A Guide to Fair Pricing: Mastering Construction Cost Adjustments
Fluctuation provisions in construction contracts are designed to adjust the contract sum. This might be needed to reflect changes in labour, material, and associated costs. By adding fluctuation clauses, you can mitigate the risk of price volatility during the project.
However, in my experience, these provisions are rarely included in contracts. This often stems from a reluctance by the employer to assume the potential risk of significant price increases. Often the contractor is left to bear the full burden of material price fluctuations. This risk can be substantial and difficult to predict, especially on multi-year, large-scale construction projects.
What can you do if labour and material costs rise?
Let me put this into a relevant real-world context. Back in 2022, I acted as the commercial lead on a project just as the global pandemic was ending and war in Ukraine was looming. Working for the main contractor, my role was responsible for the procurement of the supply chain, and it turned out to be a testing experience.
The tendering steelwork contractors would not fix their quotations for more than a day due to the volatility in the market. Other contractors were also reluctant to quote on fixed prices for works too far into the future, unless a margin of safety was included in the contract sum.
Taking that stance in such challenging times was completely understandable. Our issue, as the contractor, was that the contract we had in place with our employer was agreed in 2021 on a fixed-sum basis.
A deed of variation
Thankfully, the employer understood the position and showed empathy. They accepted that their main contractor was facing a tough situation, which could even be potentially business ending.
Through a process of negotiation, we agreed to a deed of variation to increase the contract value. But it wasn’t a simple process and took a great deal of time and substantiation — and, ultimately, led to a delay to the original completion date.
Looking back in hindsight, that was the right decision and an example of the best face of our industry. Official data from the Insolvency Service in the UK, revealed that 4,165 construction firms in became insolvent in the twelve months ending on 31 March 2023.
Three key steps to ensure a successful outcome on your project
Having a provision in your contract for price fluctuations or an employer who is willing to come to an agreement is not the end of the matter. You will still need to compile a credible document that demonstrates why the prices should be amended. When doing so, there are three steps to consider:
1. Establish a narrative
Claimants often identify events in price escalation requests but fail to connect them directly to the cost increases. This leaves it up to the reviewer to infer the link. Provide a clear narrative that explicitly details how specific events caused the price fluctuations and quantifies their impact.
2. Provide relevant index or cost adjustments
The FIDIC form, for example, often utilises cost indices to calculate price adjustments. These published indices provide a clear and consistent method. Alternatively, claimants can demonstrate the actual cost difference by comparing the current material price to the originally estimated price.
3. Substantiation
To come to a successful conclusion, you are going to have to demonstrate that the price fluctuation you are claiming is accurate. Good record keeping is essential. The use of indices is a straightforward approach due to the fact they are transparent and publicly available. Even so, you’ll still have to illustrate to the reviewer what the data is telling them, leading them to a logical conclusion. Cost-based adjustments, however, demand robust record-keeping to validate both the original and revised costs.
Documenting and substantiating cost adjustments under FIDIC
Under FIDIC (2nd ed., 2017), Clause 13.7 addresses adjustments to the contract price for changes in the cost of labour, goods, or other inputs. It’s an optional provision that parties can choose to incorporate in their contract.
The application of Clause 13.7 is contingent upon the inclusion of a "schedule of cost indexation" within the contract. This schedule outlines the specific indices and coefficients to be used for calculating the price adjustments.
FIDIC guidance notes suggest that this sub-clause is particularly relevant when it would be unfair or unreasonable to expect the contractor to solely bear the risk of significant cost escalations. This typically occurs in projects with long durations or in volatile markets where price fluctuations are difficult to predict.
This article was written by Steven Woolnough, Chartered Quantity Surveyor, MRICS, MCIOB, MCICES, MCIArb.
To understand more, the practical use of FIDIC 2017 intermediate course covers variations and adjustments. Visit the webpage now to see the full course outline.
Will Your Contract Admin Stand Up to Future Claims?
Good contract admin (or administration) is key to any successful project. If a claim is to succeed, it must contain certain essential elements: Cause, effect, entitlement and substantiation.
In other words:
- What happened that gave rise to the claim.
- The dates that various events occurred.
- The effect of delays on the time for completion
- In the case of incurred costs: Are they appropriate? Are they calculated correctly?
- Does the contract contain entitlement to compensation?
- Is every statement or fact in the claim substantiated?
We should also remember that the onus is on the claimant to prove that the claim is just. It is not the respondent’s job to do this when reviewing the claim.
To achieve this, the contractor’s contract administration systems must be able to support future claims. If they are not, it will be difficult or impossible to prepare a claim that fulfils these criteria.
