Allowances and contingencies are often confused with one another, but understanding their differences is crucial to successfully executing project contracts.
One simple, yet effective, way to remember these differences is that allowances are the “known” unknowns, such as underground utility conflicts, while contingencies are for the “unknown” unknowns, such as changes in a project’s scope. Allowances are typically used to cover the scope of items where the extent of the work is not known at the time the guaranteed maximum price (GMP) is submitted. On water treatment plant facilities, this unknown work may include the type and quantity of structural concrete repair, underground utility conflicts, or performance coating repairs to name a few. These variances in quantities and types, and therefore price, are typically reconciled with the allowance. Through the change order process, the change order is either added or deducted from the contract price depending on whether the amount of established allowance is exceeded or under-run.
The “unknown” unknown, or contingency, is the dollar amount added to an estimated price that allows for items or conditions that are uncertain and require additional costs. There are two primary types of contingencies: owner- and contractor-specific. Owner contingencies include those amounts reserved for additions to the project’s scope or owner’s risk items, while contractor contingencies are the amounts built into the contractor’s anticipated price for the project to account for contractor risk. Owner contingencies often arise on projects with a GMP, in which the owner funds the contingency, so that costs arising from risks are drawn from this contingency fund until it is exhausted. Any unused funds are typically reverted to the owner or are shared with the contractor.
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A contractor contingency is used when there is a degree of statistical certainty that unpredictable individual costs will arise. Often thought of as “spent money,” this type of contingency is set at a level that balances the desire to have liquidity with the contractor’s need to control risk on a project, such as risks associated with incomplete designs, scope errors, or escalation. The contractor’s contingency exists to mitigate project-related risks for which the contractor is responsible, and it’s critical for parties to not lose sight of the basic purpose of the contractor’s contingency; it should not be viewed as a possible source for project cost savings. Again, any unused funds are typically reverted to the owner or are shared with the contractor.
Early in the preconstruction process, the contracting team should have a detailed risk management discussion to outline the risks associated with the project. During this discussion, the teams should discuss:
- Differences between allowances, contractor contingencies, and owner contingencies;
- Possible risks on the project and how these can be covered through use of the above;
- The agreeable amounts of the allowance or contingency, whichever is chosen;
- What will happen with unused contingency or allowance, or if the contingency or allowance are overrun at the end of a project.
Once the team determines to move forward with a contingency, whether contract- or owner-specific, the clause should:
- Clarify both the owner’s contingency and the contractor’s contingency;
- Describe the types of costs or risks for which the contingency is to be used;
- Determine a process by which contingency is accessed during the project, and the paperwork and approvals needed to use contingency;
- Outline whether there is supplemental funding of contingency, if there is an overrun, and whether or not there is sharing of unspent contingency at project closeout.