What can be done about fixed price contracts when galloping costs cannot be reined in?

Supply chain issues arising from price inflation due to shipping and building materials is concerning, however it is the rate of inflation that causes the most anxiety, especially in fixed-price contracts. Construction cost inflation in 2021/2022 is unprecedented, after decades of price stability in the supply of materials, labour and plant, is it time to ditch fixed-rate contracts in favour of contracts which include fluctuating clauses? JCT contracts contain an optional fluctuations clause which last saw significant use within the industry some 20-30 years ago. Do we dust those off now?

Discussions on fluctuations and how to provide for these of course do not help those who are currently locked into a fixed-price contract, which most construction contracts are, who face two key problems;

1. trading losses as contracts become under-priced due to costs outrunning the original price, and;

2. costly delays to the work.

Major contractor the Mace Group Ltd agrees and stated “fixed price projects are putting contractors, especially smaller subcontractors…, who have fewer resources and flexibility, at high risk of losing money” .

Issues such as these will inevitably lead to demands from contractors and subbies for more money, walkouts by or replacement of contractors and subbies (both potentially a repudiatory breach of contract – which is terminal to the contract) and attempts to renegotiate.

What options are available to adjust the price?

So what can be done?
Each case will be different, however, options may include:

• a claim for loss and expense if the Payer is culpable for delays; or

• the potential to recover losses in the valuation of variations; or

• a price adjustment based on the legal principles of mistake or potentially force majeure.#

However, these are all theoretical legal arguments for contract price adjustment and our preference is to turn to the practical and commercial solution of renegotiating contract prices to try to get an amicable outcome to preserve the supply chain and the project programme.

Renegotiation is not likely to be straightforward

For the contractor; a walkout or a refusal to continue will be seen as a repudiation of contract, and whilst a time-tested negotiation strategy if misused, not only will the contractor have wrongfully terminated but also if any price increase was derived from the above threats, they may be deemed legally unenforceable. If the repudiation argument is valid and the repudiation accepted, then this brings the contract to an end and exposes the contractor to a claim for the extra over costs of completing their works. So this is a potentially risky path.

It might be that certain normal materials are in short supply with a long lead time, and the threat of a walkout and no hope of engaging others for months might leave the Payer with no choice but to agree to the price increase. This is potentially economic duress.
Am I Negotiating or exerting Economic Duress?

If the price increase is more than the current market value then it is potentially economic duress. If it is cheaper for the Payer to accept the increase in price rather than go to market and source a new contractor it is likely not economic duress.
The following cases highlight the difference between financial pressure as a negotiation tactic and economic duress:

• Economic Duress (Carillion Construction Ltd v Felix) (2000) – The contractor, having refused to make deliveries until an agreement was reached, coupled with the Payer’s anxiety around liquidated debt forced the Payer to agree to a £450k increase in contract price. The Payer disputed the price following completion, and the Court honoured the original price as it held the pressure applied by the contractor illegitimate and without justification.

• Financial Pressure as a negotiation tactic (Williams v Roffey Bros & Nicholls (Contractors) Ltd (1990) – having under-priced the works, a subcontractor ran into financial difficulties and threatened to stop work unless an increase in price was agreed. The main contractor considered that engaging a replacement would cost considerably more, so there was an agreement to pay the extra. The Payer disputed the price following completion, but this time the Court held that the updated agreement was enforceable as the contractor (Payer) had derived a benefit by paying the same sub-contractor rather than hiring a more expensive replacement, it is financial pressure but not economic duress.

What do these cases tell us?

The principle in these cases is, any negotiated upward adjustment in price should not leave the Payer with no choice nor a practicable alternative but to submit to the financial pressure.  Where there is no alternative contractor/ sub-contractor/ materials or one cannot be obtained in-time at market price, any threats to stop work are likely to be seen as economic duress. Where it would cost more to complete with an alternative then the negotiated price any relating work disruptions are more likely to be seen as financial pressure normal in commercial relationships.

Practical considerations when entering a new construction contract

As the inflationary pressures are here to stay, any employer, funder, contractor or sub-contractor should bear in mind the following considerations when contracting:

• Include Fluctuation clauses in your contract – Many construction contractors, such as JCT, contain optional fluctuation provisions. Serious consideration should be observed, especially for contracts with long lead times or no set end date to ensure your fee does not become undervalued by rampant supply and material costs;

• Consider alternative procurement methods – such as; two-staged tendering where the main contractor is engaged early on in design and buildability where actual cost or savings later on is split between the parties.

• Financial Due-diligence – carry out regular checks on companies within your supply chain. Do they have liquidity, are they resilient to market changes, or will they fold without delivery?

• Transfer of Ownership of materials – consider where materials will be stored and when title will pass. Check your contract : employers will/ should seek to include clauses specifying when legal ownership of goods is transferred, even when stored on contractor or third-party premises.

• Early ordering of and payment for materials – This locks in prices. JCT and NEC contracts provide for advance payments and for security for early orders. Consider if what is required can be obtained and which party will bear the cost.

There will likely be many instances of tension between parties, especially from funders and employers wishing for the “certainty” of fixed prices over the currency of a project; particularly so for long projects. However, this will place pressure on subbies and contractors, who cannot deliver if they are insolvent.

Realistically, fixed price contracts may diminish over the next decade it is therefore important that all parties be proactive to address the many commercial factors collaboratively in finding the most commercial solutions for all concerned.

Beware Legal Footfalls

When already party to a fixed-priced contract, any attempts to:

• stop work;
• alter the contract unilaterally; or
• replace contractors/ sub-contracts without a ‘supplement the labour’ clause may be a repudiatory breach of contract.

We have addressed repudiation by the Payee above.

If there is repudiation by the Payer, the Payee is likely to be considered entitled to the sums due for all work done to that point in time, plus all retention and damages for losses and expenses incurred, including loss of profit (subject to the term of any contract).

When faced with under-priced contracts, stubborn negotiators and inflating construction materials, any considered walk out by contractors or attempts to source replacement contractors by Payees could put their business at risk without professional consultation.
If you are encountering difficulties arising from the current materials crisis, please get in touch with our construction team for expert advice.

Bibliography

Rogers, D., 2022. Rocketing costs sees Mace revise tender prices up by half for rest of 2022. [online] Building. Available at: <https://www.building.co.uk/news/rocketing-costs-sees-mace-revise-tender-prices-up-by-half-for-rest-of-2022> [Accessed 10 June 2022].