price for the entire scope of a construction project. This agreement provides developers with significant advantages, primarily centred around financial predictability and risk management.

The key benefits of using a fixed price building contract include:

Benefit	Description
Cost Certainty	Developers gain complete clarity on the total project cost from the outset. This simplifies financial planning and is often required by Australian banks for construction loans.
Risk Transference	The builder assumes the financial risk for unexpected cost increases in materials or labour, protecting the developer’s budget.
Reduced Administrative Burden	The locked-in price reduces the need for developers to meticulously review every expense, minimising day-to-day oversight and stress.
Incentivised Efficiency	Contractors are motivated to manage expenses carefully and complete the project efficiently to protect their profit margin, potentially leading to a quicker turnaround.

Potential Drawbacks & Risks of Fixed Price Agreements

While fixed price contracts offer security, they also present potential drawbacks that developers must consider. The rigidity of these agreements can create challenges, particularly if the project needs to evolve.

Potential risks associated with a fixed price contract include:

Drawback / Risk	Description
Limited Flexibility	Making changes to the project’s scope or design after signing is often difficult and expensive due to a restrictive variations process.
Potential for Compromised Quality	To protect their profits, some builders may be tempted to use lower-cost materials or take shortcuts, which can lead to quality issues.
Risk of Disputes	If changes to the scope of work become necessary, the inflexibility of the fixed pricing can lead to disputes over who bears the additional costs.
Higher Upfront Costs	Builders often include a contingency buffer in the price to cover unforeseen risks, meaning the developer might pay more than the actual cost if no issues arise.

Understanding a Cost Plus Building Contract

Key Benefits of a Cost Plus Contract for Developers

A cost-plus contract can be particularly advantageous for developers managing complex or high-end residential builds where the scope is likely to evolve. This model offers a level of adaptability that is difficult to achieve with a fixed price contract, alongside greater transparency in project spending.

The primary benefits for developers include:

Benefit	Description
Greater Flexibility	Allows for modifications to the project scope and plans, even late in the process, without triggering complex or expensive variation claims.
Increased Transparency	Developers have close visibility over expenditures, with builders typically providing regular, detailed budget reports and invoices.
Reduced Incentive to Compromise Quality	The builder’s profit margin is guaranteed, reducing the incentive to use cheaper materials or take shortcuts, often resulting in higher-quality construction.
Potential for Cost Efficiency	The builder’s margin is often lower than in a fixed-price contract, meaning the developer may pay less if the project proceeds smoothly without unforeseen issues.

Potential Drawbacks & Risks of Cost Plus Agreements

While a cost-plus contract offers flexibility, it also transfers the majority of the financial risk from the builder to the developer. The final project cost is not determined until after completion, which introduces a significant level of budget uncertainty.

Developers should be aware of the following drawbacks:

Drawback / Risk	Description
Potential for Spiralling Costs	Without a fixed price, the final cost can escalate beyond the initial budget, and the developer bears the full risk of these overruns.
Heavy Administrative Burden	Requires active and time-consuming participation from the developer to manage costs by diligently scrutinising all pay applications, reports, and invoices.
Less Incentive for Cost Control	Since the contractor’s profit is often a percentage of total costs, the responsibility for ensuring cost-effectiveness falls heavily on the developer.

The Key Difference Between a Fixed Price & Cost Plus Contract

How Financial Risk is Allocated in Each Contract Type

In a fixed price contract, the financial risk is placed almost entirely on the builder. The contractor agrees to a predetermined price for the entire project, meaning they are responsible for absorbing any unexpected cost overruns. If material or labour costs increase during construction, the builder bears that financial burden, protecting the project owner from budget blowouts.

Conversely, a cost plus contract shifts the majority of the financial risk to the project owner. Under this model, the final price is not known until the project is complete. The owner agrees to pay for:

• The actual costs of labour and materials
• Plus a builder’s margin

This means if expenses escalate beyond the initial estimate, the owner is responsible for covering the difference.

Comparing Flexibility & Cost Control Mechanisms

A significant point of difference between the two construction contracts is the level of flexibility each offers. A cost plus contract provides a high degree of flexibility, allowing project owners to change the scope and design, even late in the construction process. This adaptability is ideal for complex or custom projects where the full scope may not be known from the outset.

Fixed price contracts, on the other hand, are much more rigid. Making changes to the project scope can be difficult and expensive, often leading to disputes over the cost of variations. This lack of flexibility improves them suited for projects with clearly defined plans and specifications that are unlikely to change.

