Mon 06 Mar 2023

What do I need to consider when agreeing a new construction contract?

Welcome to this five week blog series looking at inflation and other challenges currently facing the construction industry. 

Higher interest rates, labour shortages, inflation and an anticipated domestic recession; it is fair to say that there are challenges ahead for many industries in the UK. Companies operating within the construction industry can be particularly susceptible to downturns in the market as they typically operate on comparatively low margins and as such are more sensitive to higher borrowing costs. Indeed, many construction companies have previously relied on relatively cheap borrowing to weather previous economic challenges. Unfortunately, it is forecast that the construction industry will fall into a recession in 2023, with output forecast to drop 4.7%. With such a bleak forecast it is unsurprising that many within the construction sector are looking carefully as to how to minimise their exposure.

For those that have not already entered into a contract, you should make provision for increased labour and material costs and higher inflation. Certain standard form contracts already contain optional clauses designed to meet these challenges. That being said the clauses in most standard form contracts to address inflation, such as the fluctuation clauses in the SBCC/JCT and the optional Clause Option X1 in the NEC 4 suite, may be too imprecise to effectively deal with the current economic climate. These clauses are also often deleted or not included in the contract, leaving the Contractor with little or no protection.

The majority of industry and government forecasts predict, however, that these challenges are more of a short term and immediate issue and in addition inflation is affecting the price of certain materials more than others.  It is therefore recommended that a bespoke set of clauses be instructed focussing upon particular materials as well as the more generalised inflation and price adjustments. Such clauses ensure the contractor has ability to adjust its pricing in the vulnerable period between tendering and placing material orders whilst the employer can introduce a cap to limit their exposure to risk should the contractor delay in ordering materials. Whilst some employers may be initially resistant to the introduction of such clauses they can be of benefit to all when properly drafted.  Without such clauses the risk of insolvency of contractors can dramatically increase and this risk is just as big a threat to projects as inflation.  It is of no benefit to either party if a contractor cannot afford to complete a project or has to cut corners to stay within budget or becomes insolvent during the contract.

The next article will look at whether or not your standard form contract protects you from inflation. You can read it here.

Should you require assistance with any aspect of a construction contract, we have a large and experienced construction team who would be happy to discuss this with you.

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