With material prices rocketing, this month’s contract clinic question comes from a reader worried about how to price timber costs for a residential project tender. Helen Johnson and Tim Attwood reply.
The question
We’re building a timber-framed residential project in Sheffield and our suppliers won’t guarantee prices for more than a few days at a time, but the client wants a tender price. Contractually and commercially, what options are open to us to help us manage the constantly changing prices, and what are the risks?
The answer
There are a number of options available in this scenario. The best option for your project will depend on how you and your client feel about risk, and the likelihood of a changing contract sum. It sounds as though your client is keen to have a fixed contract price. However, one option available is to agree with your client for your contract to include a fluctuation provision.
Fluctuation provisions are clauses in construction contracts. They allow adjustment of the contract sum to account for changes in the cost of labour, materials and associated costs. Fluctuation provisions aim to mitigate the risk of changes to the cost of these items during the construction contract.
Fluctuation provisions are commonly deleted from standard form contracts. In a fixed-price contract, the contractor is deemed to have taken account of the risk of price increases and will bear that risk if the cost of materials and/or labour increase.
Uncertainty surrounding Brexit, material shortages and the recent spike in inflation have led to an increased use of fluctuation provisions. The aim being to insulate contractors from rising prices. Many projects are complex, long-term or require procurement of materials vulnerable to price changes. In such cases, contractors should consider the inclusion of fluctuation provisions.
This is not just an advantage for contractors. For employers, price adjustment mechanisms can avoid contractors adding a premium to the contract sum to account for the risk of price changes.
Equally, employers should consider the implications of holding a contractor to a price that is no longer profitable or viable. Such a scenario could result in poor work quality or contractor insolvency. Of course, this comes at the expense of contract price certainty. Some employers (and funders) will find that difficult in terms of budgeting for a project.
Complex provisions
Fluctuation provisions are complex. As such, there will be increased work involved for cost consultants in assessing sums due or compensation events. Fluctuation provisions will apply to normal assessments throughout the project, as well as claims in the event of a dispute.
The form of contract you opt to use will assist as a starting point for drafting your fluctuation provision. The JCT 2016 Standard Contract and the Design & Build Contract both include three optional fluctuation provisions, available on the JCT website. These options are:
- Allows for the ‘contract sum’ to be adjusted in circumstances where contributions, levies or taxes payable in the contractor’s capacity as an employer of workers changes.
- Should be used where the parties have agreed to allow for labour, materials and tax fluctuations. If, after the ‘base date’, the market price of any materials, goods, electricity or fuels increase, the difference in price is paid to the contractor. (However, note that the inverse also applies should the cost of materials fall.)
- Operates by dividing the contract sum into work categories corresponding to the type of work to which they relate and for which there is a separate price index. At the end of each period, the value of each category is adjusted using the most relevant index. Each valuation is adjusted by the increase (or decrease) in a standard mix of indices.
The price payable under the NEC3/NEC4 ECC can be adjusted by selecting Option X1 in the secondary option clauses. NEC provides the calculation to be applied using price indices, the proportions and base date information.
Providing a pricing mechanism
Alternatively, parties are also free to omit the standard form fluctuation provisions and provide a pricing mechanism of their own. Indexation is a procedure whereby a contract for the provision of goods and services includes a periodic adjustment to the prices paid for the goods or services.
This will be based on the change in the level of a nominated price index. The parties can agree which indices to use and how they should apply to their contract pricing structure.
For example, there are timber price indices produced by Forest Research. If adopted, the parties should consider carefully (i) what they want to be indexed, (ii) which index is the most appropriate, and (iii) the drafting of the clause to ensure that the formula for adjustment works.
If your client agrees to allow for price fluctuations, remember to get advice on the contract drafting to make sure that all parties are clear on the mechanism and how it will work during the life of the project.
Helen Johnson is a partner and Tim Atwood is a senior associate at law firm CMS, based in Sheffield.
This article is opinion and does not constitute legal advice. You should always seek formal legal advice from a specialist lawyer where required.
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Thanks for the valuable information