The mechanisms for cost control also differ greatly between these contract types:

• Fixed Price Contract: The builder is heavily incentivised to manage expenses and operate efficiently to protect their profit margin. The responsibility for cost control rests firmly with the contractor.
• Cost Plus Contract: The burden of cost control falls to the project owner. To ensure the project does not exceed its budget, the owner must actively monitor all expenses. This typically involves:
• Requesting and scrutinising detailed expense reports from the builder
• Closely tracking all invoices for materials and labour
• Adopting detailed cost-tracking and reporting systems to manage spending

How to Choose the Right Contract for Your Project

Analysing Your Project’s Scope & Complexity

The nature of your construction project is a primary factor when choosing between a fixed price and a cost plus contract. The level of detail in your plans and the likelihood of changes during the build will guide you toward the most suitable agreement.

Contract Type	Ideal Project Characteristics
Fixed Price Contract	• You have complete and detailed plans, specifications, and expectations before construction begins. • The project is relatively straightforward and of a limited scope. • The likelihood of significant changes or unforeseen issues is low.
Cost Plus Contract	• Large, complex, or high-end residential builds with custom designs and premium materials. • Projects where the scope is likely to change or evolve as construction progresses. • Builds with unpredictable elements, such as renovations or projects on difficult sites.

The adaptability of a cost-plus contract allows for modifications to be made more easily, without the often difficult and expensive variation process associated with a rigid fixed price vs cost-plus agreement.

Assessing Your Financial Risk Tolerance & Trust in the Builder

Your personal comfort with financial uncertainty and the strength of your relationship with your builder are also critical considerations when choosing the right contract. Each contract type allocates risk differently, and your decision should align with your financial goals and confidence in your contractor.

A fixed price contract is designed for those who prioritise budget certainty and have a low tolerance for financial risk. By locking in a single price upfront, you transfer the risk of cost overruns to the builder.

This approach provides peace of mind, knowing that unexpected increases in labour or material costs will not affect your final payment. This makes the fixed price contract a safer option if you require strict cost control.

On the other hand, a cost plus contract is more suitable for developers who are willing to accept a degree of budget uncertainty in exchange for greater flexibility. With this model, you assume the financial risk, as the final cost is not determined until the project is complete.

This arrangement requires a high level of trust in your builder’s ability to manage expenses transparently and efficiently. A positive and collaborative relationship is essential, as you will be working closely with the contractor to monitor spending and make decisions throughout the build.

Important Contract Administration & Legal Considerations

Managing Variations Under Fixed Price & Cost Plus Contracts in NSW

In any construction project, changes to the original scope of work, known as variations, are common. A variation can involve adding work, removing work, or modifying specified materials.

According to the Home Building Act 1989 (NSW), any variation for a residential project must be documented in writing and signed by both the builder and the owner before the work commences. This written documentation is a crucial part of contract administration and must clearly outline:

• The nature of the change
• Its effect on the contract price
• Any impact on the project’s completion date

Failing to follow this process can lead to payment disputes and complicate the project.

The approach to pricing and approving variations differs between a fixed price and a cost plus contract:

Contract Type	Variation Management Process
Fixed Price Contract	• The builder must accurately calculate all associated costs and their margin for the variation. • This calculation must be presented to the owner for approval before proceeding. • If rates are not specified in the contract, costs must be based on reasonable market rates.
Cost Plus Contract	• While offering more flexibility, the builder must maintain transparency. • They need to demonstrate that all costs claimed for the variation are reasonable and directly related to the additional work performed.

What to Look for in Your Building Contract Clauses

When reviewing a building contract, it is vital to scrutinise certain clauses to understand your financial commitments and obligations. This is a key aspect of contract administration that protects you from hidden costs and future disputes.

Contract Type	Clause to Review	Key Considerations
Fixed Price	Provisional Sums	• An estimated allowance for a specific task where the exact cost cannot be determined upfront (e.g., asbestos removal discovered after demolition).
Fixed Price	Prime Costs	• An allowance for specific items not yet selected when the contract is signed (e.g., fixtures and fittings like ovens, tapware, or lights).
Cost Plus	The Builder’s Markup	• The percentage added to the actual cost of labour and materials to cover overhead and profit. You must understand how this is calculated.
Cost Plus	Cost Tracking and Approval	• The contract must outline the process for how costs will be tracked, reported, and approved, including the frequency and required documentation for invoices.

Conclusion

Choosing between a fixed price and a cost-plus contract requires a clear understanding of their fundamental differences in financial risk, project flexibility, and cost control. The right selection ultimately depends on your project’s specific scope, your tolerance for budget uncertainty, and the level of trust you have in your builder.

For specialised guidance on choosing the right building contract and ensuring your project is protected, contact the property law experts at LawBridge. Our team provides trusted conveyancing for property developers & builders to help you make a confident and secure decision for your development contracts.

Frequently Asked Questions