Does my construction contract safeguard me from inflation and if not, what can I do?

There is always a risk, for both parties, that costs fluctuate during a project. Last year, in particular saw the construction industry dealing with sharp price increases. Whilst it is projected that this will stabilise over the course of this year, we are often asked how can parties to a contract protect themselves from inflation, and what can be done for those who have already entered into contracts.

For the purposes of this blog we have considered the situation of a contract based on either an NEC or an SBCC form of contract.

Position under NEC

The NEC has six different forms A, B, C, D, E and F. Options A, B, C and D allow for a secondary option X1 "price adjustment for inflation". This is not mandatory so can only be included by agreement.

Optional Clause X1 provides a formula for calculating a "Price Adjustment Factor" which is then applied to a proportion of the value of the works, which proportion should be set out in the contract data. This means that the contractor carries the inflation risk for the remaining proportion of the works.

The NEC also provides that parties should give an Early Warning Notice as soon as they become aware of any matter which could increase the Price of the contract or the Contractor's total cost. Whether inflation will increase the price or cost will depend on the contract terms.

Once notice has been given, parties should then attend a Risk Reduction Meeting/Early Warning Meeting to discuss how to reduce the impact of such a matter and seek a solution. Depending on the project and the material, this may be as simple as agreeing to an alternative material or it may require substantial re-design. NEC4 also specifically introduces an “early warning interval” into contract data 1. This is where the Client states the interval that they are proposing to have early warning meetings for the duration of the project. The regular occurrence of these meetings should be beneficial to both parties.

Position under SBCC

Under the SBCC Standard Building Contract (With Quantities) there is a choice of three optional clauses to address fluctuations.

Option A, which is the default position, allows for fluctuations in relation to contributions, taxes and levies payable by the Contractor as an employer. Therefore, if inflation drives up wages, the associated contributions, taxes and levies will also increase, and that element of inflation risk is addressed.
Option B relates to fluctuations in labour and materials costs and tax. This covers scenarios where wages fluctuate as a result of industry changes. Under Option B the Contract Sum is said to be calculated based on (amongst other things) market rates for materials, goods, electricity and fuels at the base date. Should those costs increase, the Contractor can claim the difference from the Employer.
Option C provides a formula to adjust the Contract Sum in accordance with the Formula Rules issued by the JCT/SBCC. Option C also makes specific provision in relation to items manufactured overseas which allows the Contractor to claim for any price difference between the market rate when the item was bought and the rate at the base date. In addition to inflation increases, this could also see the cost of Brexit tariffs being passed on to the Employer.

Unfortunately, if the contract does not make any provision for price fluctuations, parties are bound by the agreed contract price.

Next week we will look at protecting the supply chain. If you haven’t read the previous blog in this series, it can be found here. You can read the next blog in the series here.

Should you require assistance with any aspect of a construction contract, we have a large and experienced construction team who would be happy to discuss this with you.