Cost escalation in a post-pandemic world

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Timothy Bates and Bodene Robertson-Wright of Auckland law firm Tim Bates & Co highlight some common construction contract issues to look out for, and set out a fact scenario to demonstrate how these operate in context.


This month’s article sets out some of the mechanisms in construction contracting that can operate to address price increases in building contracting generally.

In a post-global pandemic world, the procurement of materials, including key building materials, is currently highly relevant in the context of contracting.

There are several layers to the problem and how they play out in terms of contracting.

This article does not hope to solve those issues. Rather, it points out some of the terminology and aspects of a contract you ought to look for guidance to in addressing these issues.

Cost fluctuation clauses

The first clause that comes to mind when we talk about significant cost increases in a building contract is a Cost Fluctuation clause.

These are especially relevant in respect of a lump sum contract, for in this contract the contractor has agreed to carry out the work for a fixed price, or in a measure and value contract, in that it has agreed to do the work at a fixed rate per item of work.

A Cost Fluctuation allows a contractor to achieve price increases either with reference to a general index being applied to a formula or, alternatively, it will have reference to actual cost.

It is one method of a contractor protecting itself against rising materials costs.

Provisional sums

Another way a contractor may protect itself against rising costs is to include provisional costs in their contract price, or prime cost sums where they apply to materials.

Prime cost sums relate to materials, but in some contracts prime cost sums and provisional sums are all described as provisional sums.

If this method is used by a contractor, they will insert a prime cost sum for a material, and the materials included may never be ordered.

If the materials are never ordered, the figure allowed comes out of the price.

If they are ordered then the price will be varied to reflect the difference between the prime cost sum and the actual cost of the materials calculated in the manner provided for in the contract (i.e. margin may apply to this item).

Contingency sums  

Typically, some contracts will include contingency sums, being sums for which expenditure is unknown.

Where works are ordered under a contingency sum, the price will be adjusted to take into account the amount spent in doing work.

Where no work is ordered under this clause, it simply comes out of the contract price.

Tags

This remains a well tried and tested method of a contractor keeping uncertain sums or aspects of the contract works out of the price.

In this way, the introduction of tagged items into the month-to-month charging is not subject to the scrutiny like a material that has been allowed for in a tender.

It simply comes in at its cost plus however the contract deals with materials (the contract margin is likely to apply).

Variations

It is likely that variation clauses may find their way into any debate about materials not being able to be supplied due to supply chain issues.

For instance, if the cladding material has to change due to supply issues, and this, in turn, impacts the carpentry contract because of a more complicated method of affixing the cladding itself, then the variation clauses in a contract are likely to be triggered.

Fact scenario

Mr and Mrs Brown wish to carry out a high-end build in Wellington. They intend to build a three-storey, architecturally-designed property using teak board. The contractor has given a fixed price of $2 million to complete the build.

There is difficulty for the contractor in locating teak board in time for the cladding stage of the build.

He had envisaged this difficulty when he priced the contract, and placed a prime cost sum in for the teak supply. Due to the non-availability of the teak, cedar is substituted for teak.

The contractual outcome of this is that the teak prime sum comes out of the contract but is replaced with the cost of supply of cedar plus margin.

In addition, there is a small variation increase due to there being slightly more labour involved in affixing the cedar.

Post note

These are very challenging times to contract in, and this article hopes to have set out some methods and terminology that apply to address escalated price for materials.

Every situation will have its own unique facts, so it is very important that extra care goes into considering material price escalation.

Note: This article is not intended to be legal advice (nor a substitute for legal advice). No responsibility or liability is accepted by TM Bates & Co or Building Today to anyone who relies on the information in this article.

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