New Development on Cost-Plus Contracts in Iowa

October 8, 2019

By Rhiannon K. Baker

Introduction to the Case

Business group meeting to sign a construction contractCost-plus contracts are common in the construction industry, and a recent case in Iowa will have significant implications for business practices in that industry.

In September 2019, the Iowa Court of Appeals issued a decision on a dispute involving a cost-plus contract in Olmstead Constr., Inc. v. Otter Creek Investments, LLC, 2019 WL 4678167 (Iowa Ct. App. 2019). The project owner, Otter Creek Investments, entered into a cost-plus contract with Olmstead Construction to build a convenience store and gas station.

After receiving invoices submitted by Olmstead, Otter Creek requested documentation substantiating the billed costs. Despite the request, Olmstead Construction did not provide the requested documents and therefore Otter Creek did not pay the invoices. Olmstead Construction thereafter filed a mechanic’s lien and filed a lawsuit claiming breach of contract and foreclosing the lien.

The Court’s Decision

Prior to this case, there had been no Iowa case addressing whether a cost-plus contract required the contractor to justify the expenses billed on a project. In analyzing the nature of a cost-plus contract, the Iowa Court of Appeals noted that a cost-plus contract “demands that the contractor maintain accurate and detailed expense records” which “allows the owner to check on the contractor’s expenditures.”

The court concluded that “any contract requiring an owner to reimburse a contractor’s costs implicitly allows the owner to approve the contractor’s accounting system and audit contract costs and pricing data.” As such, “if the owner disputes the billing, the burden is on the contractor to prove ‘each and every item of expense,’” and the contractor has the “duty … under a contract on a cost-plus basis to keep adequate records to justify the actual costs reported and further to keep the usual documents to substantiate its claims for reimbursement.”

The court held that because Olmstead Construction did not provide Otter Creek with the requested documentation substantiating the costs, Otter Creek was not required to pay the disputed invoices, and its failure to pay those invoices did not constitute a default under the contract. View the full opinion here.

Takeaway

The case serves as a warning to contractors to keep “meticulous cost records” or risk finding that their expenses are not reimbursable. The court also noted that it was insufficient for costs and expenses to be based on estimates or approximations.

Those in the construction industry need to heed the court’s warning and be sure to keep detailed records substantiating all costs. Not only is that a good business practice in general, but it is now a legal requirement in Iowa for contractors to be entitled to payment.