Cost of the work is the longest definition in a guaranteed maximum price contract and the one owners read last. It decides what the owner reimburses, what the contractor absorbs inside its fee, and how much underrun is available to share at the end.
Why the definition does more than it appears to
A guaranteed maximum price contract pays the contractor the cost of the work plus a fee, up to a ceiling. Three of those terms are numbers. One is a definition running to several pages.
Everything inside the definition is reimbursed at cost. Everything outside it is the contractor’s problem, paid from the fee.
That boundary has two separate effects and owners usually see only the first.
The first is direct. Items inside the definition are paid by the owner. A broad definition costs more than a narrow one.
The second is indirect and frequently larger. Shared savings are calculated as the difference between the guaranteed maximum price and the final cost of the work. Every dollar that counts as cost of the work reduces the underrun by a dollar, and the owner loses its share of it.
So a broad definition costs the owner twice: once in reimbursement and once in the savings calculation, which is the mechanism described in what shrinks the savings pool.
What clearly belongs in cost of the work
Most of the definition is uncontroversial and takes up most of the pages.
Trade contracts and purchase orders. Wages and burden for workers directly employed on the site. Materials incorporated into the work. Rental of equipment. Temporary facilities. Permits and fees required for the work. Site safety. Cleaning and waste removal. Insurance and bonds specific to the project.
None of these is normally argued about, and an owner reading the definition for the first time will find eighty percent of it reasonable.
The argument is confined to a short list of items near the end, usually in a subsection about other costs incurred in the performance of the work, and in whatever appears in the parallel list of costs not to be reimbursed.
Which means the whole exercise is a matter of reading two lists against each other and looking at what is on neither.
The contested items
Home office and off site personnel. Time charged by people not based on the project. Sometimes legitimate for specific functions, and it should be stated as named roles at stated percentages rather than as a general entitlement.
Contractor owned equipment. Charged at internal rates that may exceed local rental rates, and with no external invoice to check against. Capping these at prevailing rental rates is the usual protection.
Rework and correction of defective work. Should be excluded, and the exclusion should be explicit. Where the definition is silent, rework is reimbursed as ordinary cost of the work and the owner is paying to fix mistakes.
Costs arising from contractor negligence or from a trade contractor failure. Same point. An explicit exclusion turns a contingency question into a contract question.
Insurance deductibles and losses within them. Where a builders risk deductible is $250,000 and the contract is silent, the owner frequently pays it as cost of the work.
Legal costs and claim preparation. The cost of a contractor preparing a claim against the owner should never be reimbursable by the owner, and yet a broad definition can be read to include it.
A worked example
Illustrative figures. Not taken from any client project and not a quotation.
A 73 million dollar project with a fee of 3.75 percent and a shared savings clause at 70 percent to the owner.
The definition of cost of the work includes a general subsection covering other costs reasonably incurred, and the list of non reimbursable costs is four lines long.
Over the job, the following are charged as cost of the work: rework and correction of defective installation, $420,000. Contractor owned equipment at internal rates above rental equivalent, $260,000. A builders risk deductible on a water damage event, $250,000. Off site project accounting and purchasing support, $310,000. Legal fees relating to a trade contractor dispute, $180,000.
Total $1.42 million, all of it reimbursed.
The second effect is the savings. Those same charges reduce the underrun by $1.42 million, and the owner 70 percent share of that is roughly $990,000 foregone.
The owner is worse off by $1.42 million directly, and by a further amount in savings it would otherwise have received, against a definition that could have excluded four of the five categories in half a page.
The relationship between the definition and the fee
A contractor negotiating a guaranteed maximum price has two levers: the fee percentage and the breadth of the definition.
Owners negotiate the first hard and the second not at all, which means the negotiation is one sided in a way neither party usually articulates.
A fee of 3.5 percent with a broad definition can be considerably more expensive than a fee of 4.5 percent with a narrow one, because the difference in the definition runs to more than a percent of contract value on many projects.
The clean way to conduct the negotiation is to settle the definition first and then the fee, so that the percentage is being applied to a known basis. Owners who do it in the other order are agreeing a rate before knowing what it is a rate for.
It is also worth asking the contractor what the fee covers, in writing, and then reading that answer against both the definition of cost of the work and the general conditions schedule, since the same item appearing in two of the three is being paid twice, as in general conditions in a GMP.
What to change, in order of value
Five amendments, none of them long.
Exclude rework, correction of defective work and costs arising from contractor negligence, explicitly.
Cap contractor owned equipment at prevailing local rental rates, evidenced.
State who carries insurance deductibles, by policy, with a number.
Name any off site personnel by role and percentage, or exclude them.
Exclude the contractor’s own legal and claim preparation costs in any dispute with the owner.
Those five take half a page and they are agreed without difficulty before signature, because at that point the contractor is competing and none of the five is an item it expects to incur.
After signature all five are live commercial positions and each one is argued on its own, at the moment it arises, when the answer is worth money to somebody.
A sixth is worth adding on projects with a long tail. State that costs incurred after substantial completion are reimbursable only for named closeout activities, so that extended supervision during a slow punch list period does not accumulate as cost of the work against an owner with nothing left to withhold.
That one is usually granted, because no contractor plans to be on site for six months after completion, and it matters a great deal on the projects where somebody is.
Read together, the six amendments take about half a page and they are the highest return half page in the whole agreement. Each one addresses a cost that is entirely foreseeable, that will otherwise be reimbursed by default, and that reduces the savings pool by the same amount a second time.
An owner who negotiates nothing else in the definition should negotiate these.
What we do
We read the definition of cost of the work against the list of non reimbursable costs and against the general conditions schedule, and identify what appears in more than one and what appears in none. Then we write the five exclusions and price what each is likely to be worth on your project, including the effect on the savings pool. That work is part of the readiness review. When the signing date is already close, the Rapid GMP Review covers the largest of these exposures in five to ten working days.
Questions people ask
Is a broad definition ever in the owner’s interest?
Rarely, and where it is, the reason is usually that a narrower one would have produced a higher fee or a larger contingency. That trade is worth making consciously. What is not worth doing is accepting breadth without noticing, which is the usual situation.
Should self performed work be inside cost of the work?
It has to be, since the work has to be paid for somehow. What matters is that it is priced competitively against outside bids and that any margin inside it is disclosed as fee rather than buried as cost. Without that, the contractor is setting its own price.
How long should reading the definition take?
An hour for the definition itself and another for the non reimbursable list and the general conditions schedule alongside it. Two hours is enough to find most of what matters, because the contested items are always in the same few places and the rest of the definition is boilerplate.
This is general information about construction contracts and is not legal advice.