News & Insights

Making contract provisions for cost increases in the construction industry

It’s been fairly well publicised that the construction industry is currently experiencing a serious shortage of key materials, particularly steel, cement, and timber. The sector is also facing labour shortages, notably a lack of lorry drivers and subcontractors.

The causes of the shortages are exceptionally high demand globally, pandemic difficulties and supply issues linked to Brexit. A global shortage of shipping containers is an additional factor.  The effects are widely felt in terms of higher costs which squeeze profit margins. Smaller contractors are likely to be disproportionately affected.

Given a continuing level of uncertainty, it is important for parties to consider the fluctuation risks they may face during a project and to allocate such risk accordingly by including adequate fluctuation provisions to their contracts.

Fluctuation provisions in a contract allow the contract sum to be adjusted to take account of changes to the price of labour, materials, and other costs throughout a construction project. If fluctuation provisions are incorporated into the contract then the contractor may be entitled to be reimbursed for some, or all, of any additional costs caused by rising prices. Calculating the increased cost may be achieved by using an index-based formula or by using a published list of market prices.

In the past these provisions have often been excluded from contracts in the UK due to the low rates of inflation, but this approach may no longer be acceptable to some contractors.

Some standard form contracts available include optional fluctuation provisions. For example, the Joint Contracts Tribunal (JCT) provides three approaches to fluctuation provisions across its suite of standard contracts. Option A is the default option which provides for changes to contributions, levies and taxes. This may be insufficient for projects lasting more than a few months. Options B and C are also available for the JCT Standard Building Contracts and Design and Build Contract. Option B makes provision for changes in tax, labour and materials costs and Option C allows for contract sum adjustments according to formula rules.

Given these varied contract options, care should be taken when using standard form contracts, particularly if you want to use, or exclude/limit, the fluctuation provisions. FSP is well placed to advise on the most appropriate type of contract relative to the risks involved and to assist with the drafting of bespoke amendments which set out in clear and unambiguous terms how the effects of price fluctuations will be allocated between the parties.