How much money have you actually authorised your contractor to spend? If your answer is “we agreed on an hourly rate”, then you may still have an important part of the agreement missing.
An hourly rate tells you what each hour will cost. It does not tell you how many hours will be worked, what the final invoice will be, or when the contractor should come back for further approval.
I believe that contracts based on hourly rates or reimbursable costs should have a clear spending limit and a process for approving increases. This is important whether you are the client paying for the work or the contractor doing it. Both sides need to understand what has been authorised before the money is spent.
Problem: An Agreed Rate Does Not Limit the Total Cost
I believe “no limit contracts” are risky. By a “no limit contract”, I mean an arrangement where work is charged at agreed rates or reimbursed costs, but there is no clear maximum authorised expenditure. I am discussing spending limits here, rather than limits on liability.
These arrangements can occur with engineering consultants, construction contractors, maintenance providers or other specialists. The parties agree on rates and tell the contractor to proceed, but leave the total financial commitment unclear.
Hourly rates can be appropriate when the work is difficult to define. You might need a consultant to investigate a problem before anyone can estimate the effort required to solve it. The risk arises when that flexibility allows work to continue without a clear financial decision point.
The client and contractor may have different expectations
Imagine a consultant is engaged at $200 per hour to investigate recurring equipment failures. The client expects a short review costing about $10,000. The consultant expects to keep investigating until the cause is understood.
After reviewing records, interviewing operators and arranging specialist input, the consultant submits an invoice for $28,000. The client is surprised. The consultant is surprised that the client is surprised.
The rate was agreed, but the extent of the spending was not clearly agreed. The client may dispute the amount or delay payment while seeking additional funding. The consultant has already incurred costs and must spend time explaining and defending the work.
Whether payment is legally due depends on the agreement and circumstances. From a project management perspective, you should aim to prevent that disagreement before it occurs.
Having a project budget does not authorise every purchase
A project might have a $500,000 budget, but that does not mean a consultant has permission to spend any amount up to $500,000. Other contractors, equipment purchases and internal costs may need most of that money.
There are several different amounts to understand: the overall project budget, the estimated cost of a particular service, the amount authorised under its contract, and the amount a particular person can approve.
An estimate of $20,000 is also different from an instruction authorising expenditure up to $20,000. Make the intended meaning explicit. Otherwise, one party may treat the estimate as a limit while the other treats it as an approximate forecast.
Small instructions can create a large commitment
A request for another site visit, an additional drawing or a further options assessment might seem minor. Several such requests can add substantially to the cost, particularly when several people are involved.
This is one reason to manage scope creep. Paying by the hour does not remove the need to agree what work is included. The client still needs to decide whether additional work is worth its cost.
The person requesting that work may not have financial authority either. A site operator can explain a technical problem, but may not be authorised to approve another $15,000 of consulting work.
The contractor also carries risk
An unlimited arrangement might appear attractive to a contractor because more work means more revenue. However, that revenue may come with disputed invoices, delayed payment and damage to the client relationship.
The contractor may also commit staff or subcontractors before confirming whether the client has approved the associated costs. If the client challenges the work, the contractor still has those commitments to manage.
Relying on a familiar client’s verbal assurances is risky too. Their project manager may leave, and the replacement may ask for evidence of approval. As I explain in Document All Client Communication, the project should not depend on one person’s memory of what was agreed.
Solution: Set a Spending Limit and Approve Changes Before Proceeding
The practical solution is to establish written spending authority, monitor the costs against it, and obtain approval for increases before exceeding it. Make this part of the original agreement.
Define the work and the authorised amount
Agree the scope, deliverables, rates and maximum authorised expenditure. Identify the assumptions behind the estimate, such as the number of site visits or rounds of review. State what is excluded.
Make clear whether the limit includes expenses, travel, materials, subcontractors and taxes. A labour fee limit offers limited protection if substantial additional charges sit outside it without their own controls.
For an investigation, you might initially authorise a defined assessment and a recommendations report. Further design or implementation can be considered after that report is complete.
The Australian Government’s guidance on preparing a contract is a useful reference for describing the work and setting out payment arrangements. The important point for this lesson is that both parties can identify what expenditure the agreement actually permits.
Clarify what the spending limit means
A spending limit needs to work with the other contract terms. There is an important difference between these two arrangements:
- An hourly engagement authorising a defined stage of work up to a maximum amount, with further approval required if more funding is needed.
- An obligation to complete the entire agreed scope for no more than a specified price, with the contractor carrying the relevant overrun risk.
