The Not to Exceed Clause: A Contractor's Friend or Foe?

Construction projects are full of uncertainties and it’s common to see costs start to creep past the total amount that was initially budgeted for the project. This is why many contracts include a "Not to Exceed” clause, which defines the maximum amount or “not-to-exceed price” of the project. Often it’s used as a “check valve” so that spending on a project is better regulated and to make sure that any increases in the contract amount go through proper approvals.

We’re going to walk through why not to exceed clauses exist and what contractors need to watch for to protect their bottom line.

What is a Not to Exceed Clause?

A Not to Exceed (NTE) clause is a finite number agreed upon by the owner and contractor for all materials and time in the contract. The owner usually asks for an NTE clause in a contract so they can understand the total risk before greenlighting a project. An NTE establishes a ceiling price that will include all budgetary items including the budget as defined by the construction drawings, line items defined by supplemental design documentation, change orders, and other costs like permit fees.

NTE clauses provide clarity and set boundaries that maintain accountability throughout the entire project. But, while NTE clauses give the owner a buffer for any cost escalations throughout the project, they also shift more risk onto the contractor. To protect their bottom line, contractors will often add additional project float costs which will inflate the NTE limit. 

While the NTE cost will be higher, it still limits the project budget’s ability to grow exponentially without any cap or further approval to raise the limit and gives the owner a clear understanding of their risk. In the end, an NTE clause encourages contractors and owners to collaborate together throughout the project to find cost-effective solutions as they are both aware of total costs.

As a contractor, check your contract for a ‘cost-sharing rider’ which is intended to incentivize you to save money versus trying to get as close to the NTE cost as possible. 

Types of Construction Contracts the NTE Clause Applies To

An NTE clause is typically used in two types of contracts: Guaranteed Maximum Price and Time and Materials.

Not to Exceed Clause in Guaranteed Maximum Price Contracts

A guaranteed maximum price (GMP) contract sets the maximum price for a project and is often used when there is a well-defined scope of work. 

The costs for a GMP contract are typically split into three buckets. First are the actual costs incurred for the project, including all items from the construction drawings, soft costs, and any logistical costs. The second is either a fixed fee of profit or a percentage fee of profit that will be paid to the contractor. Finally, the third bucket is the NTE cost which will account for any cost overruns, delays, etc. which can’t be predicted but can be estimated. To protect yourself from going beyond the NTE cost and eating into your profit, you must include a markup that you feel outweighs the risk associated with unaccounted-for expenditures. 

Not to Exceed Clause in Time and Materials Contracts

The second type of contract where you’ll often see NTE clauses is in a time and materials contract. In a time and materials (T&M) contract, the project owner will pay you for all your time (labor) and material costs, plus a markup for the project

T&M contracts are open-ended in nature and a not-to-exceed clause protects the owner from runaway costs. On the flip side, it can negatively affect your profit, because when scope gets changed/added, this not-to-exceed clause may not always be increased. The language inserted into this part of the contract needs to not only protect your markup/profit but should make the project scope very clear so that future changes can be fairly negotiated.

How to Determine the NTE Amount

Much of the risk here falls on you as the contractor. Follow these tips to keep your job under the ‘not to exceed amount’ and protect your profit.

• Price out all time and material for the job. If the scope is unknown or vague, make sure to include a healthy allowance or wording in the contract that clarifies what is not included in the contract sum.
• Due to the volatility of rising costs, include an allowance (this could be a flat percentage across the board or individual costs per line item) for varied pricing of labor and materials.
• Calculate your daily/weekly/monthly churn (staffing, human resources, logistics, etc.) and add a clause in the NTE language that addresses what happens if a cost is incurred because a project extends past a defined duration.
  • This type of clause is crucial for you to include in a contract with an NTE, because it protects you from unforeseen delays. From the weather and supply chain issues to labor disputes and delayed payments, the construction industry is full of unpredictable challenges. You must account for all potential delays on the job site as they can quickly eat into your profit. 

Positives and Negatives of Using an NTE in a Construction Contract

Most of the benefits of an NTE clause are for the owner, but it's important that you understand what they're getting out of it and the goals of having one in the contract.

Benefits: 

• Guards the owner against unexpected overrun prevention.
• Ensures transparency and accountability in budgeting.
• Motivates parties to find cost-effective solutions if cost-saving measures are included in the contract.

Potential Pitfalls:

• Determining the actual cost of the NTE can be challenging as you have to account for a multitude of factors.
• Risk shifts to the contractor for any overages above the NTE as the added sum may not cover all potential contingencies.
• When the scope is not well-defined, including an NTE in a contract is highly problematic for the contractor.

Since the NTE clause decreases the owner’s risk, a contractor must be confident that they have taken into account all contingencies as the budget cost is capped.