Misuse of contingencies in construction: when is the limit reached?

In construction practice, preliminary estimates are indispensable. They offer flexibility for parts of the work that are not yet determined in detail at the time the contract is concluded or depend on the client’s choices. But what if a contractor uses set items to cover its own uncertainties or risks, unrelated to the client’s choices? On Feb. 28, 2024, the District Court of Northern Netherlands ruled on just such a case, with the contractor getting the lid on it.

What is a contingency again?

A contingency is an amount that is included in the construction contract as a preliminary estimate for an as-yet unspecified part of the work. Think of plumbing, paving or the kitchen layout. The amount of the provisional estimate is often estimated on the basis of experience, but is emphatically indicative and not definitive: the actual costs depend on choices made by the client or circumstances that are not yet known at the time the contract is concluded.

Alternatively, the estimate can be “used” as a guide price. This is the case if the work is objectively determinable, where there is little freedom of choice for the client, for example, making a foundation in accordance with the issued specifications. In that case, the main rule is that the costs may not exceed 110% of the submitted estimate.

The case: contingency as a hedge against contractor risks

In this case, the contractor had included a large number of provisional sums, including for more installation work, with the motivation that not everything was yet known about the technical requirements. Gradually it turned out that certain work turned out to be much more expensive than the preliminary estimate allowed. The contractor charged the client for these overruns, without the client having made choices that justified the higher costs.

The client opposed these costs, and successfully. The court determined that the adjustment item had been misused in this case: the amount had not been included for work that depended on the client’s wishes or choices, but as a safety net for unforeseen circumstances on the contractor’s side. That is not what adjusting items are for.

The court was crisp and unrelenting:

“A preliminary item is intended for parts of the work whose nature or extent still depends on later choices made by the client. A preliminary item is not intended to cover uncertainties or risks of the contractor himself.”

In other words, a proposal item may not serve as a disguised part of the work on a directional basis. If the contractor foresees risks (such as ambiguity about subsoil, installations or permit requirements), he must either include them in the contract price through a mark-up or make arrangements based on more/less work.

In this case, the court refused to consider the additional costs as additional work. Thus, the client did not have to pay the excess. The contractor’s claim was rejected. This is partly because the contractor did not record the agreements that would show the additional work. Had he done so properly, the outcome of the case could have been very different.

Conclusion: contingencies are not a shadow budget

This ruling shows that in construction, preliminary estimates are not legally optional. They must have a clear relationship with choices made by the client. Uncertainties on the contractor’s side do not belong therein and must be regulated through a different regime. By making this distinction sharply in contracts and execution, you as an entrepreneur avoid costly surprises.

Advice

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