Prime Costs and Provisional Sums, why a lump sum allowance is not enough

How often have you heard a builder or owner say, “We’ll just put in an allowance for that and figure it out later”? But what if you actually build the home and get to the end of the works and then the owner turns around and says, “Well actually, the Domestic Building Contracts Act 1995 (Vic) (DBC Act) prohibits you putting in a provisional sum or prime cost item in a manner inconsistent with Division 4 of the DBC Act, and therefore you’re not entitled to payment for those items.” And they’d be 100% right! So, before you put in any allowances, prime costs or provisional sums make sure you have an understanding of your legal obligations. In practice these terms are often confused, or sometimes builders use a simple term to cover both, for example ‘allowance’.  Regardless of the terminology used by a builder or owner, the treatment of these items in the building contract is what’s important to ensure a builder can charge the costs.

What is the difference between a prime cost item and a provisional sum?

A prime cost item is defined in s3 of the DBC Act as ‘an item (for example, a fixture or fitting) that either has not been selected, or whose price is not known, at the time a domestic building contract is entered into and for the cost of supply and delivery of which the builder must make a reasonable allowance in the contract’.  For example, an oven may be a prime cost item, where the builder may know they need to supply a 900mm freestanding oven, but the owner has not selected the oven at the time of the contract, so therefore the oven is included in the building contract as a prime cost item, for the reasonable cost of the builder supplying that oven. The prime cost item might be for a standard oven at $1,100 but then the owner selects an upgraded oven for $2,300, so the builder will issue a variation to cover the additional $1,200 (if the builder satisfies the requirements as set out below).

A provisional sum is also defined in s3 of the DBC Act as ‘an estimate of the costs of carrying out particular works (including the cost of supplying any materials needed for the work), under a domestic building contract for which a builder, after making all reasonable inquiries, cannot give a definite amount at the time the contract is entered into’. For example, traffic management where a builder may estimate that they need 2 days of traffic management at a cost of $800 a day, but the works are delayed due to an unforeseen event and the builder requires 5 days of traffic management. Therefore, the builder would issue a variation to cover the additional 3 days at $800 (total $2,400), again subject to the builder satisfying the requirements as set out below.

Is the provision ‘reasonable’?

If a builder enters into a domestic building contract, then the builder makes a warranty (under section 20 of the DBC Act) ‘that any provisional sum included by the builder into the contract has been calculated with reasonable care and skill taking account of all the information reasonably available at the date the contract is made, including the nature and location of the building site’.

So how does a builder determine what a reasonable cost is?

The reasonableness test will vary according to each contract, but according to section 21(3) of the DBC Act, factors to be considered are:

  • The information that the builder had, or reasonably should have had, at the date of the contract; and
  • The nature and location of the building site.

Some builders put in excavation costs as provisional sums. Whilst a builder may be entitled to do this (on some sites), under section 30 of the DBC Act, the builder is required to obtain foundation data prior to entering into the contract. Therefore, if the builder should have (and could have) obtained the necessary foundation data depending on the nature and location of the building site, the builder may not be entitled to the additional amounts claimed simply because they have a provisional sum for excavation costs.

Does the contract provide the required information?

Some builders use standard form building contracts and complete the provisional sum or prime cost items in the provided schedules.  Other builders just put allowances, provisional sums or prime costs items in the tender document, while others put these items in their terms and conditions.

The DBC Act is very specific about the requirements to be included in the building contract. Section 22 of the DBC Act requires major domestic building contracts to ‘contain a separate schedule for each item or sum’, and the schedule must include:

  • A detailed description of the item or of the work to which the sum relates;
  • A breakdown for each item or sum (showing at least the estimated quantities of materials and the unit cost to the builder);
  • Any margin or additional charges (and how such an amount is to be determined).

Can a builder charge any amount once these works are completed?

Assuming the works have been carried out, or the items have been supplied, builders will often just issue a variation for the total amount they wish to claim for these items. However, section 23 of the DBC Act requires a builder to give the owner a copy of any invoice, receipt or other document that shows the cost to the builder of any prime cost items, or that relates to any provisional sum, in a domestic building contract, and must do so as soon as practicable after receiving the invoice, receipt or document.

Therefore, for example, if the provisional sum relates to excavation costs, the builder must provide the owner with the invoices, receipts or any other documents which show the costs of the excavation as soon as practicable after these invoices are received.

What are the risks if a builder does not comply with the Act?

If a builder does not comply with the DBC Act, not only are there penalties which may be imposed against the builder (e.g. a breach of section 22 of the DBC Act is 50 penalty units per breach), but the builder also risks not being able to charge the additional costs.

Under section 16(1) of the DBC Act, a builder who enters into a domestic building contract must not ‘demand, recover or retain from the building owner an amount of money in excess of the contract price unless authorised to do so by [the DBC] Act’.  Therefore, if the provisional sum or prime costs have not been claimed in accordance with the DBC Act, then the builder may not be entitled to claim any amount above the ‘fixed’ contract price.

Further, if the additional amount is a valid prime cost item or provisional sum, then any additional amounts will not be caught by section 41 of the DBC Act.  That is, an owner may end a major domestic building contract if the contract price rises by more than 15%, but any valid prime cost item or provisional sum ‘is to be ignored in calculating any price rise’.

Tips to avoid disputes arising with provisional sums or prime cost items

A good understanding of the above, will reduce the chance of getting to the end of a building job and having a dispute about the additional charges added to your final claim. So, remember to:

  • Ensure the description in the contract is clear and the detail is in accordance with section 22 of the DBC Act;
  • Factor in things the builder ought to reasonably have known at the time of the contract signing; and
  • Include the builder’s margin in a spreadsheet for any provisional sums or prime cost items in their building contract.

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