Expanding Your Contractor Business: Time & Materials Contracts Posted on Feb 01, 2019
Sometimes contractors desire to take on projects when it is impossible to get an accurate estimate of the total project cost, the schedule cannot be defined or changes are likely to be requested during construction. In these situations, figuring out the appropriate cost for estimating the project carries significant risks and limitations for the contractor because the project scope or timeline is uncertain. Time and materials contracts (“Time & Materials Contract”), also called “cost plus contracts,” provide a solution for contractors in this situation as they allow contractors to ensure that all of their costs are covered while working on the projects.
Under T&M Contracts, the contractor gets paid for their direct costs to complete the project plus a markup for overhead and profit. The markup can be a percentage of actual costs or a fixed fee based on the contractor’s initial cost estimate. These types of contracts are typically considered to be the highest risk for the owner and the least risk for the contractor who generally gets paid as long as they keep working. Evenso, some owners prefer time and materials contracts because they provide complete transparency into the contractor’s costs given that the owner will be verifying invoices and timesheets. Additionally, T&M Contracts can include a “not to exceed” budget to establish a maximum project cost and incentive for the contractor to work efficiently. The owner might even save money if the project is completed earlier than expected. Some owners also like that the profit on a T&M Contract is predetermined and fixed. This sets a bar on how much profit the contractor can build into the total project cost. From the contractor’s perspective this might prove disadvantageous if they don’t calculate a profit margin that adequately covers their fixed costs.
Most contractors take projects on a time and materials basis at times, so it is important to be aware of the risks and limitations of these types of contracts. One of the most important limitations for contractors in California and other states with respect to time and materials projects is that T&M Contracts are illegal with homeowners. For instance, there is no provision under California law for time and materials contracts in home improvement projects. Time and material agreements with homeowners in California violate legal subsection guidelines that are required for home improvement contracts such as start and stop dates, a firm payment schedule that specifically references the completed work and a total or fixed contract price identified when payments are made that directly relates to work that has been completed. Thatsaid, there is still room for T&M Contracts in California as these rules don’t apply to contracts between contractors and businesses or to subcontracts between a home improvement contractor and its subcontractors and suppliers.
The key provisions to negotiate in T&M Contacts are the labor rate, any material markup, possibly adding a "not-to-exceed" budget or maximum labor hours, and the definition of billable hours. The labor rate specifies a fixed rate for all labor, including administrative personnel. When using T&M on large projects, contractors usually offer discounted labor rates to reduce the total project cost. T&M contracts typically include a markup of 20 to 35 percent on wholesale material costs. Not-to-exceed amount provisions provide a cap that represents the maximum amount that can be charged by the contractor no matter how long the project takes or how high the materials costs run. T&M Contracts can also set a maximum number of labor hours, and if the contractor exceeds a specified amount of labor hours, the additional hours cannot be recovered. Owners and contractors should negotiate these terms when using T&M Contracts as a tool for constructing projects when the project scope or timeline is uncertain.