How to manage cost-reimbursement contracts

Contract process
January 29, 2024
6
min
Cost reimbursement contracts are agreements between two parties that outline how costs incurred by one side will be paid back to the other. 

These are complex contracts that exist in multiple formats, which can make handling cost-reimbursement contracts challenging. Businesses will need to track estimates, project dates, renewals, and more.

Contract lifecycle management software (CLM) can streamline this process and remove complexity. Using a CLM, you can manage these contracts throughout their lifecycle, from template to signature and beyond.

Keep reading to discover what cost-reimbursement contracts are, some practical examples of them, and how CLM can enable you to manage every aspect of your cost-reimbursement contracts more efficiently.

What is a cost-reimbursement contract?

A cost-reimbursement contract is an agreement made between two parties to provide payment for allowable expenses incurred by the other party. The contract stipulates that the buyer is to cover the costs of any work that needs to be completed. These could be straightforward or complex costs. 

Final pricing is set when all work has been completed or by a specific date set out in the contract. Usually, this will be in line with a budget determined by vendor cost estimates which can’t be exceeded without express permission. 

In contrast to a fixed-price contract, where the risk lies mostly with the contractor, a cost-reimbursement contract places risk more squarely on the project owner. However, this doesn’t alleviate all risks, like uncontrolled growth in a project's scope for example. 

Types of cost-reimbursement contract

There are a few different types of cost-reimbursement contracts, all applicable to different scenarios. 

  • Cost contracts. This contract will only require you to pay the amount stated and no additional costs.

  • Cost plus fixed fee. This contract reimburses the contractor for all incurred costs, in addition to a fixed fee. This additional fee is non-negotiable, regardless of how the contractor has performed in the project. This leaves the customer at a higher risk and the contractor at a lower risk.

  • Cost plus incentive fee. This contract reimburses the contractor for all incurred costs plus an additional incentive based on the contractor achieving a predetermined performance objective set out in the contract. The two parties work together to determine the value of this incentive fee, often a percentage of the savings both parties share.

  • Cost plus percentage of costs. This contract ensures the contractor receives full payment for the project and a percentage of these costs. This is a less popular version of a cost-reimbursement contract as it's a higher risk for the owner. For example, there’s a risk that contractors could artificially increase costs to increase their profit. That said, there are more regulations applied to this type of contract to avoid this occurring.

  • Cost-sharing contracts. In this case, the contractor agrees to share some of the contract expenses. It’s then down to the customer to compensate the contractor for a portion of the expenses. 

The aim of a cost-reimbursement contract

Cost-reimbursement contracts exist to protect sellers and maintain stable profit margins. Often, this means that risk is lessened for the seller and pushed onto the buyer instead. 

Profit is more predictable as a result of this. Depending on the type of agreement you choose, each party may have more flexibility when it comes to sharing costs, offering incentives, and potentially reducing the total cost of the project. 

When do you need a cost-reimbursement contract?

Cost-reimbursement contracts should be used for projects that include a significant cost that needs to be shifted onto the buyer. 

This type of contract will help you to forecast the revenue you’ll make from the project accurately. This is a safer bet than taking a risk with cost, as you can ensure you’re going to profit from the project. Ultimately, you’re in control of cost even when you’ve taken a risk on the project.

Elements of a cost-reimbursement contract

It’s important to take into account the requirements of your particular project, such as the type of agreement, the buyer, and the legal jurisdiction you’re operating in. However, no matter what type of cost-reimbursement contract you’re creating, they should all include the following elements.  

Project value

This outlines the exact amount the contractor or seller will be paid for their services on top of their costs. This reflects the true value of the deal for a majority of cost-reimbursement contracts and it should be clear whether it is a fixed number or based on a specific formula.  

Cost estimate

It’s common practice for a cost-reimbursement contract to include an estimate of costs. This should be as accurate as possible from the seller and also outline what happens if the project meets or exceeds this number. Ideally, this would also include stipulations on how to approve additional costs and their payment. 

Coverable costs 

Use this section to clearly outline the type of costs the buyer should be covering. This should be as specific as possible and encapsulate all costs the buyer is likely to incur. If cost sharing is going to occur, the contract should differentiate which party is expected to pay which cost.

