ConstructionPro Week, Volume: 2 - Issue: 4 - 01/25/2013

Are Cash Allowances a Solid Contracting Practice?

By Bruce Jervis

 

A “cash allowance,” or more formally “stipulated allowance,” is an amount stated in a fixed-price contract which is attributable to a discrete element of the work. If the actual cost of that work exceeds the allowance, the project owner is responsible for the overrun. If the cost is less than the allowance, the owner receives a credit.

 

Allowances can be useful. They provide owners with flexibility while maintaining the predictability of a fixed-price contract. Allowances can also accommodate an element of the work which is still ill-defined. But the excessive use of allowances is a formula for dispute. This was illustrated in a recent Indiana case.

 

The contract for construction of a commercial building stipulated allowances for broad swaths of trade work; for instance, $175,000 for electrical work and $139,000 for plumbing. It was not surprising that the parties disputed matters such as responsibility for overruns, advance written notice of overruns, and adjustment of the fixed price when applying for payment.

 

It is one thing to stipulate an allowance for, say, transformers. This would allow the project owner to later make a choice of equipment. But to stipulate a large sum for all of the electrical work is an indication the project design is not at a point where it can be appropriately priced on a lump-sum basis.

 

What is your opinion on the use of allowances? Does the practice merely provide cover for poorly defined work and lead to excessive disputes? Or is it a legitimate and useful contracting tool? If the latter, what procedures or limitations would you impose on the use of stipulated allowances? I welcome your comments.

 

COMMENTS

Yes the practice does provide cover for both the Owner and the Contractor for poorly defined work. If misused, it will lead to dispute, probably more along the deduct line. As an Owner, we seldom use bid allowances. When we do, it is generally for installation of a piece of equipment we are providing or for one - maybe two items that are either not yet fully designed or a concrete bid is not avaialable. We would never consider using it for undefined major or minor subcontracted work.
Posted by: Tom Burrows - Friday, January 25, 2013 10:37 AM


We use allowances for assumed quantites of work items when exact quantities cannot be determined during design, such as for roof deck repair, brick replacement, etc. When coordinated with unit prices stated on the Contractor's bid form, there is a sound basis to adjust the cost to the actual quantity needed.
Posted by: Dennis Porcelli - Friday, January 25, 2013 11:14 AM


IMO, allowances should be used very carefully. As implied by Mr. Jervis, overuse and misuse can lead to disputes. And, allowances should never be used for labor or installation because monitoring/controlling these costs is impossible from the client’s perspective.

In an environment where the client wants to proceed with the contract and get started with construction before documents are 100% complete, it would not be unusual for the design team and the CM or GC to identify numerous items such as finishes which are not yet selected by the designer and approved by the client. In this team atmosphere, where all the parties are motivated to get started everyone will discuss the intended level of quality and establish a reasonable allowance for: carpeting, door hardware, wall coverings and possibly lighting, plumbing fixtures etc. Then, later in the design process, the designer and the client will make the actual selections. It is far too easy for the quotes to come in “right at the allowance” and of course, if the quotes are above the allowance, the contractor will politely advise the team of the added cost. Credits going back to the client are often negligible.

My recommendation is for the designer and client to identify the level of quality desired as early in the process as possible. The specifications need to reflect a minimum of three selections (complete with make, model# and desired finish; not just “or approved equal”). Of course, it is not unusual for the client to have a preference. At the time of bid (or quoting the actual cost when addressing allowances) the CM or GC should be required to submit the cost of each selection. Now when the client prefers one product over another, they will know the cost impact. It is important that the GC, the subcontractors and vendors not know the true selection of the item until after the quotes are in. And, keep in mind that pricing provided by manufacturers, vendors to designers is often radically different from pricing provided to the subcontractor. For instance, one plumbing sub may be a high volume dealer with American Standard, whereas another may be working closely with Kohler. As a result, the pricing levels will be different. Furthermore, OH&P percentages may be different between contractors and vendors.

Unfortunately, construction is a contentious industry. Avoiding use of allowances will reduce the opportunity for these disputes. When allowances are deemed to be fitting for the circumstance, diligent management of the process is appropriate.


Posted by: Steve Pick - Friday, January 25, 2013 12:07 PM


Allowances are, just as you say, a way of accommodating poorly defined work. Allowances are also used as a way for owners to shop the work with the GC and, in effect, negotiate small portions of the work. The potential impacts of this, if abused, on project planning and scheduling are obvious. Contract type has a lot to do with this practice it would seem. For instance, in my experience there is much lower frequency of allowances in CM, DB and IPD contracts. As an architect, I generally tried to limit or eliminate allowances where possible and to certainly not use them as a substitute for proper performance.
Posted by: Marshall Wilson - Friday, January 25, 2013 1:33 PM


Allowances should be used exclusively for finite materials and products.

It should not be used for labor charges or any other potentially thumb-on-the-scale aspects of a project.
Posted by: Morton Frank, FAIA - Saturday, January 26, 2013 11:13 PM


In the FIDIC form of contract (which is the most commonly used contract type used in our region)allowances are called 'provisional sums'. They are indeed, typically used to cover poorly defined work or for procurement & installation of as yet undefined or unspecified equipment. Based on previous experiences, my approach has usually been to design or specify the work or equipment in question and have the contractor provide a separate quote for this work. Pursuant to negotiations on the price, I then perform an 'add & omit'; a change order is prepared removing the provisional sum (allowance) and the firm lump sum amount is added to the contract sum. This goes a long way to mitigating against disputes. The caveat is that it sounds a lot easier to perform than it actually is, but this approach does reduce the likelihood for disputes. In any event, allowances are a last resort. IMO.
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