Cost Plus Percentage of Cost Contracts
Q. FTA Circular 4220.1F references the Common Grant Rule prohibition on the use of the cost plus a percentage of construction cost contracts.
- Question 1. Is this only for construction projects, since my project concerns rolling stock purchase with possible changes to the car?
- Question 2. If Grantee directed a change to a contract where cost cannot be ascertained at the time of Grantee's directed change, wouldn't it make sense to reimburse the contractor for their cost plus overhead and profit to make them whole? Is that permitted?
We are buying rolling stock and have a contract clause for grantee directed changes that provides that grantee will reimburse for the actual cost plus overhead and profit. It is intended for regulatory design changes (e.g. ADA, FRA) in the car that is being manufactured since it is very difficult to forecast what costs are involved in a redesign. In the contract provision, overhead and profit has a % cap. Overhead is subject to audit to ensure that they are not charging more overhead then they actually incur (but they cannot charge more than the stipulated cap), and profit is negotiated (but not to exceed the stipulated cap). We want to ensure that this contract provision is not violating FTA regulations.
A. The prohibition concerning cost-plus-percent-of-cost (CPPC) contracting applies to all contracts, not just construction contracts. Your contract clause would not violate the CPPC prohibition if it merely places a cap on the overhead and profit rates that will be negotiated on future change orders. The important point is that the overhead and profit rates not be fixed in advance, so that the grantee is bound to pay actual costs plus a pre-determined rate for overhead and profit. These rates must be negotiable and the overhead rate that is negotiated should be "provisional," and subject to later audit where it will be adjusted to an actual overhead rate. You are, however, allowed to put a cap on the overhead rate so that the final rate payable will not exceed the cap even if the audited rate should be higher than the cap. (Revised: October 2010)
Q. Is the contract outlined below a cost plus percentage of cost contract, even if the modifications show a target cost, base fee and maximum available award fee?
- Cost plus award fee contract. 8 percent base. 7 percent award fee.
- Contract ceiling $508 million. Contract grows due to scope changes over a six-month period to almost $1 billion.
- Agency continues to pay the award and base fees on the increased cost at the original percentage rates.
- First 20 of original contract modifications do not restrict or provide either a target amount for the base or award fee. Contract modifications thereafter contained an identified scope of work and target cost, base fee, and maximum available award fee. These fees, of course, were calculated using the predetermined rates.
A. It is not uncommon to negotiate a profit or fee rate on changes or added scope using the negotiated percentages in the original contract. This is not the recommended approach but it is not prohibited. The additional fee should be based on such matters as the degree of risk in the added work, the amount of investment, the percentage of work subcontracted, etc. The award fee cannot be a percentage of cost.
However, it is important to distinguish between using ("negotiating") projected/ estimated costs vs. actual costs in arriving at the profit or fee dollars. If the agency is using the Contractor's projected/estimated (proposed) costs as the basis to negotiate fee, then this is not a CPPC situation. If, however, the agency uses actual costs (i.e., after the costs are incurred) as the basis to establish fee, then we would have a "de facto" illegal CPPC situation (this principle has been established by the GAO on Federal contracts). We would also note that it would not be legal to establish terms in a contract that promised to pay the Contractor for actual costs incurred plus a predetermined rate of profit on those costs. This too would be a CPPC contract. The fee payable must always be expressed and fixed in the contract in $ terms, not % terms, so that if the Contractor overruns the estimated costs in completing the statement of work, there must be no additional fee paid on those cost overrun $. The fee to be paid for completing the scope of work must be fixed and payable regardless of how much it actually costs the Contractor to finish the work.
If the agency is treating all cost growth as fee bearing $, they should document the file to explain that the Contractor in fact completed the scope of work originally established, so that it is clear that the additional estimated costs, and fee negotiated, are associated with "new" or "changed" work as defined in the contract modifications. (Reviewed: October 2010)
Q. For an A&E contract, vendors typically provide a calculation of overhead (e.g., 1.45) and profit. The Best Practices Manual indicates that for construction and T&M related contracts, one is not to use cost plus percentage of cost arrangements. Does that apply to A&E? If so, how is one able to determine the overhead markup without having the calculation?
A. We believe you are confusing how contract prices are negotiated with how contract payment terms are structured once they are negotiated. Contract prices for A&E services will almost always be negotiated on the basis of a cost proposal from the A&E that presents estimated costs for labor, overhead as a percent of labor costs, travel, etc., plus an amount for profit or fee that is usually expressed in the proposal as a percent of total estimated costs. The grantee will then evaluate the proposed labor costs, overhead rates and profit rates for reasonableness, and negotiate either (a) a firm fixed price contract (to include all costs and profit), (b) a cost plus fixed fee (CPFF) contract where the contract value includes an estimated cost amount and a fixed amount of fee dollars, or (c) a time & materials contract that provides for a fixed billing rate per hour for various labor categories that includes all costs and profit. Using rates to negotiate overhead and profit does not result in a cost plus percent of cost (CPPC) type of contract.
