Last month, the Construction Products Association warned that attacks on shipping in the Red Sea were becoming a “significant issue” for construction products. Now, as attacks have continued, shipping costs have increased and operators must take alternative, longer routes to their destinations. Some major shipping companies have avoided the Suez Canal altogether, and several Asian steelmakers have withdrawn from the European market.
Unfortunately, this crisis is only the latest in what is becoming a chain of national and world events driving material prices up. 2021 and 2022 saw unprecedented price rises due to material shortages, increased administration processes at ports, and shipping delays, and this has led to issues in costs and delays that persist in projects today. As a result, it pays (or at least limits costs!) to be prepared.
With cost-increases practically unavoidable, the question arises of who pays the extra cost of materials where the cost has been factored in to the price agreed in the contract? The general rule is that where the contract does not provide a mechanism for contractors / subcontractors to share the effects of price increases with other involved parties, then it is the contractors / subcontractors who will shoulder the effects of the price difference. The risk lies where it falls.
The good news is that parties can plan effectively for future contracts. Contractors and subcontractors should be careful to include clauses in their contracts to prevent future financial implications. We consider some of the contractual options available to contracting parties below.
You can include a price variation clause within a contract. Most standard form contracts have the option for including such provisions. These clauses can be used when there is a set price contracted for the works, and when a cost-plus contract has been used by the parties.
Fluctuation Provisions in JCT contract, for example and other price variation clauses exist to provide a safeguard against unforeseen changes to the price of materials which are needed to carry out the works.
However, parties should note that the threshold to trigger a price variation is usually high – the price increase must normally go beyond the regular fluctuation in market prices.
Employers may not initially see the benefit of a price variation clause where there is an increase in costs. However, these clauses can help to maintain progress on a project as they aim to prevent delay and disruption caused by unforeseen market circumstances. Such provisions are likely to protect cash-flow, reduce the risk of disputes and prevent contractors from becoming insolvent, which is bad for all parties connected to the project.
If you would like to know more, Quigg Golden are presenting a seminar on 18 May 2024 that will offer an in-depth exploration of price variation clauses and their operation. Click here for further information.
The NEC provides various contract pricing options (Options A through to E). Under Main Options A and B, the Contractor will assume the risk of inflation, but under Main Options C and D, the risk is shared between the parties. However, the risk allocation can be altered by Secondary Option X1.
NEC4 Secondary Option X1: Price adjustment for inflation is a Secondary Option Clause provided by the NEC – this is a bolt-on clause which the parties can add to their contract, should they wish. Option X1 allows for price adjustments to the Works by considering the price set against the latest price index.
Most JCT contracts also provide an option for the parties to include “Fluctuation Provisions” which deal with changes in respect of the cost of labour, materials and tax. These provisions can be included in the contract via the contract particulars. However, in our experience they are usually excluded from the contract. This perhaps indicates that either (1) Parties are not aware of these provisions or (2) Choose not to include them. Either way, this can have significant detrimental consequences.
In addition to the optional fluctuation provisions, the JCT suite of contracts provide a list of Relevant Events which may entitle a Contractor to claim for additional time due to material price increases. The Relevant Events upon which a Contractor might be able to rely include:
Contractors should however be aware that although “force majeure” is a Relevant Event, it is not a Relevant Matter. This means that although the contractor may be entitled to additional time (thereby offering protection against LADs), the contractor will not usually be entitled to additional money.
Parties would be advised to set a budget for price increases as well as including Price Variation Clauses such as the JCT Fluctuation Provisions and NEC4 Secondary Option X1. Design teams should review raw material availability and estimated delivery times to determine a realistic estimation of the Completion Date. Alternative material options should be identified or where there is no alternative, then this should be made very clear in the tendering process. Parties would be advised to operate on an open-book basis and contractors need to be ready to provide compelling evidence with regards to the effects of inflation on both existing and future contracts.
The construction industry has not yet had the chance to recover from the pandemic, Brexit, high interest rates or the selection of other factors weighing on the economy in recent years. The world’s complex yet fragile supply chains look set to continue facing crisis, and as a result, when it comes to drafting contractual clauses that concern delay and / or suspension of the Works due to material shortages and / or rising costs, you should identify the potential risks and clearly set out how that risk is to be split between the parties to the contract. In particular, you should set out any entitlement that the contractor may have for additional time and / or money if the project is affected by material shortages / price increases. The actual form of words you should use in the contract can be tricky. It needs to be precise and work with all the other terms of the contract.
As always, think ahead, and be careful what you sign.
If you are currently facing any of the problems set out above, then Quigg Golden can provide you with further advice. Do not hesitate to contact us.
Published 5 August 2024