Do not assume that adding “total fee not to exceed” automatically gives both parties the same understanding. Agree whether the contractor must complete the deliverables within that amount, or whether the amount limits the work currently authorised.
Also agree what happens if the funding is insufficient. Set out the notification, approval and any suspension arrangements, including responsibilities for leaving work in a safe condition. This avoids discovering at the limit that the client expects completion while the contractor expects to pause.
For a specific procurement example, the US Federal Acquisition Regulation addresses ceiling prices for time-and-materials contracts. Those rules apply to the relevant US federal procurements, but they also provide a useful illustration of formally controlling this type of expenditure.
Check who can approve the spending
Identify the person authorised to approve the initial commitment and any increase. Check whether their authority covers the revised total contract value, rather than assuming they can approve it because the additional amount is small.
My post on delegation limits explains why knowing the client’s approval process matters. An approval request can take considerably longer if it needs to go to a more senior manager or committee.
Authority for every dollar spent does not mean seeking permission for each hour separately. It means that the hours and costs fall within a valid, documented authorisation. Your team can then work within that approval without constant interruptions.
Give an early warning
Agree when the contractor must report that the limit is approaching. A notification at 75% or 80% may suit some engagements, but choose the trigger to allow enough time for a decision. Those percentages are examples, not universal rules.
If approval takes two weeks, allow for the work and commitments expected during those two weeks. On a rapidly progressing job, a warning at 80% might already be too late.
The warning should explain the costs incurred, commitments outstanding, work remaining and revised forecast to complete. It should also explain why the forecast has changed and what choices the client has.
For example, suppose an investigation has an authorised limit of $20,000. At review, the position is:
- Costs incurred: $12,000.
- Further committed costs, not included above: $3,000.
- Additional work needed to complete the agreed investigation: $9,000.
- Forecast total: $24,000.
The forecast is $4,000 above the authorised amount. Reporting only the $12,000 already incurred would hide the approaching problem. The client needs to consider the $24,000 forecast while there is still time to approve an increase, agree a reduced scope, or arrange a pause under the contract.
Monitor work done and costs committed
Do not rely only on invoices received. Timesheets may be submitted late, subcontractor invoices may arrive next month, and orders already placed may create costs that have not appeared in the accounting reports.
Track costs incurred, remaining commitments and the additional cost forecast to finish. Avoid counting the same cost twice. Compare the resulting total with the current authorised amount.
Your project management plan should explain who monitors these figures and how often. For a short investigation, weekly reporting may be appropriate. For work spending money quickly, you may need more frequent checks.
Obtain written approval for increases
When further funding is needed, submit a clear request before proceeding with the affected work. State the reason, additional amount, revised total limit, remaining deliverables and any effect on the schedule. Get approval from the authorised person using the process required by the contract. A cost report advising that the forecast has increased should not be treated as approval to spend that increased amount.
Record the decision and update the relevant contract documents, purchase order and cost controls. Make sure to record all this information (refer to Document All Changes, Variations and Agreements.) Make the current approval easy to find, and communicate it to the people allocating work.
Use limited approval when work must start early
Sometimes a project needs an initial investigation while the main contract is still being negotiated. Your wider agreement may take time, but the preliminary work still needs clear terms.
Use an appropriate written interim agreement covering the authorised tasks, rates, maximum amount and period, together with the other terms needed for that work. Check that the intended agreement is properly approved by both parties.
For example, the initial authority could cover inspection and a findings report up to $5,000. That should not quietly become permission to proceed with detailed design or construction.
Keep approvals practical
A spending limit will be less effective if the approval process is so slow that people routinely bypass it. Make the process clear, proportionate and easy to follow, while retaining the necessary financial controls.
Where appropriate, authorise defined stages or work packages. Allow for uncertainty in the estimate and retain suitable contingency in the project budget. Contingency held by the client does not automatically increase the contractor’s spending authority.
A cost-plus arrangement with a fixed fee may help avoid increasing the contractor’s fee simply because reimbursable costs rise. However, it still needs expenditure controls. Choosing a fee structure does not replace monitoring costs or approving further commitments.
Lesson: Agree the Spending Authority Before Spending the Money
I believe you should have a clear spending limit for work charged at hourly rates or reimbursable costs. Both the client and the contractor should know the authorised amount, what it covers and how further expenditure will be approved.
Monitor the forecast cost as the work progresses. Raise potential overruns early, and obtain written approval before exceeding the agreed authority. Make sure the approval comes from someone who can actually give it.
An hourly rate can give a project useful flexibility. A clear spending limit helps both parties use that flexibility with fewer surprises, less risk of payment disputes and better control over the project budget.
