INFLATIONARY COSTS IN CONSTRUCTION PROJECTS
15 / 06 / 2022
The construction industry is experiencing inflationary pressures, not seen in the UK for 40 years.Unfortunately, it is likely to be with the industry for some time to come. Below we set out some commercial steps that developers can consider to ameliorate the worst effects:
- Early and ongoing collaboration with the contractor(s) and other members of the project team will be key to addressing inflationary pressures for a particular project and agreeing who will bear the inflationary risk or how it will be shared
- Early planning, design and sourcing is even more important in inflationary times. Consider whether there are alternative designs, suppliers, materials or components that could be substituted and are less prone to delay risk and inflation. If the specification/Employer’s Requirements does not allow for substitutions, can/ should that be changed by agreement? Suppliers need to consider availability and delivery times of key components and materials and how these may be secured.
- Consider early ordering of and payment for materials or key components to lock in prices. JCT and NEC contracts provide for advance payments and for security for early orders and deliveries by way of advance payment and off-site material bonds. However, if such bonds are a precondition of early payment, consider if what is required can be obtained and which party will bear the cost? The bond market generally has hardened considerably since Covid, therefore carefully consider the terms offered by bond companies..
- If materials are going to be stored off site, consider who will pay the storage charges and when the legal ownership in those goods passes.. Check the terms of all your contract and contract documents carefully to ensure that they are consistent and reflect precisely what has been agreed about early delivery and payment. Check if any early payments will be made and what conditions precedent need to be fulfilled by any funders. Most payers and funders will want goods for which they pay formally vested in them by way of a “vesting deed” to guard against supplier insolvency.
- Place greater emphasis on security and protection for materials and fuel both on and off site. More thefts may occur as prices rise and indeed are already being reported .
- Carry out regular financial checks on the companies within your supply chain. Consider whether they are sufficiently resilient and have their own plans in place to deal with shortages and delivery delays.
- Consider whether alternative procurement methods may be appropriate: for example two stage tendering where the main contractor is engaged early to participate in progressing the design, buildability, procurement and pricing for a later second stage tender; “open book” pricing namely-payment of the actual cost of materials plus an agreed profit and overhead percentage; prime or target cost so if the actual cost is greater or less than the target, the parties share the increased cost or saving; or a combination of approaches.
- Consider any elements of the contract sum which are labelled prime cost as this is not a fixed price and may increase both the contract sum and the programme once instructed to be expended
- Consider the overall risk profile of the proposed project both in relation to price and programme and how the risk is going to be allocated.
There is an obvious tension between employers and their funders requiring fixed prices for budgetary and funding reasons and the supply chain’s ability to deliver at fixed prices over the currency of a project.
This is particularly the case for a long programme and one that relies on materials that are in short supply.
How realistic fixed prices are for any given project and how this can be addressed will depend on many commercial factors.
Inevitably though, as with Brexit and Covid, all parties involved in a construction project will be best advised to collaborate in finding the best solutions for all concerned.