Cost plus percent of cost (CPPC) contracts may never be used for any procurement, whether construction, A&E, etc. A CPPC contract is one that is structured to pay the contractor his actual costs incurred on the contract plus a fixed percent for profit or overhead (that is not audited/adjusted) and which is applied to actual costs incurred. When negotiating contract prices grantees will always have to obtain overhead rate information and evaluate those rates. Negotiating contract prices on the basis of those rates does not result in a CPPC contract unless the actual payment terms are structured on a CPPC basis. As explained above, the three allowable forms of contracting (fixed price, CPFF and T&M) do not use CPPC methods of compensation even though overhead and profit rates are used to negotiate those contract values.
Note that the fee to be paid on the CPFF contract is fixed in terms of dollars and is not expressed as a percent to be applied to actual costs incurred, which would constitute an unallowable cost plus percent of cost (CPPC) contract. As for compensating overhead costs, the CPFF contract may stipulate a provisional billing rate for payment purposes but must also provide for an audit of overhead costs after completion of the contract and adjustment of the amounts billed during contract performance to reflect the final audited rate for the fiscal periods during which the contract was performed. Grantees may not fix overhead rates on CPFF contracts without allowing for audit and adjustment after audit as this would constitute a cost plus percent of cost method of compensation. (Posted: March, 2012)
Q. Does a 10% "processing fee" added to the cost of a subcontract transform a contract into a Cost Plus Percentage of Cost Contract? Our vendor for an AVL/CAD system is subcontracting for wireless data services on behalf of RFTA for 5 years. RFTA will pay the vendor the actual cost of the wireless data services through its contract with the vendor. The vendor will pay the wireless data service provider for all actual wireless data costs and wants to charge RFTA a 10% "processing fee" on top of actual costs for wireless data services. The 10% "processing fee" will not be charged on work performed by the Vendor; it will be charged on costs incurred through a subcontract with the wireless data service provider.
A. It is commonplace for a prime contractor to add a fee/profit markup to subcontracted work. However, 10% would be considered excessive by almost any standards. In fact 10% would be the fee expected for work performed by the prime contractor itself. A fee markup of about 3% would be more common on subcontracted work. You should do some market research to determine what has typically been paid by other public agencies on competitive procurements for similar services. To avoid an impermissible CPPC contract arrangement, you must negotiate a fixed amount of fee dollars with the prime contractor for all work on the contract, including subcontracted work (i.e., a cost-plus-fixed-fee contract). The fee dollars would be negotiated, of course, based on the prime contractor's estimated contract costs as agreed upon with your agency. You must NOT structure the contract payment terms to stipulate a fee percent to be applied to the prime contractor's after - the - fact, actual incurred costs. This would be an impermissible CPPC contract. (Posted: June, 2012)
Q. Invariably, we encounter unforeseen site conditions on some of our construction projects. Typically, we require the contractor to submit a pricing proposal within 30 days and we allow them to continue work so that the project can stay on schedule to the extent possible under the circumstances. How do we limit our cost exposure without agreeing to a cost plus percentage of cost situation which we know is illegal?
A. FTA rules allow for Time and Material type contract when they are the only feasible contract type that can be used. In this case we would say that T&M contract change orders should be issued. The change order would include a “not to exceed” (NTE) dollar limit. The contractor would be required to submit a proposal within 30 days, which would be negotiated on a lump sum basis if possible. If lump sum is not feasible, the change order would be settled as a T&M change, again with a NTE dollar limit. We would also suggest the contract contain T&M rates at the inception, which would then allow for the circumstances you mention. (Posted: February, 2013)
Q. How can we avoid CPPC contracting when the change order being issued requires work that is not quantifiable and thus impossible to price with any degree of accuracy?
A. The Federal contracting remedy for these types of situations would be a Cost Plus Fixed Fee or a T&M form of compensation. The CPFF approach is preferable since it fixes the contractor’s fee (profit) in dollar terms in advance, thus removing any incentive to spend additional dollars in order to negotiate a higher profit at the end of the job. T&M is also allowable under Federal rules but only when all other forms of contracting are not feasible. It is not acceptable to issue an un-priced change order and wait until all or virtually all work and costs are complete before negotiating. The Comptroller General has determined that this practice is in fact a CPPC contracting method. (Posted: March, 2013)
Q. Is it permissible for a grantee to use standard AIA contract clauses that require payment of fixed multiple on actual costs incurred?
A. The AIA payment provisions violate the prohibition against CPPC contracting and may not be used on FTA funded contracts. (Posted: August, 2013)