Material and labour shortages have become synonymous with the construction industry following Brexit and the impact of global lockdowns arising from the COVID-19 pandemic. Global and European supply chains ground to a halt in 2020, causing uncertainty within the supply chain and surging raw material costs. Industries started to gear up in 2021. However, before full capacity could be reached to alleviate some of the strains on the construction industry, rising energy prices and the Ukraine war (and subsequent sanctions and restrictions) have resulted in the industry being plagued by further disruption and uncertainty.
Far from being resolved anytime soon, it is predicted that these issues will continue well into 2023 and may worsen due to UK-specific pressures such as rising inflation, the weakening of the pound (which is now at its lowest level against the dollar since 1985), striking workforces and the looming forecast of a recession this winter.
Accordingly, it is paramount that businesses ensure that they are appropriately safeguarding themselves against the risks associated with supply chain disruption when entering into new contracts, or where there is opportunity to revisit existing contracts.
This article will highlight a number of contractual provisions which may assist parties in understanding (and protecting) their legal position when it comes to supply chain disruptions and rising costs, as well as providing commercial solutions to these issues.
- The impact on current projects
- Price fluctuation provisions
- Force majeure
- Termination provisions
- Frustration
- Commercial discussions
- The impact on new contracts
- Price fluctuations
- Force majeure
- Advance orders
- Provisional sums
- Subcontractors
- Final thoughts
The impact on current projects
The Ukraine war, rising energy prices, inflation and a forecasted recession will likely impact every project in the UK (and further afield) in one way or another.
To understand how to mitigate supply chain chaos and strive for certainty, the first step is to assess the risks to a project. This will require (1) consideration to be given to the factual circumstances and risk factors such as delayed programmes, material shortages and increased shipping costs followed by (2) a detailed review of the contractual provisions that govern the agreement between the parties and which sets out what happens and who bears the consequences of the factors established in part (1) of the review.
In respect of point (2), we have set out below the contractual provisions that should be reviewed and which will determine whether the contract provides any relief from the circumstances identified under part (1).
Price fluctuation provisions
The first step for any project experiencing price hikes is to check for price fluctuation provisions. For example, the contract may be re-measureable or there might be a specific clause to deal with price adjustments. Either way, the terms of the main body of the contract should be reviewed, as well as the other annexed contractual documents (taking into account their order of precedence). For example, it may be that the contractor’s proposals or materials schedules provide for some form of adjustment if material costs rise and, if not contradicted by those contractual documents higher up the line of precedence, there may be an argument for a price adjustment.
However, typically, employers have sought to pass the risk of procuring materials to the contractors and, more often than not, contractors have been willing to accept this risk, albeit at a premium on the lump sum cost, in order to win the work. These fixed price contracts are commonplace and there will be contractors right now that are feeling the strain where price hikes sit with them.
As at November 2019, construction materials costs had reached a 40-year high1. Prices had further risen by 23.8% as at May 2022 compared to 2021 prices2. This trend is anticipated to continue due to rising inflation, compounded by rising labour and energy costs (albeit there will be slight relief to businesses for the next six months in respect of energy costs). Consequently, those fixed price contracts signed even within the last year will be working from materials rates that are out of date, likely resulting in losses to contractors.
Therefore, if there are no price fluctuation provisions, there may be other provisions that shift the risk between the parties and which should be considered.
Force majeure
Contracts can contain force majeure provisions which allow claims for an extension of time and/or price adjustment when an event causing delay to completion of the project occurs, but which was not reasonably contemplated by the parties when the contract was entered into. In some contracts, such as the FIDIC Standard Forms, examples of force majeure (referred to as “exceptional events” in the 2017 update) are provided, and include events such as war or political unrest, and clearly set out when such an event would trigger the provision. In order to invoke a force majeure provision, the first step for a contractor would be to ascertain those events that are causing the delay or increased costs. From there, the force majeure provision in the contract would need to be analysed to ensure that the event is covered. Employers receiving notification that a relevant event has occurred should carefully review the terms of the force majeure provision as provisions of this type tend to be drafted stringently and interpreted just as narrowly.
Additionally, some standard form contracts, such as the JCT and SBCC Design and Build 2016, allow termination of the contract where suspension of works or delays caused by an event of force majeure extend beyond a certain period. However, before you seek to terminate the contract, it will be important to review the termination provisions to consider whether you are liable for any costs to the other party.
Termination provisions
Few contracts allow for contractor termination at will. However, often there is provision for an employer to terminate at will. Again, it will be important to review the termination provisions as this can be a useful tool, if available. For instance, where a contractor has entered into a fixed price contract which has become onerous and unprofitable, the cost implications of termination may be more palatable than the costs involved in completing the works.
Frustration
Frustration can be considered if an event has made the performance of the contract impossible. It is likely to be invoked by the contractor. However, the fact that a project has become more expensive or more onerous is not, in of itself, a reason to operate the mechanism. Accordingly, beware of operating this option and seek advice before doing so. If a contract is terminated on the grounds of frustration, but is not, as a matter of fact, frustrated, the terminating party can be held accountable for the costs associated with the wrongful termination in the form of a claim for damages.
We have considered some of the contractual provisions which may assist. However, if the contract provides no suitable solution, there may be other options which can be adopted.
Commercial discussions
For instance, where it is clear that there is no leeway for the contractor in terms of a price adjustment, and the price increases are at the point of making the project commercially unviable for the contractor, a sensible option may be to try to enter into commercial discussions with the employer.
