Inflation Destroying Estimates? A solution… in Price Escalation Clauses

The year 2022 will be remembered for many other things; contractors' estimates were ruined thanks to out-of-control inflation leading to increased material prices, staffing costs, and overheads. The perfect storm of the continued material shortage experienced since the pandemic and price rises has led to many contractors feeling the squeeze and suffering losses. Whilst the general position is that the contractor bears the risk of increased costs, this is also a risk to the employer where contractors going out of business will increase costs and delays for their projects. The solution could lie with a Price Escalation Clause in the contract.

A price escalation clause gives the contractor the ability through the contract to pass on or share cost increases to the employer legitimately. It could also be worded to allow cost reductions to be passed on. The benefit of the contractor passing on savings to the employer is that the employer is more willing to accept a price escalation clause. A further advantage of a price escalation clause is that the mutual benefit can reduce the likelihood of a dispute crystallising later in the project as there is less pressure on the contractor. Likewise can drive overall costs down, with contractors likely to reduce their contingency allowance in tenders with the risk of rising materials removed.

Price escalation clauses are already drafted in some standard form of construction contracts.

The JCT Design and Build contains a clause which allows a modification to the overall prices for changes in the market rate for materials and labour. The NEC4 Engineering and Construction Contract provide the optional clause x1which has a broad remit which can include cost increases. With both of the above examples, the proper notices must be severed to entail the contractor to an increase; therefore, proper commercial management techniques are vital. Don't hesitate to get in touch with us if we can help with operating a price increase clause.

Without incorporating a price increase clause, which could be inserted into the contract after the commencement of the contract with the agreement of both parties, there are Other options to consider. Firstly, suspension of the works until the material cost reduces. However, it will likely cost the employer more in the longer term. Suppose there is an option to source different materials or use another supplier to that named in the contract. In that case, this may be a collaborative method for the parties to consider. Additionally, it may be worthwhile for the employer to purchase the materials directly, protecting the contractor's cash flow and saving the employer from paying the contractor's markup.

At Velocity, our team can help both contractors and employers navigate the rising cost of materials; we can offer pre-contract advice looking at issues to avoid in the contract, such as the probability of a variance in pricing and costs, which can include bespoke drafting of clauses to ensure both parties are protected. If required, one of our team can sit next to you in pre-contract negotiations and support you to ensure you get a result which looks after your interests. Where contracts have already been agreed upon, we can review existing arrangements to check what provisions already exist in the agreement or if there is an opportunity to add a clause. Furthermore, we can advise where a clause is potentially unlawful and the steps to take to ensure you suffer no harm due to this clause.

Don't hesitate to get in touch with our team if you have any questions about price escalation clauses or would like our support with an ongoing issue you have.

The content of this blog is intended for for information only and is not an alternative for legal advice. Velocity Dispute Management accepts no responsibility for the actions of another party as a result of this blog or the content of any third party source which this blog refers.