Determining ‘cost of construction’ in the absence of construction

LAW
Werner Sabo, FAIA, CSI, and Shawn Goodman
The traditional way architects set their fee is to base it on a percentage of the “cost of construction.” Many form contracts, including B101-2007, Owner−Architect Agreement, developed by the American Institute of Architects (AIA), provide this method as one of the possibilities. However, there can be a host of problems with a fee based on a percentage of construction cost.

For instance, in a recent case handled by the authors’ office, the contract (an AIA B141-1997, Standard Form of Agreement Between Owner and Architect with Standard Form of Architect’s Services, with similar provisions to the B101-2007) provided the architect’s:

compensation shall be computed as follows: Lump sum of 5% of construction cost.

The architect submitted monthly invoices that reflected a total fee, based on an estimate of the anticipated cost of construction, and a “percent complete.” Doing the math yielded the amount due then, on each invoice.

Importantly, the invoices did not expressly state what the estimated cost of construction was. In fact, the estimate itself, which never changed, was only verbally presented at a meeting with the owner, and was never actually reduced to writing. Each invoice was generated based on this estimate, and anyone reading them could back the estimated amount out of the “total fee” which also never changed. For the architect, this made perfect sense and everything was clear.

Unfortunately, the project was never bid. The architect was nearly done with construction documents, but received only one payment from the owner before the project was abandoned. When the owner refused to pay the balance of the fee, a demand for arbitration was filed and hearings were held. Due to the lack of actual construction or even bidding, the owner defended the architect’s claim by arguing that, under the contract, no damages could be awarded. After all, in the absence of any real construction costs, how could one determine the architect’s fee, which was supposed to be a percentage of those costs?

Instead, the owner argued, the architect should be limited to “equitable” damages, basically the “value” of the services provided. Not surprisingly, the owner placed little value on those services, maintaining the architect was not entitled to the amounts invoiced.

Luckily, while the contract did not define “construction cost,” it did define “cost of the work:”

The Cost of the Work shall be the total cost or, to the extent the Project is not completed, the estimated cost to the Owner of all elements of the Project designed or specified by the Architect.

The Commentary on AIA B141-1997 also very helpfully provides, in pertinent part and with emphasis added:

As the project develops from ideas into reality, various elements of cost will inevitably change and become more certain. The definition of cost of the work takes these changes into consideration. During design, for example, the barometer of cost will be the architect’s estimates. Once a contractor’s bid or proposal is accepted, this supersedes the architect’s most recent estimate. Next, the cost of the work is as defined in the owner-contractor agreement as revised by contract modification during construction. When final completion is achieved, the cost will be the total cost paid by the owner for the work.

Because the architect used the term “construction cost” as opposed to the defined term “cost of the work,” the owner argued these were different terms entirely. Fortunately, the arbitrator agreed with the architect and awarded the unpaid amounts. This did not sit well with the owner, who tried, and failed, to have the courts overturn the arbitrator’s award.

There are several important lessons to be learned from this case. First, parties should take care to make sure the terminology used (e.g. “construction cost” as opposed to “cost of the work”) is consistent. Had the contract at issue simply used the defined term, “cost of the work,” rather than the undefined term, “construction cost,” the owner would not have been able even to try to sow confusion over whether, or to what extent, the two differed from each other.

Second, the architect should have anticipated the possibility the project would terminate before an actual construction cost is determined. This could be accomplished by writings establishing an agreed-upon construction cost estimate that may change from time to time. The owner and architect would agree that estimate (which is clearly set and understood by the parties) would serve as the basis for the fee until such time as the contractor is hired for a set cost. Even then, the cost will likely change for various reasons until final completion. The owner may balk at paying the architect more simply because the cost of materials goes up, and will demand a credit from the architect if the cost actually goes down (even if the architect had to do extra work to save that money).

This leads to the authors’ final suggestion—fix the architect’s fee at some appropriate time, such as after the design development phase. A lump-sum fee is easier for most owners to understand and eliminates many issues down the road. Any changes to the design will then be additional services not based on construction costs. If the project is abandoned, the architect will be entitled to its fee based on how far along the architect’s work actually progressed.

Werner Sabo, FAIA, FALA, is an architect, attorney, and partner at the Chicago law firm, Sabo & Zahn. He is the author of Legal Guide to AIA Documents, now in its fifth edition, published by Wolters Kluwer. Sabo can be reached at wsabo@sabozahn.com.

Shawn Goodman is an attorney at Sabo & Zahn. He can be reached at sgoodman@sabozahn.com.