In our June 2022 edition of Construction Matters, we noted a steady increase in interest from project participants on the use of price escalation clauses, driven by COVID-19-related supply chain issues and inflation. We observed that principals and contractors should consider, at the outset, how the risk of cost escalation can be minimised or shared on a project.
There are a number of ways to structure a construction contract to deal with the risk of cost escalation. Cost-plus contracting is being sought more frequently by contractors. Principals who are less keen on paying on a cost-plus basis, and who insist on a lump sum, may have to accept much larger contingency in the present contracting environment. That contingency could be reduced by introducing price flexibility options into the contract. Price flexibility options include allowing for more provisional sums and providing for rise and fall.
Rise-and-fall clauses are making a comeback after decades of absence, when inflation was relatively low and supply chain issues were not acute. Their absence has meant it is necessary for project stakeholders to now reacquaint themselves with the principles behind a workable rise-and-fall clause.
A simple operative rise-and-fall provision would state that the contract sum (or specific rates and prices) will be adjusted for rise and fall in costs as set out in an accompanying schedule. The schedule would contain a description of what aspects of the contract sum are subject to rise and fall, and a formula for the cost adjustment. Usually, the rise-and-fall formula adjusts materials and/or labour costs and is a result of close consultation between quantity surveyors or other technical personnel and legal advisers.
The elements of the rise-and-fall formula will typically involve some consideration of:
- Which components of the contract sum, or which rates and prices in a schedule of rates, are to be adjusted
- Which indices are to be used to measure the price movements, e.g. the Consumer Price Index (CPI) or other indices (such as the Producer Price Indexes, and the labour, Australian materials and imported materials indices) published by the Australian Bureau of Statistics
- Where the adjustment is to a schedule of rates, then if the schedule items are not already appropriately categorised, they may need to be to match the chosen indices
- A risk buffer may be considered, e.g. the first 2% increase is the contractor's risk
- The base date
- The adjustment date
- The period within which movements in cost are to be measured, e.g. monthly or yearly
An example of a formula applying these considerations is Schedule 7 of GC21 (Ed 2), the NSW government’s general conditions applicable to public works.
Formulae for rise and fall can be complex, and it is advisable to do worked examples to make sure the formula works as intended. Careful drafting of the narrative aspects of the formula is also recommended, otherwise a disagreement could end up in litigation.
An example of a dispute that went to court regarding the reference dates is a case where it was unclear whether the calculation was to be by reference to the index at the date of tender/contract, or periodically, given the formula allowed for periodic adjustment. 1
Failure to provide in the contract for alternative indices could lead to the formula being inoperative, with the consequence that no rise–and-fall adjustment can be made. Ambiguous words that allow for flexibility in selecting an alternative index if one is discontinued (such as “the nearest index consistent with the intention of this annexure”) may lead to disagreement and litigation.2
In conclusion, there is a need for some industry re-education on rise-and-fall provisions, and care should be taken in drafting both the technical and the legal aspects of rise-and-fall clauses.