Fluctuations provisions in construction contracts – the basics

Fluctuations provisions in construction contracts – the basics

What are fluctuation clauses?

Across the board, concerns are being raised regarding the cost of construction contracts and construction inflation generally, whether this relates to contracts already signed or those soon to be entered into. In such cases, clients will often ask: why are the costs so high? What can I do to protect my business? Are there any contingencies that I can build into my agreements? Such questions are common in situations where tendering contractors are having trouble with their suppliers committing to fixed prices. The higher the contract sum, the more of an impact factors such as high inflation rates will have on the overall sum. Although fixed price contracts are common, in the current market, if contractors can’t obtain agreement from suppliers to agree to a fixed price for construction materials, it can become troublesome.

Why are construction costs so high?

Turning to the first question above: prices are soaring in most sectors, as we are all aware. There are myriad factors which have led to this and the answer is not straightforward. Partial causes include the impact of the Russia/Ukraine conflict, Brexit impacting supply chains in the UK, and the continuing fallout of the Covid-19 pandemic. The knock-on effects of these factors include severe labour shortages and increases in the prices of key materials such as steel and timber.

How fluctuations work

During times like these, fluctuations provisions in construction contracts are more relevant than ever. Put simply, these clauses can benefit contractors during uncertain periods by allowing contract prices to be adjusted to reflect changes in the cost of materials, administrative costs, labour and transport costs during the contract period. They may also allow for cost increases where there are inflationary increases, or increases brought about by new or increased tariffs/duties. As such, where “input” costs vary for reasons beyond the contractor’s control, there will be a measure of protection in place. Not only does this approach provide the contractor with the ability to recover the costs they are actually due, it means that the employer is not bound by their contractor’s estimates of changes in cost and they will only pay what is actually incurred.

Fluctuations provisions are common in the standard form contracts – with these often being available as an option in a contract – and their key purpose is sharing risk. These provisions are even more important in large projects which are due to last several years. Fluctuating price contracts are used in a variety of contexts, including target cost contracts, re-measurement contracts, reimbursement contracts, and lump sum contracts. As noted above, it is also possible to include clauses dealing with adjustment in fixed price contracts. Tying into this, there are multiple ways in which fluctuating price mechanisms can be drafted and it will be up to the contracting parties to determine which are most appropriate in the circumstances. As is demonstrated in many types of contracts, such clauses may refer only to particular wage agreements. Alternatively, they may be calculated by reference to a formula or nationally published price indices. Although calculating actual cost increases (or anticipated increases) may be time consuming, this can be very helpful.

In terms of how these provisions operate in practice, a key point to note is that both parties to the contract must agree the provisions from the outset, otherwise there is no ability to claim for the relevant additional costs, unless the increases can be apportioned to a period of delay which has not been caused by the contractor. This may be relevant where labour costs are concerned, for example. An example of how these adjustments might work in a lump sum contract can clearly be demonstrated by considering labour or materials costs. In these cases, the contract sum is based on the cost to the supplier or contractor of labour and materials at a specific moment in time. The contract sum may then be adjusted for actual changes in such costs.

Do you require assistance?

From a client perspective, a key commercial driver is always to obtain as fixed a price as possible at the outset of the relevant works. As such, common market practice was previously to omit fluctuations options from construction contracts. Ironically, however, given that most contractors are currently reluctant to submit tender returns without the inclusion of a fluctuations provision, the market has shifted, and clients now often agree to fluctuations provisions which stem from certain materials and supply chain issues, with the goal of getting key projects off the ground.

Although these provisions can be extremely useful, particularly at the moment when market conditions are volatile, they are not always appropriate. In some cases, employers may simply refuse to entertain these clauses and this can of course result in proposed tenders not being agreed. Even with that being the case, we do expect these provisions to become even more commonplace, at least over the next few years.

As with all contract terms, having well-drafted contractual provisions in place to account for price increases is crucial. We can step in to help at any stage of the process so if you require assistance negotiating or drafting a construction contract, or in relation to a related dispute, our team would be delighted to help.

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