What is the purpose of a Limitation of Cost clause in contracts?

A Limitation of Cost clause in contracts is specifically designed to set a maximum limit on the total cost that can be reimbursed under a contract. This clause is particularly relevant in cost-reimbursement contracts, where the contractor is compensated for allowable costs incurred, up to a specified ceiling. The primary purpose of this clause is to protect the funding agency or contract issuer from unexpected cost overruns. It essentially allows the agency to have a clear understanding of financial risk, as it establishes a boundary beyond which costs cannot be claimed.

By defining this limit, the contractor is also incentivized to manage costs effectively, as exceeding the limitation means that any additional expenses will not be reimbursed. This empowers both parties by fostering accountability and planning while ensuring that government or organizational funds are utilized within an agreed framework.