Increased costs in building projects and how to deal with them
The last 18 months have been nothing if not interesting, particularly for the construction industry, and it's not over yet. The latest significant challenge facing the industry is that of increased costs. This is occurring at every level, with materials and labour all increasing in price.
There are many reasons for this, which many commentators are describing as a perfect storm, but the primary driver is the ineluctable law of supply and demand – as demand increases, and supply decreases, prices increase.
Demand is increasing for construction materials and labour world wide as governments try to revive economies by "building back better", projects which have been on go slow or stop because of lockdowns are now roaring back to life as vaccination is taking effect, residential projects are on the rise as people reappraise their living preferences and adapt their homes, and delayed projects are starting.
Shortages of materials are occurring as national and international supply chains are disrupted by the knock on effects of international lockdowns, shipping is still recovering from the Suez Canal blockage and remains affected as the pandemic rolls around the world, availability of labour is affecting production capabilities, shortages of HGV drivers are restricting deliveries, post Brexit new import and export procedures are bedding in and countries are focussing on domestic supply rather than export.
These shortages are likely to be exacerbated early next year when products will need a UKCA marking and the European CE certification system is no longer recognised.
The supply of labour, particularly skilled construction labour, has been affected by self isolation and lockdowns, Brexit making the UK less attractive for European workers, workers going home, workers remaining on furlough and international demand for labour increasing.
The only missing items at the moment are civil unrest, which is flaring up in some countries but so far seems to be limited, and inflation – but that may be on the horizon too!
What happens if you are in the middle of a building project? How do you, as either contractor or employer, deal with these increased costs and shortages?
The first thing that all parties should think about is that it is nearly always cheaper, quicker and more efficient to resolve any problems by working together and finding an agreed solution than falling out and risking an insolvency. When a contractor, for example, goes bust mid-project, it is a very time consuming and expensive exercise to get the project back up and running and back on track. There may be knock on insolvencies as subcontractors go bust in turn, replacement contractors will not want to take on the risk of the works to date and will charge accordingly, it will take a while to understand what works remain outstanding, goods and materials may have been removed, subcontractors will not come to site until they have been paid outstanding monies, which can be legally tricky, and there will be many other legal issues that need to be resolved. If a commercial arrangement can be made, even if it may mean paying more now, or accepting slightly less than a full entitlement, it is usually well worth doing it.
The CLC, via its Product Availability Working Group, and an open letter to the industry as a whole, has urged a flexible, collaborative and team based approach to current pricing and availability issues. The government has also been urging the industry, throughout the pandemic, to collaborate and work together. It makes sense.
The second thing to think about is the contract. What sort of contract have you got, and what does it say about price, costs and delay?
The most common procurement method in the UK is the lump sum contract, whereby the contractor agrees to build to an agreed specification, for an agreed price, and within an agreed time. In general terms, one or more of those 3 things can only be changed if the contract allows them to be changed. Contracts will have specific lists of circumstances allowing the changes, such as a variations clause, or a clause allowing the contract period to be extended if certain specific circumstances occur. In the absence of such clauses, and without an ancillary agreement, the parties are stuck with the original agreement, and the agreed price does not change, with the contractor bearing the risk of any increase in costs or delays in supply of materials.
If you have a contract that was entered into before around February/March 2019, it is unlikely to cater for covid, although it might if you are lucky have express provisions for Brexit related disruption and/or increased costs. If you have covid and/or Brexit clauses, check them to see if they deal with your situation. Remember that if the covid clause was drafted early on in the pandemic, it may need further consideration or amendment by agreement in the light of the events of the last 18 months.
You are most likely to have a contract in a standard form, most probably a JCT or possibly an NEC or FIDIC contract, depending what the project is. These standard forms are often amended by substantial suites of contract amendments, so it is not possible in this article to offer specific advice on what to do. The best advice is to read the contract, and its amendments, carefully, paying particular attention to the clauses dealing with the calculation of the contract sum, advance payments, entitlements to extensions of time and/or loss and expense, liquidated damages and delay, force majeure clauses, variations or changes, specification and substitution of materials and impediment by the employer.
Options to consider for amending the contract by agreement might be:
- Changing the contract sum and/or the completion date;
- Agreeing to waive or reduce LADs;
- Agreeing advance payments for specified goods and materials where the lead in times are long to allow earlier ordering, subject to safeguards regarding ownership, eg vesting certificates, advance payment bonds or parent company guarantees;
- Changing the basis on which the contract sum is calculated by perhaps adding a fluctuations provision.
Until an agreement is concluded, parties should continue to protect their rights by serving any notices required under the contract carefully and in accordance with the relevant notice provisions, and following all the required contract procedures. In addition, the parties should continue to observe the contract as drafted, so if the contractor is under a duty to proceed regularly and diligently with the works it should do so as far as possible and both parties should take active steps to mitigate any loss.
Alternatively, or in addition, the parties should explore using the existing contractual mechanisms, ideally in a collaborative manner, to manage the situation, such as:
- If specified materials are not available or not available when required, consider using replacement materials and treating this as an instruction or a variation under the contract. Clause 2.2.1 of the JCT Design and Build Contract may be of assistance here, as it requires the materials and goods, "so far as procurable" to be as set out in the Employer's Requirements.
- Interpreting the extension of time clause generously to include disrupted supply of materials, or unavailability of labour, under a force majeure or similar provision, even though the clause might not specifically cover the particular circumstances or there might be some doubt as to its applicability. The only way to be certain of a clause's meaning is to ask a tribunal to decide.
- Awarding extensions of time and agreeing payment for prolongation and loss and/or expense.
- If there is a difference of opinion over the meaning of a contractual provision, consider a quick fix solution such as jointly instructing a barrister or a solicitor to decide the issue for you. Such a determination can be non-binding but could be a useful way of unlocking a dispute and quicker than adjudication or arbitration.
If collaboration is not possible, then unfortunately you will be stuck with the contract you have, and be prepared for some old fashioned, adversarial contracting, plus possibly corners being cut to reduce costs, over generous claims, multiple adjudications and, ultimately, potential insolvency.
When negotiating a new contract, think about the following issues:
- using local supply chains wherever possible to reduce supply chain risk. This is also more environmentally friendly
- what standard form you should use, the NEC suite for example is seen as less adversarial and more collaborative than the JCT suite
- how risks should be allocated between the parties, particularly in relation to costs and delay
- how to deal with unavailability of specified materials or long delays in obtaining them, for example by including provisions for alternatives and how the cost should be allocated
- providing for advance payment for materials, with appropriate safeguards
- introducing fluctuations provisions to deal with increased costs. This can be done in a number of different ways and options to consider might be adjustment for price changes after the base date, an uplift across the board on a predetermined formula based on a series of indices, or a cost plus contract
- how changes in the law should be dealt with
- look at the drafting and effects of the force majeure provisions particularly carefully
- replacement subcontractors
- longer mobilisation and lead in times
- the effect of changes in the law and the effect of industry guidance such as the Site Operating Procedures
Ultimately, there is no getting round the fact that current projects will cost more, and be delayed, due to circumstances beyond the control of anyone, and sharing or allocating that extra cost fairly is more likely to get the project finished successfully.
Administered pragmatically and flexibly, and with a bit of sensible adaptation and creative thinking, existing contracts based on the standard forms should be able to respond to the current situation.