Material shortages and construction contracts: what to be aware of

Construction professionals everywhere are likely be wrestling with product availability issues, labour and transport shortages and the resulting cost inflation. This situation will probably worsen before it improves. The Construction Leadership Council (CLC) has warned the industry to plan for increased demand and longer delays. 

Covid-19 has had a profound impact on the construction supply chain while Brexit has only added to the existing material and labour difficulties in the UK, highlighted by the HGV driver shortage – migrant workers from Europe, previously widely employed in the industry thanks to the EU freedom of movement rules, are no longer available.

What can contracting parties do?

With cost increases unavoidable, the question that arises is who pays the extra cost of materials where the cost has been factored into the price agreed in the contract?

The general rule is that where the contract does not provide a mechanism for contractors and subcontractors to share the effects of price increases with other involved parties, then they will shoulder the effects of the price difference.

The Procurement Advisory Note (PAN01/21) in Northern Ireland has recommended that parties work together in “a spirit of mutual trust and cooperation” where the crisis has affected existing contracts.

The good news is that parties can plan ahead effectively for future contracts. Contractors and subcontractors must ensure clauses are included in their contracts to prevent future financial disaster.

Below are some of the contractual options available to contracting parties.

Most standard form contracts have the option for including a price variation clause. JCT contracts provide an option for contract particulars to allow the adjustment of rates to deal with unforeseen additional costs due to inflation. These price variation clauses exist to provide a safeguard against unforeseen changes to the price of materials which are needed to fulfil the contracted works.

However, parties should note that the threshold to trigger a price variation clause is high – the price increase must go beyond the regular fluctuation in market prices, which is what we have seen in 2021. These clauses can be used when there is a set price contracted for the works, and when a cost-plus contract has been used by the parties.

Employers may not initially see the benefit of a price variation clause where there is an increase in costs. However, these clauses can help to maintain progress on a project as they aim to prevent delay and disruption caused by unforeseen market circumstances. Such provisions are likely to protect cashflow, reduce the risk of disputes and prevent contractors from becoming insolvent, which is bad for all parties connected to the project.

The NEC provides various contract pricing options (options A through to E). Under main options A and B, the contractor will assume the risk of inflation, but under main options C and D, the risk is shared between the parties. However, the risk allocation can be altered by secondary option X1.

NEC4 secondary option X1: Price adjustment for inflation is a bolt-on clause which the parties can add to their contract, should they wish. Option X1 allows for price adjustments to the works by considering the price set against the latest price index.

The JCT suite of contracts provide a list of relevant events which may entitle a contractor to claim for an extension of time. With regards to material price increases, relevant events upon which a contractor might be able to rely include:

Contractors should, however, be aware that although force majeure is a relevant event, it is not a relevant matter. This means that although the contractor may be entitled to additional time (thereby offering protection against liquidated and ascertained damages), the contractor will not usually be entitled to additional money.

Most JCT contracts also provide an option for the parties to include ‘fluctuation provisions’ which deals with changes in respect of the cost of labour, materials and tax. These provisions can be included in the contract via the contract particulars. However, in our experience they are usually excluded from the contract. This perhaps indicates that either the parties are not aware of these provisions or choose not to include them. Either way, this can have significant detrimental consequences.

Parties would be advised to set a budget for price increases as well as including price variation clauses such as the JCT fluctuation provisions and NEC4 secondary option X1. Design teams should review raw material availability and estimated delivery times to determine a realistic estimation of the completion date.

Alternative material options should be identified or where there is no alternative, then this should be made very clear in the tendering process. Parties would be advised to operate on an open-book basis and contractors need to be ready to provide compelling evidence with regards to the effects of inflation on both existing and future contracts.

When drafting contractual clauses that concern delay or suspension of the works due to material shortages or rising costs, you should identify the potential risks and clearly set out how that risk is to be split between the parties to the contract.

In particular, set out any entitlement that the contractor may have for additional time or money if the project is affected by material shortages or price increases. The actual form of words you should use in the contract can be tricky – it needs to be precise and work with all the other terms of the contract.

So, think ahead, and be careful what you sign.

James Sargent MCIOB is a senior associate at Quigg Golden.