Sunday, April 12, 2009

Lump Sum vs Not-to-Exceed Contracts

In negotiating consultant contracts, there two primary payment options: lump sum or not-to-exceed, also known as time and materials.

Under lump sum contracting, it is very important to have a clearly defined scope of work. Without clear expectations in the scope of work, a public agency risks having the consultant return and ask for additional compensation for what should have been included in the original lump sum amount. Deliverables should be articulated in the contract.

Likewise, under a lump sum method, the actual contract (or amendment) should not show specific hours and hourly rates for particular tasks. If this level of specificity is included in the contract and the consultant expends hours beyond those mentioned, they may ask the public agency for additional compensation. The documentation of negotiations and how the public agency and consultant agreed upon the lump sum (tasks, hours, hourly rates) should be part of the file maintained by the agency, but not made part of the contract.

Consultants frequently like lump sum since it gives them the motivation to try to be more efficient and thus make an additional profit. Without a clear scope of work and deliverables, however, a consultant may cut corners on performance. From a public agency's payment perspective, lump sum is easier to administer (not having to check detailed invoices showing hours worked), but it may result in a higher payment to the consultant than if a not-to-exceed method is used.

Under the not-to-exceed method of payment, the public agency agrees to pay the consultant for the actual hours worked to perform the scope of work, up to a maximum amount. Thus, if the work takes fewer hours than agreed upon, the public agency ends up paying less.

Whether to use lump sum or not-to-exceed depends on a number of factors including how detailed and clear the scope of work is, the level of sophistication of the agency in its ability to negotiate a contract amount, and the dollar amount of the work. Lump sum may work well for clearly defined work and deliverables where the agency has the ability to estimate and accurately negotiate the amount of work and the dollar amount is not too large. Bigger contracts with more uncertainty about what work is required, or where the agency really doesn't know the dollar value of the work, may be better under a not-to-exceed method.


Anonymous said...

What if the contract includes elements of both approaches? A contractor agrees to provide security services for a set number of hours per year for a set hourly price (lump sum). But the contractalso includes an additional 10% asa not to exceed amount. What are some of the possible contingencies that would allow th econtractor to invoice at the higher not to exceed levels? Flood, fire, tornado? New union contract rates? Other unforseens?

Mike Purdy said...

Please contact me directly so we can discuss your specific questions.