The causes of supply chain disruption are well known the world over. Accordingly, it will be of little surprise to an employer to have such discussions. Employers will be well aware of the struggles affecting the construction industry and, in our experience, some employers will expect to discuss measures to ensure that the project meets its targets.
Opening up channels early between parties can allow for pragmatic solutions to the rising costs within the supply chain. For example, it may be that, in return for shouldering some of the burden on costs, an employer may seek an expedited programme. This would make sense in industries such as energy where bringing energy projects live earlier than anticipated can allow them to benefit from increased energy costs, recouping some of the increased construction costs.
Alternatively, there may be an option to discuss alternative suppliers of materials, perhaps those that can reduce shipping costs. For instance, the JCT standard form provides that materials and goods “as far as procurable” should be of the kind and standards described in the Employer’s Requirements, leaving a possibility that alternatives could be used to avoid delay. Although the signed contract may not have such wording, there is the possibility of a variation, given the circumstances.
Essentially, where there is no room for price adjustment for the contractor, it will be a commercial decision for the employer, depending on the project and circumstances, as to whether it wants to assist the contractor. It may be better for employers to renegotiate than risk the contractor falling into insolvency and being unable to perform its obligations, which in turn could cause further delay, disruption and increased costs. Accordingly, employers should be wary before they leave the contractor to sweat over the rising costs.
The impact on new contracts
Where the contract is yet to be signed, there may still be time for parties to reassess the contractual provisions to ensure certainty in this ever-changing economic climate. It is important to take advice on the proposed terms of those contracts before entering into them.
Price fluctuations
As noted above, price fluctuation provisions can deal with the scenario of fluctuating material and labour costs. The benefit of such provisions will primarily be for the contractor, and so it may be difficult to see how an employer would wish to agree such terms now, although in some instances it may be that the employer has little option where contractors are less willing to accept the risk.
However, such provisions can be beneficial to both parties. There may be less risk of a contractor going bankrupt or coming into difficulty and falling behind with the project, where some of the pain is shared.
Such provisions can be in the form of a pain/gain share where the employer will saddle some of the price increases, but could stand to benefit if there are any savings elsewhere. This may make such provisions more palatable. There is also the option to allow for adjustments if the costs tip over a certain level or if work under the contract does not begin by a certain date, or if material costs increase during a certain time. There can be some creativity here, but any wording must be clear and unambiguous and we would advise that advice should be sought in drafting/amending such provisions.
Essentially, during the negotiation process, parties should explore where the risk should sit for supply chain disruption and the costs that they are prepared to accept for shouldering that burden.
Force majeure
Now that the current strains on the construction and manufacturing industries are well known, it is difficult to see how any force majeure event would be triggered by them as most issues likely to be raised as a result are foreseeable. That said, parties should carefully consider the wording of these provisions, in light of the events over the past two years. Additionally, it remains to be seen if an employer will accept such provisions.
There may also be the option for an extension of time or cost where there is a change in law provision, such as, for instance, optional clause X2 in the NEC3 and NEC4 Contracts. However, such a change in law (including any legislation imposing sanctions) would usually be required to come into effect after the contract was entered into in order for such a provision to apply.
Advance orders
A way to mitigate the risks of supply chain uncertainty is for advance orders to be made for materials. This would require discussion with the employer around advance payments and also agreed provisions regarding ownership of the materials whilst in storage, as well as where such materials should be stored. However, this may provide certainty as to cost and also reduce the risk of delays.
Provisional sums
Contractors could seek to include provisional sums for those aspects of a project that are hardest hit by the uncertainty and price fluctuations, although this may then make tenders less competitive.
Subcontractors
Another important point to remember is that it is essential that contracts up and down the line of a project are back to back i.e. have similar provisions in respect of pricing adjustments. It would be extremely unfortunate if a fixed price were agreed with the employer, yet a price adjustment option was provided to subcontractors, or in fact when price inflation occurs no subcontract is yet in place.
Final thoughts
The present economic and political environment can leave contractors and employers exposed to rising prices and unpredictable delay. The first port of call is always to check the contract terms and take advice where necessary.
It may be that a price fluctuation clause, or relevant event, may allocate the risk but it is important to ensure that parties are fully aware of the terms of the contract into which they have entered and where the risk of uncertainty and unpredictability lies.
Where a party does find that it shoulders the risk and there is no assistance from the contractual terms agreed, it is worth looking at other options. This could include looking to renegotiate clauses so that risk is shared to allow works to be completed, or putting in place sufficient steps to ensure orders are placed ahead of time and attention is focused on procuring key materials and keeping an eye on market trends to purchase at a sensible time. This may sound like advice directed at a contractor. However, employers should bear in mind that any contractors that struggle to stay afloat following price rises and delay may, subsequently, cause loss and delay to the project. Accordingly, in these unprecedented times a commercial approach to a solution may be required.
Fundamentally, it seems clear that the market will not settle anytime soon. The predicted recession is likely to worsen matters in the UK in the short term. Accordingly, parties should be alert to the drafting of their contracts and the allocation of risk.
Finally, whatever is agreed, parties must remember to abide by the notice provisions of their contracts to avoid any argument that an application for an extension of time or price adjustment is invalid because the application has not been validly served. Additionally, any party making such an application will need to demonstrate that they have properly endeavoured to mitigate loss.