Legal specifications 

As with any contract, certain sections are standard such as: 

  • Party info
  • Contact info 
  • Breach of contract clause
  • Date of agreement 
  • Signature box

Alongside others, this provision is necessary to make these agreements legally binding. 

Advantages and disadvantages of cost-reimbursement contracts 

A cost-reimbursement contract has advantages and disadvantages, depending on who you ask. For example, it can put risk on the seller if the buyer falls through on their obligations. Let’s take a look at the pros and cons of this type of contract. 

Advantages 

  • Contractors have little incentive to cut corners which increases security for the buyer

  • These contracts are incredibly useful when the objective is quality over cost.

  • Final costs are typically lower as prices don’t need to be inflated to cover contractor risk

Disadvantages 

  • Costs aren’t set and can be changeable

  • Contract managers need to be vigilant to ensure only those agreed-upon costs are paid

  • If a buyer fails to pay the costs as agreed in the contract, the seller could be out of the value of the deal

  • For certain contracts, a higher level of oversight is needed to make sure that any award or incentive fee is fairly handled

  • In some cases, this type of contract leads to lower incentives for efficiency

Creating and managing cost reimbursement contracts 

The best starting point for these contracts is creating a standardized agreement template using contract management software. This should include all the essentials mentioned above and act as a foundational model for the majority of your cost-reimbursement contracts. 

The template can then be approved by your legal team and populated with drag-and-drop smart fields ready to be filled in with the project-specific details. It's good practice for this template to be adaptable according to individual projects or tailored to meet specific client requirements. 

Let's take a look at this process in practice. 

Managing cost-reimbursement contracts

Like all contracts, cost-reimbursement contracts demand proper management to mitigate risks and prevent negative legal consequences. 

Fortunately, cost-reimbursement contracts adhere to a standardized format, facilitating their management through tools such as Juro.

1. Automate cost-reimbursement contracts

The first step in creating these contracts involves your legal team crafting automated contract templates for commercial teams to self-serve

Templates can be swiftly populated using a natural language Q&A workflow or by extracting data directly from a customer relationship management tool like Salesforce or Pipedrive

This minimizes the need for legal teams to allocate time to low-value tasks such as authoring contracts for standard agreements.

2. Establish contract approval workflows

For higher-value cost-reimbursement contracts, implementing contract approval workflows is essential. 

With a contract management platform like Juro, users can manually set up approval workflows for each contract or automate the process using conditional logic rules. If higher-value contracts necessitate approval from specific stakeholders, this can be incorporated at the template level. 

So, if a cost-reimbursement contract exceeds a predefined threshold, it automatically requires approval before progressing to the next stage of the contract lifecycle, reducing risk.

3. Negotiate contracts in one place

Given the complexity of cost-reimbursement contracts, negotiation is often required before reaching a mutual agreement. In a manual workflow, this can become time-consuming as contracts are moved between platforms like Word and email to be redlined

Juro simplifies this process by allowing users to negotiate contracts within the platform, streamlining communication and collaboration. Automated workflows mean users can share contracts, make amendments, and reach agreements without leaving the platform.

4. Sign cost-reimbursement contracts anywhere

Cost-reimbursement contracts do not mandate wet ink signatures and benefit from electronic signatures. Juro's built-in eSignature functionality empowers legal and commercial teams to sign contracts within the same platform where they were created. This feature is accessible on various devices, particularly beneficial for on-the-go contractors who need to sign contracts while on-site.

5. Track contractual obligations

Managing cost-reimbursement contracts goes beyond signature, especially when it comes to managing complex contracts like cost-reimbursement contracts. From monitoring contractual obligations for compliance to specifics such as ensuring a cost plus fixed fee is paid upon a project completion. 

Juro allows you to monitor your contracts easily by enabling users to search through contracts at speed, as well as setting up contract reminders

Simplify the management of your cost-reimbursement contracts

Juro's intelligent contract automation platform facilitates the seamless creation, execution, and management of routine contracts at scale for all teams. 

To learn more about how Juro can streamline the management of cost-reimbursement contracts for your business, request a demo via the form below.

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