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When it comes to meeting deadlines and budgets, a little bit of a cushion is always a plus for contractors. That could come in the form of some extra time built into the schedule or as additional material that saves the day when, for instance, an inexperienced worker butchers a few pieces of drywall.

The same can be said for extra money tacked onto a project’s budget.

Contingencies are additional line items established above and beyond the expected cost of construction in order to cover unanticipated costs. But one size does not fit all.

Types of contingency funds

There are two basic types of contingencies — contractor-funded and owner-funded, said attorney Quinn Murphy with Sandberg Phoenix in St. Louis.

Contractor-funded contingencies, he said, typically are included in a construction company’s bid in order to pay for potential shortfalls, unknown conditions or other unexpected costs that might render the bid inadequate.

An owner-funded contingency, on the other hand, is money that the owner sets aside — in addition to the amount of the construction contract. This extra bucket of money is meant to help avoid the burden of processing change orders for emergencies and for items that don’t significantly change the scope of work. Murphy said that the contingency in this scenario is typically 2% to 10% of the contract amount.

A timely example of an expense that qualifies as a contingency item is the extra cost of material driven by one of the new tariffs on imported Chinese goods imposed by President Donald Trump’s administration earlier this month.

Not considered a contingency, said attorney Kenneth Fields of Greenberg Glusker in Los Angeles, would be something the contractor missed in the bid or some other mistake that is normally part of the due diligence process before turning in a proposal.

However, it is possible, he said, that an owner would step in with money from the contingency fund to save a project from going off the rails.

If a contractor is underwater financially, Fields said, the question for the owner then could become whether to use the contingency to bail the existing contractor out or use it to make up for the extra costs in hiring a new contractor. "You have to make a business decision," he said, "as to what’s going to be more economical."

Lump sum and cost-plus contracts with a guaranteed maximum price, Murphy said, are the delivery methods where one would likely see an owner-funded contingency, but, really, it can be used on almost any contract type. It’s up to the owner.

A project for which the design is not fully fleshed out, said Tim Hegarty, a partner at the law firm of Zetlin & De Chiara in New York City, is also the type of project where one is likely to see an owner-funded contingency.

"They would need to carry some funds to complete the design and … for potential scope change," he said. "The owner will want to carry funds for … unforeseen conditions and the inevitable project delays. They want to facilitate the construction process going forward without stoppages due to disputes."

But owner-funded contingencies, Murphy said, are also where some contractors can get into trouble. "They view it as accessible by them," he said. "They just don't understand how it's going to work, and so they are really, really lean on their bid because they know there's going to be this contingency out there. Then they get into the middle of the project, and they submit [a claim against the contingency], and the owner rejects it."

Contractors need to understand that a contingency fund is not a "piggy bank," he said, and that the money is reserved for certain circumstances that should be outlined in the contract.

Change order versus contingency

No matter what type of contingency fund is attached to a project — paid for by the owner or included in the contractor’s bid — there can still be a reluctance to classify extra expenses as contingencies.

For contractors, dipping into an owner’s contingency means that there will be less money for emergencies down the road, Murphy said, and using their own contingency funds — now line items in their budgets — will leave them with less cash at the end of the job. The owner also is motivated to resist spending money out of its own contingency fund because any unused cash is returned at the completion of the project.

This is where change orders come into play. In order to keep money in their pockets, Murphy said, contractors might try to submit an extra expense as a change order rather than as a contingency item. For a true change in scope this isn’t a problem, but, at some point the architect and owner have every right to question why the contractor isn’t tapping into its contingency line item for smaller expenses. In that case, they may start denying change orders.

These issues can become even more complicated, Fields said, if the owner is subject to lender rules that restrict how contingency funds are to be used or how much additional capital will have to be invested into the project to cover additional scopes of work.

Crafting a contingency clause

For contractors and construction managers, the key to heading off a dispute starts with the contract. As with most contracts, construction or otherwise, being as specific as possible early on can help mitigate misunderstandings during the life of the project.   

The key questions to ask when defining a contingency include, Hegarty said, are how the contingency will be calculated, what approval rights the owner has and what kind of reporting will be required regarding the money spent.

Splitting what’s left in the contingency fund between the contractor and owner, according to how much each put up at the beginning of the project, can also be an incentive on both sides to approach the contingency with restraint, Murphy said.

Of course, contractors, Fields said, should try to make the clause as broad as possible, allowing the contingency to be tapped for what they deem appropriate.

The American Institute of Architects' series of contracts, Murphy said, offers some of the most favorable language for contractors regarding contingency funds.

"My biggest piece of advice for contractors," he said, "is to thoroughly discuss what the funds are to be used for, how they will be accessed, who controls that decision and the mechanism by which they're controlled so that there are no surprises. You really run into problems with the contingency funds when one party has a view of how they're to be used and the other party doesn't share that view."

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