Managing Cost Increases in Construction Contracts
By Lucinda Robinson, Partner, Fenwick Elliott
The consequences of Russia’s invasion of Ukraine have joined forces with a surge in demand for construction products, Ofgem’s permitted energy price hikes, the ramifications of Brexit and fall-out from Covid-19 to strip the construction industry of resources and increase prices.
Ukraine and Russia export raw materials include copper, aluminium, oil, bitumen, neon (used in semi-conductors for micro-chips), timber and iron ore used for steel. Reduced supplies from both countries to the UK (or Europe where the UK then sources the materials) caused by the war, or sanctions imposed in response to it, will trigger shortages and delay. The impact will be felt at almost every stage of construction, from the erection of steel frames to installation of aluminium windows and timber cladding, from M&E works to roofing.
According to the Construction Leadership Council’s Construction Product Availability Statement (8 March 2022), price inflation is an even greater concern than material shortages. It cites increases of 5 to 10%, and even up to 20% for energy intensive products. Coupled with the soaring energy prices as Europe and the UK seek to reduce reliance on Russia, the cost of construction will rocket.
With parties set for disputes over inflated prices and delays, what can they do to defend their positions under existing contracts and prepare themselves for future conflict in contracts being negotiated now?
Price Inflation Clauses
Parties should check their contract to see if it provides for price inflation for all or specified materials. Subject to bespoke amendments:
JCT DB 2016 includes a standard fluctuations clause, provided it is selected in the Contract Particulars. Otherwise, the risk sits with the Contractor.
NEC4’s main options A and B place the risk on the Contractor, with options C and D splitting the risk between the Parties. Option X1 allows for price increase before the Completion Date under these 4 options (if selected), subject to details being included. Cost reimbursable options E and F place the risk with the Employer.
FIDIC’s Yellow Book 2017 provides that, in some circumstances, adjustments can be made to the Contract Price to account for changes in law (clause 13.6) or for rises or falls in the cost of labour, Goods and other inputs to the Works (clause 13.7).
Working with the supply chain to communicate requirements early will help keep ahead of further price increases and shortages. Diversifying the supply chain might also help to secure access to materials. However, if materials cannot be supplied at all, consider if others that are easier to obtain can be substituted. Clause 2.2.1 of JCT DB 2016, for example, permits alternatives to be procured if those specified cannot be purchased and the Employer agrees. Even if there is no similar clause, parties can agree to use alternatives.
Changes involving a cost saving might be most attractive to Employers and, if instructed, the change could entitle the Contractor to time and money too.
Time and Money
Contractors will need an extension of time to defeat the levy of liquidated damages for delay caused by material shortages.
JCT DB 2016
The Contractor must prove the delay was caused by a Relevant Event. The word “war” does not appear in the list of Relevant Events, but the Contractor may be able to rely on one or more of the following (assuming they have not been deleted by amendment).
Force majeure (2.26.14) is not defined in standard JCT forms but is understood to include war (Lebeupin v Crispin), so may be more helpful to Contractors. The Contractor will need to prove the war caused the delay, but if it did, then this may be its strongest argument on time. There is no equivalent Relevant Matter, so the Contractor cannot rely on this to recover its associated losses.
Civil commotion, terrorism and/or the activities of relevant authorities in dealing with it (2.26.10) sounds relevant, but it is not clear if this Relevant Event would apply. Civil commotion has been interpreted to mean something between a riot and civil war in an insurance context, which is not what is occurring in Ukraine. Whilst the Russian advances are terrifying, it is not clear if it is “terrorism” for the purposes of this clause. If the clause was supposed to cover war, then why was the term “war” not included? A Contractor seeking to rely on this clause may want to hedge its bets and rely on at least one more as well. There is no related Relevant Matter.
If the impact of the war presents as the Employer preventing the Contractor from proceeding, then the Contractor may rely on the applicable Relevant Event (2.26.6), which also constitutes a Relevant Matter.
If the Employer instructs a change to the Works because of material shortages, price inflation or agreed solutions to address them, then the Contractor could rely on this Relevant Event (2.26.1) and Relevant Matter. Employers may be careful not to do this, or at least not without agreeing the time and cost implications upfront.
The exercise after the Base Date by the UK Government of any statutory power directly affecting the execution of the Works may come into play if it is the sanctions applied to Russia by the UK that causes the delay. There is not a related Relevant Matter.
All potentially applicable compensation events enable the Contractor to claim time and money, provided they have been incurred because of the event in question. These include:
NEC’s equivalent of force majeure is clause 60.1(19), which is a four-part test. If the event (1) stops or delays works, (2) could not be prevented by either party, (3) is not one of the other compensation events, and (4) at the Contract Date would have been judged by an experienced Contractor to have such a small chance of occurring it was unreasonable to provide for it, then the Contractor can recover. War and sanctions would be covered provided they commenced after the Contract Date.
