This article originally appeared in the May 16, 2018 edition of the Cascade Business News.
Construction contract allowances are itemized budget estimates that can be useful to help plan for costs of materials that are unknown at the time contract documents are executed, such as fixtures, finishes, or cabinets. They can allow contractors to bid work when the design is incomplete but the project must begin nonetheless. In my experience as a construction manager and litigator, I have often encountered situations where overuse or misuse of allowances leads to disputes and litigation. How can you avoid this risk?
Some degree of design uncertainty is expected for construction projects, especially when construction must begin before the design phase is complete. When this happens, either the contractor or the homeowner must accept the risk of an incomplete design. Contractors, however, should avoid underestimating or hiding the true anticipated project cost with the use of allowances. When allowances must be used, these three guidelines should always be considered to help you avoid uncertainties and risks as much as possible.
1. Restrict allowances to materials only
In order to avoid or minimize disputes related to billing for allowances and related expenses between contractors and homeowners, restrict allowances to the purchase price of materials or finish components only. Do not include any adjunct or related costs, including labor, installation, supervision, permits, inspections, overhead, profit, etc. All of these adjunct costs should instead be included in the base contract price.
Labor costs associated with allowances should especially be isolated because labor costs can vary widely depending on the finish material (i.e., 4 x 4 tile versus 10 x 10 tile). If there is a change to the project scope that causes an increase in labor hours, be prepared to demonstrate how the change will increase labor costs, and follow the contract change order procedure carefully by documenting and presenting back-up costs. Be prepared to explain how the labor estimate related to the particular material anticipated, and how the change calls for an attendant increase in labor costs. This will prevent risk of future misunderstandings and disputes.
2. Itemize allowances
Entering into a lump sum contract with large allowance items may restrict a contractor’s ability to get paid for extra work. A contractor cannot simultaneously agree to a lump sum while also keeping the contract open for interpretation. For instance, using allowances for bulk portions of the project including “landscaping” or simply, “flooring,” can lead to disagreement over scope, time, and cost. By itemizing allowances, and defining them clearly, contractors can minimize disagreements and risk.
Note that while the egregious use of allowances might seem to place the risk on the homeowner for aspects of the project that cannot be finalized in advance, a contractor cannot create a time and materials contract by using allowances.
3. Avoid allowances altogether if possible
Allowances provide a solution when it is not practically or economically feasible to complete design prior to finalizing the contract. However, allowances should not be used as a stand-in for items that should be subject to a hard bid. Do not use allowances simply to put off design for another day. If an item can be a hard bid at the time of contracting in a lump sum contract, then it should be. If the contract contains allowance items for a large percentage of the contract price, then it might be appropriate to separately contract for design services.
In short, don’t use allowances as an excuse for inadequate design. Allowances should be used if needed, for materials only, never for services, design, or building systems.
Allowances are all too frequently used for design uncertainty, rather than material uncertainty, leading to contract risk and disputes. Do yourself a favor and use allowances sparingly or not at all. If you abuse allowance items, you hold the risk.
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