The COVID-19 pandemic has given rise to a construction boom fuelled by government grants and low interest rates. As a result, building costs are climbing faster than inflation.
After working to adapt to pandemic impacts in 2020, contracting parties face new challenges in 2021 as demand for labour and materials exceeds the available supply.
Significant contributing factors include:
- A government grant-fuelled surge of activity in the domestic building sector.
- Freight constraints leading to decreased import of materials from offshore suppliers.
- Labour shortages due to border closures and zero foreign migration.
- Global industry dependence on materials manufactured overseas, such as photovoltaic modules used on solar farms coupled with a global surge in demand for renewable energy projects.
Contractors who operate on low profit margins cannot afford to price the risk of supply issues upfront in the current market. The easiest route to Contractor self-protection is to nominate items vulnerable to supply shortages as provisional sums. This exposes the Principal to price fluctuations that may exceed its budget and impact its ability to obtain finance for the project.
This article outlines the perspective we have gained from recent experience where contracting parties have worked with the Principal to manage uncertainties regarding cost and time in the face of this unprecedented market.
Bulk ordering materials
Some tier 1 contractors have avoided product supply uncertainty by bulk ordering materials and storing them at an off-site location. Any risk to the Principal can be managed by the Contractor with provision of a bank guarantee against the advance payment and requiring the materials to be stored securely.
In this case, a Contractor can ensure profit margins remain intact and avoid negotiations with the Principal about sharing the cost impact of supply chain delays. We acknowledge that not all contracting parties have the cash flow to stockpile materials.
Sharing the risk of rise and fall
We see Principals moving away from contracting models that promote ‘risk dumping’ and entrenched protections where one party’s interest is subordinated to the other. These contracts lead to a misalignment of interest and inevitable disputes. Instead, there appears to be a mindset shift to a ‘best for project’ focus.
Once considered a rare occurrence in the industry, we are now seeing an increased frequency in Contractors requesting a cost escalation clause for certain products, particularly structural steel and timber. Such a clause should require the Contractor to provide:
- advance written notice of the price increase to the Principal before ordering the affected products; and
- evidence such as quotes or documents demonstrating that the increased costs are competitive and unavoidable.
Other clauses that may facilitate shared risk of increased costs include designating a set percentage increase in supply rate for which:
- increases of less than the given percentage value will be assessed by the Superintendent as a variation without margin; and
- increases exceeding the given percentage value will lead to collaboration between parties to consider alternative options to deliver the works.
Another way contracting parties can account for change in project costs is the application of a formula at the project’s end. These formulas may be based on the Construction Index Number from the Australia Bureau of Statistics or the Rider Levett Bucknall Index.
Force majeure and COVID delays
Force majeure clauses that allow the Contractor to claim for COVID-related delays are the norm in head contracts in 2021. However, usually, a force majeure clause will only protect a Contractor if the event is not reasonably foreseeable.
Typically, we do see Principals permitting the Contractor EOT relief (but not delay damages) for COVID related events that come into existence after the date the parties signed the contract, such as Government-mandated lockdowns.
Any such entitlement should be tightly drafted to ensure the Contractor is required to provide timely notice and detailed documentation demonstrating that the delay was unavoidable. The Contractor may additionally be required to include a contingency in its program for supply and labour issues.
While these clauses cannot eliminate delays, they can provide some commercial certainty for a Principal. Principals should be allowing a more extended time between completion of construction and handover to a subsequent purchaser or lessee to mitigate against the risk of unpredictable supply delays.
Conclusion
While increasing vaccination rates will hopefully provide some relief, the consequential impact of COVID on the construction market will be felt for some time. There is a conflict between adherence to the traditional fixed-price design and construct contract model and the current need for Contractors to pass on unforeseeable cost increases post-contract.
Contracting parties must maximise innovation and value engineering to steer construction projects through the challenges that lie ahead. These challenges call for collaboration and communication in good faith between contracting parties to find solutions that drive ‘best for project’ outcomes.
*As a disclaimer, the content does not constitute legal advice and should not be relied upon as such. Appropriate legal advice should be obtained in actual situations. Feel free to contact us should you require any assistance in resolving a legal dispute
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