Alexander Jullienne, Collyer Bristow, examines how to get on top of fluctuating material and labour costs.
Housebuilders and developers are continuing to feel the impact of shortages of materials and labour amid the sustained disruption linked to Covid-19 and Brexit. It shows no signs of abating, particularly as Covid-19 cases surge due to the Omicron variant.
As construction costs increase, the profit margins for contractors and subcontractors (usually between 2-5%) on ongoing jobs subside exposing their balance sheets, particularly if they have not allocated the risk of fluctuations when pricing up the job.
Usually, when parties sign up to a construction contract, they will agree the sum and the cost of the labour and materials at that specific point in time. This point in time is often referred to as the contract’s “Base Date”. In some projects, the contract programme may contemplate the works lasting several years, during which time the cost of materials and labour could rise due to inflation and other market factors such as the shortage of labour and materials currently experienced.
Whilst shortages can cause project delay which may lead to liquidated damages being levied by the employer, they will also directly impact on the cost of the job. The greater the demand and the shorter the supply of the materials, the higher the price will be at the time of procurement. This can pose constraints on builders who would have priced the job on the historical rates.
The default position under standard forms places the risk on the contractor or builder who will agree to the rates and prices for completing the job at the outset. Usually, there will be no recourse for contractors to claim additional costs under the contractual provisions unless the parties have agreed to incorporate a fluctuations provision. Fluctuation provisions seek to provide a degree of comfort to builders.
Three approaches
Most JCT contracts offers three approaches to fluctuations which vary the scope of what can and cannot be adjusted in the event of changes after the contract’s base date.
The first approach, the default position, permits changes to the contract sum if any of the rates of contribution change, or a new tax is introduced which impacts upon the taxes to be charged. The second option, an extension to the first option, includes adjustments to the contract sum for variations in labour and materials cost. Importantly, these options require the builder or contractor to supply a full build-up of the rates and prices used during its tender. This can sometimes deter parties from signing up to this option.
A third option prescribes a formula for the contract sum to be adjusted as opposed to the actual increases. This is complicated as it the formula to be used changes depending on the type of work being carried out and there are some 60 different categories of work noted in the formula rules.
The existence of fluctuation clauses are important as in their absence they may lead to financial instability on the job which can lead to disputes. They protect for unexpected changes in the cost of materials and labour. Such clauses also can work in reverse when prices decrease, albeit such cases are rare.
In today’s particularly volatile market, builders and employers tendering for new jobs may want more certainty around the cost of the job meaning they will likely be more attracted to these fluctuation clauses. It is of course, a two-way street whether such fluctuation provisions apply and employers may insist on the contract not being adjusted due to inflationary pressures such as shortages of materials. Then it will become a commercial question for the parties on how to proceed.
