Sunday, October 7, 2012

“Not to Exceed” versus “Guaranteed Maximum Sum”

In cost plus contracts,either of the above terms may used. What is the difference between the two terms?

When you write a contract that includes a not to exceed amount, the supplier or contractor is required to stop all work once that not to exceed amount has been reached. The problem is that the work itself may not be fully completed and the supplier has no obligation to complete it unless you increase the “not to exceed” amount. A “not to exceed” amount is established by the buyer. Under a not to exceed amount the supplier or contractor has no responsibility to manage the costs as they will get reimbursed for all cost and they aren’t guaranteeing the work will be completed for that amount.

When you include a guaranteed maximum sum in the contract, the supplier or contractor is required to complete the work. The agreement is still a cost plus type of agreement, but the supplier or contractor needs to manage those costs so they can complete the work at no more than the guaranteed maximum sum. Guaranteed maximum sum amounts get negotiated between the parties and may include incentives for the supplier or contractor to deliver the work for less than the guaranteed maximum sum. If the work is not completed and the guaranteed maximum sum amount has been reached, the supplier or contractor has to pay for any additional costs to complete the work.

Since in either case it’s the buyer’s money that is being spend, the decision on which approach you use will impact the amount of time you spend managing the supplier or contractor. If you select a not to exceed approach you need to spend more time managing the supplier or contractor as their performance can cause you to need to spend more money to complete the work. If you select a guaranteed maximum sum approach you can spend less time managing the supplier or contractor as you have established the total amount you will pay and if incentives were build in for a sharing of the savings you will pay less.

In some situations you could potentially use both approaches. For example if the work wasn't fully defined you could start the work on a cost plus basis and include a not to exceed amount. Once the work is fully defined you could then negotiate a guaranteed maximum sum commitment.

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