The pandemic and the Ukraine conflict and related sanctions are causing, and will continue to cause, renewed disruption to supply chains that will inevitably interfere with the construction industry across the country. As a result, there was no planned or set way for the market to immediately address the price inflation that’s been seen.
Contractors should consider the following options when negotiating new contracts.
Fluctuation provisions
A compensatory clause in a construction contract that allows the contract price to be adjusted to reflect changes in the cost of materials or labour during the contract period. More often than not, these provisions are deleted, however, recently, there are increasing demands from contractors for them to be remain in the contract.
Contracting parties (employers and contractors) must be aware that fluctuation provisions are dealt with differently depending on the standard form of construction contract being used.
Fluctuation provisions can be tailored for circumstances, for example, for materials which are at higher risk of price changes e.g. steel, providing that where the fluctuations are allowed on certain materials, the contractor goes “open book” on these items; and tying price increases to national indices e.g. RPI and BCIS.
Provisional sums
Most contracts in the UK construction industry at present are “lump sum” or “fixed price”, which contain mechanisms for changing the contract price, but not usually for price inflation. In essence, the contractor provides a price for the works to the employer or client, and the contractor bears the risks of changes in expenditure. Contracts such as the JCT Standard Building Contract, the JCT Design and Build Contract, the NEC Engineering Construction Contract Option A and common wording used in the FIDIC Yellow and Silver books are examples.
Provisional sums are often used to challenge the increases in prices. They are included in contract specifications, proving an estimate of the likely cost of works that cannot either be sufficiently defined at the time of contracting, or works that the employer or client may choose not to undertake. The contractor, when carrying out the works, has a right to amend the provisional sum and the employer or client has the option to either instruct an increase in the contract sum in line with the increase to the provisional sum, or alternatively employ a different contractor to carry out the specific works which were linked to the provisional sum.
Where provisional sums are to be used in a contract, it is paramount that they are drafted very carefully to achieve exactly what the parties require. The contracting parties must consider; the value of provisional sums when they are entered into specifications for the works (bearing in mind it could substantially increase the price of the project); any contingency in budgets to allow for substantive increases to provisional sums and any approvals needed from funders; the affect they could have on the programme and subject to the contract being used for a particular project, the method for instructing or allowing a change to provisional sums.
Cost plus and target cost contracts
Under a cost plus contract, the contractor is reimbursed for the actual costs incurred for plant, materials and labour on a project, plus an additional fee to account for the contractor’s overhead and profit. The contractor could therefore pass on all price increases to the employer or client. The NEC Engineering Construction Contract Option E, the JCT Prime Cost Building Contract and the FIDIC Short Form Contract are all examples of cost plus contracts which could be used.
Contracts such as these have had limited use in the UK, as the primary risk is the uncertainty of the final cost of the work and concerns around a lack of incentive for the contractor to limit its costs.
Target cost contracts are often used, as an alternative, with a pain/gain sharing mechanism, whereby the contractor is rewarded with increased profits for providing the works more cheaply than the targeted cost. However, it is financially worse off if it overspends. The NEC Engineering Construction Contract Options C and D are all examples of cost plus contracts.
Alternative solutions
Contracting parties should also consider amending the relevant event and compensation event sections within the relevant standard form of contract to ensure it specifically cover issues surrounding materials.
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