Although the pandemic has obviously played a part, the repercussions of Brexit continue to have an even greater impact on the industry.
Construction News recently reported that in Northern Ireland there has been a marked dip in the number of orders placed by contractors, largely as a result of the increased cost of materials due to material shortages. Coupled with long delays to deliveries and a reduction in the availability of labour, there is heightened negativity about the next few years for the industry in Northern Ireland.
A key concern is the lack of certainty in contract pricing and costs, and therefore difficulty in negotiating contracts in which significant losses could be made by either party.
So, how do I manage the risk?
Those already tied into fixed-price contracts are facing significant difficulties with the increase in costs and how this can be managed, particularly when materials are also delayed which leads to the risk of liquidated damages. But there are options available, both commercial and contractual, that are worth exploring.
Firstly, maintain amicable relationships. Insolvency and bankruptcy matters are all too familiar to the construction industry, particularly in times such as these. Maintaining open relationships and transparent dialogue about costs with parties involved in your project is the first step to finding a solution which is cost effective and manageable. Collaboration and communication is key.
Secondly, apply contract mechanisms. Depending on the form of contract, there are ways to manage risk using the mechanisms under the contract:
- JCT Contracts
- Agree a Variation: JCT Design & Build contracts require materials and goods to be "procurable" (Clause 2.2.1). therefore on the basis that a contractor is obliged to "proceed regularly and diligently" (Clause 2.3), if materials are simply unavailable, it would be prudent for a contractor to discuss options with the Employer. Agreeing a variation to the contract or value engineering to use replacement materials could be an alternative. This could, in turn, allow a contractor to agree an adjustment to the price through the variation process, if the cost of materials had increased. However, this is not a clear cut contractual entitlement option, but a commercial consideration, hence the importance of amicable, collaborative relationships.
- Relevant Events / Notice of Delay: If, as a result of delays with material deliveries, there is likely to be a delay to the Completion Date, it is necessary to give notice under the JCT (Clause 2.24.1). Failure to give notice could expose a contractor to liquidated damages therefore it is important to ensure that contractual processes are being maintained, particularly in times of uncertainty. Consider when the delay was known to you, and perhaps whether this event is a force majeure event?
- Fluctuation Provision: Does your contract include provision for fluctuation? During the formation of the contract, parties can agree to include an option under JCT Standard Build or Design and Build contracts for labour and material fluctuations which allows for an adjustment to the Contract Sum where the market prices for materials and goods changes. If you are entering into a contract now, is this something you need to consider?
- NEC Contracts
- Contractor Risk: If, during the course of the project, the cost of materials increases, it is important to note that the standard position is that the contractor accepts that risk (as it is not an Employer's Risk), unless an amendment to the contract has been agreed. Consideration should, therefore, be given to the options below:
- Early Warning: NEC contracts provide for an early warning process whereby parties are required to notify one another of any matter which could affect cost, completion or progress of the work. This process is fundamental to the success of the mutual trust and cooperation principle of the NEC. To maintain amicable relationships, early warning notices are key.
- Agree a compensation event: If materials are unavailable rendering the scope requirements "impossible" (Clause 17.2) or preventing the works being completed by the completion date (Clause 60.1(19)), the contractor could discuss or agree with the project manager, an instruction to change the scope. Such an instruction would constitute a Compensation Event and allow the contractor to agree an extension to the completion date and / or a change in the prices.
- Value Engineering: NEC4 has introduced a new Clause 16 value engineering provision allowing a contractor to propose changes which could reduce the cost of the works. Therefore if material costs do increase (which is likely to be a contractor's risk), this is an opportunity for a contractor to propose an alternative, more cost effective solution.
- Option X1, Inflation: Under NEC Options A, B, C and D, parties can opt to include a secondary option clause, Option X1, if the Employer agrees to accept the risk of inflation. The prices can therefore be adjusted for inflation. In NEC Options E and F, the Employer already takes on the risk of inflation.
What about future contracts?
Going forward, contractors and developers alike, need to be alive to the current market and the industry circumstances which are likely to impact the cost and time taken on projects in years to come.
Ensuring that contract terms are carefully considered and negotiated will be key, in particular:
- Construction parties should consider the benefits of the NEC forms of contract which are founded on the premise that parties should work together collaboratively and in the spirit of the contract;
- Consideration should be given to risk allocation under the contract particularly for costs and delay;
- Clear and unambiguous drafting amendments to contracts should be considered to deal with the ongoing time and cost impact of material shortages / cost increases;
- Careful thought should be given to the force majeure provisions, the extent and the effect of the provisions; and
- Ensure that fluctuation provisions are included in the contract terms to deal with changes to costs.
Awareness of contract mechanisms and careful planning and drafting in future contracts, is essential when faced with challenges in the market.
To discuss any of the points raised in this article please contact Aine McGuinness.