Contract Administration: Things to Consider
Some things to consider in this respect are as follows:
- Is your record keeping adequate and can the records be easily retrieved?
- Are important and formal records drafted so that they may be understood by a person not familiar with the project?
- Are notices that are required by the contract given within the prescribed time frames? Do they contain the correct information?
- Has a baseline programme been established? Is it prepared in line with good practice?
- Are revised programmes prepared when circumstances dictate?
- Are progress updates accurate? It is difficult to subsequently claim a delay if progress has been reported showing no delay.
- Do monthly reports adequately record the events, and may they be understood by a person not familiar with the project?
- Are daily records of resources deployed to the project being maintained and submitted to the engineer on a regular basis?
- Do you have adequate and properly qualified and experienced resources to create and maintain efficient contract administration?
- Do you have adequate and properly qualified and experienced resources to prepare your claims?
If you can answer yes, to all these questions, there is a good chance of success for your claims. If not, then you may need to reconsider your approach.
For more help with these subjects, why not consider joining one of our e-courses?
Increases in Material & Other Costs
The consultancy side of our business has recently received enquiries along the lines of the following. “We have come to the end of our project and are facing a huge loss due to increases in the cost of materials and shipping and because of measures that we have had to adopt to control COVID-19. What can we do?”
Claims Class Helps Student Secure US$1 Million
This month, I am going to allow myself a pat on the back because of a success story from a recent Claims Class student.
A person from an African country contacted me to discuss enrolling in one of our claims courses. They had found out about Claims Class after purchasing a copy of my book FIDIC 1999 Notices. This is what they shared with me.
The Problem
This individual works for a Contractor on a project under FIDIC where the Employer did not pay by the due date. The clauses entitling the Contractor to financing charges and to suspend the Works in the case of late payment had been struck out of the Contract.
Notwithstanding this, my contact wrote a letter. In it, they gave formal notice of non-payment and followed up with a notice of termination based on the example contained in the book. Upon receiving this notice, the Employer organized an emergency meeting. They not only made the outstanding payments but also paid the next certified amount before the due date.
The Result
The individual then put the lessons they learned on the course into action. They submitted claims for an 81-day extension of time and associated prolongation costs. The Engineer awarded a 60-day extension of time and costs in excess of US$ 1 million. I would like to think this was excellent value for the purchase price of the course and the book!
After this success, they considered the next steps in their career progression. They have decided to specialize in contractual matters and claims. They enrolled in our Perfect Claim E-Course and are currently on track for an excellent grade.
I wish them luck in their search for a new direction in their career.
If you would like to know more about our e-courses and how they can help you take the next step in your career, visit our e-courses page.
What is Included in 'Lump Sum'?
A simple matter that often causes confusion is exactly what a lump-sum price includes.
Take a typical contract designed by the employer. The contractor is required under the contract to provide the works defined on the drawings and in the specification. In other words, the drawings show the extent and the configuration of the design. The specification describes the composition and quality of the work. Thus, it is clear that the lump-sum requires the contractor to provide whatever is included in the drawings and specification.
Claims for Additional Preliminaries as a Result of Variations
Variations - something that comes up a lot in our courses. One question crops up time and time again. Does the contractor have entitlement to payment for additional preliminaries arising from variations?
The short answer to the question (as usual) is that it depends.
What Are Preliminaries?
Why do Final Accounts lead to Disputes?
I recently provided advice on a dispute of US$250M. This sum includes variations, prolongation costs, acceleration costs, disruption costs and delay penalties. The dispute crystalised when the contractor submitted his final account. This is a familiar occurrence. In fact, a large proportion of disputes occur when the project is either nearing or after completion.
Payment for Work Not in Accordance with the Contract
A former Claims Class student asked my advice on a matter which I thought would be an interesting case study to share. The Contract conditions are FIDIC and the question around non-payment of work which was not in accordance with the contract.
Background
Each month the Engineer makes deductions in the payment certificate for Non-Conformance Reports under Sub-Clause 14.6 (Issue of Interim Payment Certificates), sub-paragraphs (a) & (b).
The Contractor does not contest the Non-Conformance Reports. They state that the defects will be rectified. A problem being that this is likely to take some time to achieve.
Late Payment: What Can We Do When We Don't Get Paid?
What can we do if we don't get paid or suffer from late payment? We get this question a lot at claims class, along with similar questions about late certification.
In some regions, this is less of a problem because legislation is quite strict on payment terms. However, elsewhere, it is common for the paying party to hang onto money for as long as possible.Read more