Articles

21 October 2022

There has been steady increase in interest in recent times from project participants on the use of price escalation clauses, driven by Covid-19 supply chain issues and inflation. 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. CPI or other published indices;
• 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.

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. 

Contributed by:

Greg Steinepreis - Partner, Squire Patton Boggs (Perth office)

^[1] Lewis Construction (Engineering) Pty Ltd v Southern Electric Authority of Queensland (1976) 50 ALJR 769; [1975] QSCFC 23.  See also Codelfa Construction Pty Ltd v State Rail Authority of NSW (1982) 149 CLR 337.

^[2] For example, Leighton Contractors Pty Ltd -v- Public Transport Authority of Western Australia [No 6] [2008] WASC 193. A case where the formula was ambiguous and a key price index was discontinued is Sino Iron Pty Ltd v Mineralogy Pty Ltd [2019] WASCA 80, although the formula concerned a royalty.