Euan Pirie: Dealing with volatile materials costs in construction tenders
Euan Pirie, partner in the specialist construction and engineering contracts advisory team at Harper Macleod LLP, looks at a solution to price uncertainty for construction materials when tendering big contracts.
Prices for construction materials have gone haywire in a perfect storm of conditions which have pushed demand up and supply down. So how do the parties to a construction contract deal with this uncertainty and risk when trying to fix a price at tender stage?
Standard form price adjustment provisions
Standard form price fluctuation provisions do exist – Option X1 in NEC provides for general inflation adjustments for example - but these options have not typically been incorporated into contracts in recent years. There has been little need for them while prices have been stable and, given their complexity, little appetite for including them “just in case”.
But these standard form clauses are not a complete answer to the current pricing crisis. The volatility we are seeing in the market at the moment relates to specific commodities – steel, timber and concrete being some of the main culprits - but not to all construction materials so the standard form clauses are too general and the reliance typically on RPI/CPI as the basis of the inflation calculation is too imprecise. The rise and fall in the cost of a basket of groceries bears no resemblance to the fluctuations we are currently seeing in specific construction materials.
The other difficulty with applying a standard clause on price fluctuation is that they tend to apply for the whole duration of the contract. From what we are seeing, the actual problem is more short term and immediate, being in the “gap” between the final tender submission date and when the main contractor can actually place orders/sub-contracts to lock in supply chain pricing.
What can you do about it?
The team at Harper Macleod has come up with a solution in conjunction with our public sector clients who are going through the process of tendering big contracts during a period of significant price uncertainty.
A bespoke set of clauses has been created to introduce a proportionate, time limited, price adjustment mechanism for the specific commodity that is problematic for the particular project.
The clauses provide for a percentage based fluctuation mechanism which serves as a cap, based on a reasonable estimate of how prices may change. For example, if a multiplier of up to 1.25% per week is stipulated, the contractor can claim an uplift on the base date price, up to the cap provided by the multiplier, by producing evidence that prices have increased since the date of tender. The contractor would be paid “actual price” incurred at the point it commits to the sub-contract/supply agreement, where this produces a lower uplift than adjusting the base date price as above.
The value of the percentage multiplier is calculated on the basis of the average increase in the material prices over past 12 months (a figure obtained using data from the relevant Building Cost Information Service (BCIS) matrix). Using the average inflation increases looking back, there is no need to consider changes in the matrix moving forward, providing certainty for the parties.
Basing the percentage multiplier on a 12-month average also evens out some of the short term fluctuations, but still provides the contractor with pricing protections that are much more directly connected to the sector that is the cause for concern than would an RPI or CPI based mechanism. If the concerns related to more than one commodity/material, the percentage multiplier used can be specific to the sector and will always be based on the most directly applicable BCIS matrix.
The percentage fluctuation mechanism applies from the tender date until a pre-agreed date, based on when bidders indicate relevant sub-contracts/supply agreements will be placed. The idea is to allow the contractor a reasonable period to place the order and claim for any adjustment that has occurred in the meantime, subject to the % cap, but not to leave those protections open to abuse.
As for the percentage multiplier, different cut-off dates can be agreed for separate categories of commodities/materials. If the contractor places an order after the applicable cut-off date, they continue to have the right to claim the adjustment but it will be limited (in terms of application of the applicable percentage based weekly multiplier) up to the relevant cut-off date, where (as above) this produces a lower variation to the prices than allowing the contractor to recover the actual costs it will occur.
A balanced solution
This set of clauses provides a balanced approach to the current crisis. The contractor has the opportunity to adjust its price to claim for increases between the tender date and placing the orders while the employer has the comfort of a cap to ensure that they do not become liable for potentially big increases in price caused by the contractor’s delay in placing orders. The mechanism also serves to ensure that bidders do not “lowball” price sensitive elements of the tender as a tactic to win the project and in the hope that they will be able to use fluctuation clauses as a means of recovering their position at a later stage.