Instructed changes (60.1(1)) constitute a compensation event and the same comments apply to this as to the JCT equivalent.
Late provision of information (60.1(3)), works instructions (60.1(4)), performance (60.1(5)) or materials for testing (60.1(16) by the Employer also constitute compensation events, which could be claimed if such events are prompted by the war.
FIDIC Yellow Book 2017
The FIDIC Yellow Book lists circumstances including war, hostilities (whether war be declared or not), invasion and act of foreign enemies, which may qualify as an “Exceptional Event” if the event:
“(i) is beyond a Party’s control;
(ii) the Party could not reasonably have provided against before entering into the Contract;
(iii) having arisen, such Party could not reasonably have avoided or overcome; and
(iv) is not substantially attributable to the other Party.”
Provided contractual notice provisions are met, a Contractor suffering delay and/or incurring costs because of the Exceptional Event will be entitled to an extension of time and potentially costs. The challenge is to prove the delay and increase in costs directly resulted from the war in Ukraine.
Other circumstances entitling the Contractor to an extension of time, including variations, are set out in sub-clause 8.5. Notably, if the Contractor can prove that delay was caused by unforeseeable shortages of personnel or Goods because of an epidemic or governmental action (8.5(d)), it may be entitled to an extension of time.
If the Contractor is to succeed on any such grounds under any contract, it will need to submit valid notices timely, meet any other conditions precedent, and provide records to substantiate its allegations about the cause and extent of delay and loss.
Termination is a drastic remedy and not to be undertaken lightly, but if the grounds can be made out, and the process followed correctly, it could offer a way out of an unprofitable arrangement.
Construction contracts will usually prescribe permitted grounds for termination. Force majeure is a valid reason for termination by the Employer in NEC4 (clause 91.7), but that will not help Contractors. JCT DB 2016 allows either party to terminate if the works are suspended for a specified period due to force majeure, civil commotion or exercise of a statutory power by the UK Government (mirroring the Relevant Events noted above) (clause 8.11). The requirement for works to be suspended could be too high a threshold for the Contractor to meet, as a shortage of some materials will not prevent all progress in many cases. The FIDIC Yellow Book 2017, also allows for termination by either party if the execution of substantially all the Works is prevented for 84 days (or multiple periods totalling 140) due to an Exceptional Event (clause 18.5), or where it becomes impossible or unlawful for either, or both, parties to fulfil their contractual obligations (clause 18.6). In many cases, material shortages or increases in price will not substantially prevent the execution of substantially all the Works or make performance impossible.
From an Employer’s perspective, termination is unlikely to solve the fundamental problem. If the incumbent Contractor cannot source materials, the likelihood is that most other Contractors could not either, so the time and cost involved of terminating one Contractor and engaging another would not be justified.
Renegotiate the deal
The construction industry may become rife with claims as the enforcement of fixed prices and levying of delay damages ripples down the contractual chain. However, forcing risk upon those ill-equipped to bear it will result in their collapse, and insolvency is rarely in anyone’s interest.
A more conciliatory approach to risk sharing may be preferable. For example, a reset of the price and programme reflecting the reality of inflated prices and scarcity of materials, plus a consideration of alternative products and a more diversified supply chain.
Records should be kept of the fact of any shortages or increased prices, the cause of them and the impact on time and money. Notes of what decisions were made, why and when, together with supporting documents, should all be maintained. Whatever claims are made, or negotiations take place, records will be needed to support them.
Those entering new contracts need to protect their position on prices and material shortages, recognising that they will not be able to argue later that the war was unforeseeable. Whilst Employers may try to resist, Contractors should try to include:
- Price increases for material in their tenders.
- Price fluctuation clauses and an appropriate indexation measure.
- A right to use alternative materials and, if the Employer’s consent is required, a caveat that it should not be unreasonably withheld or delayed.
- Realistic lead times for materials and some float in the programme.
- A cap on delay damages and/or a grace period before they are applied.
- A right to an extension of time for delays caused by war-related Government action, plus associated loss and expense, or an expansion of the force majeure provisions to ensure this is covered, perhaps even so wide as to cover all events beyond the Contractor’s reasonable control.
Whilst it is tempting for Employers and Contractors to pass their risk downstream, they should be conscious of the insolvency risk and what subcontractors and suppliers can feasibly withstand.
History does not let us say these are unprecedented times. Wars and pandemics have happened before. Force majeure clauses are a product of experience. Nevertheless, it has been many years since such events have conspired to cause costs to spiral and stocks to plummet so dramatically. Claims are likely and parties will need to rely on their contracts to protect their position so far as they can. It is hoped that the industry will take a pragmatic, conciliatory approach, so that parties can reach compromises based on realistic expectations as to time, cost and risk management.