Since COVID and the Ukraine conflict, we have seen a major rise in the cost of completing projects. Increased costs of energy, shipping, manufacturing and raw materials are often to blame.

Contractors, locked into fixed price contracts, often face a loss-making situation on projects.

Clients often seek advice on what to do in these situations. Can they claim for these increases from the Employer?

Here’s our thoughts:

In times where we face high inflation and price escalation, contractors have to allow for anticipated increases in costs when they price a job.

This is a guessing game. Whether a contractor takes a conservative view, or a protective view depends on how competitive they wish to be with the tender.

Bearing in mind that low margins may be acceptable, a loss making situation will be a road to disaster so most contractors will adopt a cautious view.

Let’s also look at this from the employer’s perspective.

This could lead to a situation where the Employer pays for a higher risk of inflation than will actually occur. To combat this, sensible employers will share the risk. They will pay for actual increases in costs rather than the tenderers’ “belt and braces” estimate.

If an employer does take this step, the employer will include a price escalation condition within the contract.

Such a clause provides that the tender should be priced on the costs prevailing at a base date, which is set during the tender period. The contractor will subsequently be compensated for actual increases which occur during the contract period.

This may include all costs. The increases would be calculated using published cost indices, or a list of base costs with increases calculated by comparison to subsequent invoiced costs. In other words, the contract will not be a “fixed price contract”.

Unfortunately, many contracts were entered into when inflation was reasonable. As a result, many projects in progress do not include such provisions. Most contractors are in a situation where they have to bear the current risk of cost increase.

We wait to see if employers will adapt the risk management strategy of including cost escalation provisions…

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