With construction cost inflation soaring in recent times, builders and developers are facing significant challenges to achieve fixed price contracts that were routinely agreed in the market until very recently.
Market factors have significantly changed the dynamic in the past 2 years and more acutely since February 2022. Many contractors are simply refusing to execute fixed price contracts.
The primary drivers of the cost increases are:
- The war in Ukraine
- COVID-related delays
- Increasing energy costs, and
- General economic inflation
The price for structural steel, for example, has reportedly increased by approx. 140% between September 2020 – August 2022.
Employers, contractors, funders, investors and their advisors are increasingly utilising innovative solutions to address their respective concerns.
A variety of approaches and solutions may be considered depending on the context and the parties’ sensitivity to cost risk.
Fixed Price, subject to carve outs
The parties can agree a fixed price subject to adjustments being allowed for (i) certain risks occurring; or (ii) costs increasing in certain respects, particularly where those are not within the control of the contractor or capable of being mitigated. The key consideration is to understand the parameters around the entitlement. Purely by way of example:
- Contingency / capped adjustments / risk sharing: The parties may agree a fixed price subject to the parties accepting that the cost consequences for a specific risk are either shared or taken by one party, up to a particular value or within specified thresholds.
- Mitigation measures agreed around key risks: The parties can agree a fixed price on the basis that specified procedures or protocols are in place to mitigate the cost impact. For example:
- Pre-ordering materials that are subject to regular / anticipated inflation: Where the design is complete and quantities of materials are known, the contractor may pre-order the relevant materials to lock in the current price for that package, such as rebar. This solution may require upfront payment, additional storage and security costs, advance payment bonds and vesting certificates where the materials are held off-site. The terms of the contract would need to facilitate each of these.
- Early warning mechanisms: The parties can agree that the contractor will produce a procurement risk schedule and agree to engage at regular intervals with suppliers to ensure that any delays or additional costs are flagged as early as possible in the project. In specified circumstances, subject to the contractor complying with the protocol, the employer may accept an element of additional cost.
Public Works Contract Inflation Co-operation Framework
In May 2022, the Government introduced a framework to apportion inflation costs in the public works suite of contracts. Under the framework, the employer may assume a share of up to 70% of inflation costs on the basis of an ex-gratia payment. However, the application of the framework is limited to the projects that are subject to the public work forms of contract. Further, it is not mandatory and only covers costs incurred after 1 January 2022.
The forms of fixed price building contracts and development agreements that were routinely seen up to recent years are now a rarity due in large part to hyper-inflation experienced across a broad range of materials.
As a result, contractors are taking a more considered approach to pricing terms and it is having a material effect on the time it is taking to get contracts over the line and signed.
Parties are increasingly seeking to address the issue of rising costs in a nuanced and innovative way. The commercial discussions and drafting we are seeing in contracts reflects the complexity of the challenge.
For more information on fixed price contracts, please contact a member of our Construction, Infrastructure & Utilities team.
The content of this article is provided for information purposes only and does not constitute legal or other advice.