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Dealing with material cost increases

HIA has put together a fact sheet about contracts and important clauses to assist in dealing with situations arising from cost increases

HIA is aware that the ongoing impacts of COVID-19 combined with increased building activity due to the HomeBuilder grant is leading to price increases across both labour and materials.

Key Facts

When accounting for and responding to price increases you should:

  • Consider the most appropriate contract to use.
    The current circumstances and the scope of work might impact on whether a fixed price or cost plus contract is more suitable.
  • Understand your contract.
    ‘Rise and fall’ clauses that allow you to account for price increases and decreases or prime cost and provisional sums may be of some use in the current circumstances.
  • Continually review the price of all building materials and factor in any increases into the contract or tender price.
  • Consider reducing the time between signing the building contract and commencing work to ensure you have the best picture of your costs.
  • Communicate the volatility of the market to owners. 
  • Be aware that once the contract is signed, you may not be able to pass on prices increases to your client.

What Contract are you using?

Two basic forms of contract are used in the residential building industry:

  • Lump sum (or fixed priced) contracts; and 
  • Cost plus contracts. 

Lump Sum (Fixed Price) Contract

Under a fixed price contract the builder agrees to bear any costs above the fixed price, except for those costs incurred because of variations requested by the client or matters outside the control of the builder, such as a fire, war, strike or natural disaster. 

But what if continuing to perform under the fixed price contract becomes unprofitable? 

Even if a rise or collapse in the market dramatically pushes up the price of materials, it is unlikely a Court will intervene and help out the builder. Future material price increases should have been contemplated when the contract was quoted.

Just as an owner is not able to reduce the amount paid if the price of materials decreases a builder is not entitled to pass cost increases to the owner.

So, when you have entered into a fixed price contract, there are very limited ways increases in the cost of labour and materials can be passed onto the client as the risk rests with the builder. 

Try and make sure any commitments you have made in a fixed price contract with an owner match those obligations the suppliers have to you.

Cost Plus Contracts

Under a cost plus contract, the client agrees to take on any escalation in prices. The client is charged for the actual cost of construction “plus” profit, which is normally expressed as a percentage of the costs of construction. 

Many owners baulk at using cost plus contracts. They want a degree of certainty in knowing how much the job will cost. 

Depending on your state, there may be some restrictions on using cost plus contracts.

Important contract clauses

Rise and fall clauses

You may be able to include a price adjustment clause in a fixed price contract. 

This type of clause enables the contract price to be adjusted when there is a shift in price for a particular material. 

Any price adjustment or rise and fall clause will have to be carefully drafted with the increase in contract price based on a formula, which will require disclosure of the contracted price of the material with the actual cost. Actual increases will need to be substantiated.

There are also some general principles that apply when using rise and fall clauses:

  • The clause must be certain to be enforceable (i.e. the clause must be clear)
  • The clause should not be unconscionable (i.e. unreasonable)
  • The clause should be workable

Drafting and applying these clauses is complex and, for these reasons, HIA contracts do not include rise and fall clauses.

There are different requirements in relation to rise and fall clauses across the country and may be subject to certain requirements.

Can you include a rise and fall clause in your residential or domestic building contract?

NSW

Yes

QLD

Yes

WA

No

SA

Yes

NT

Yes

TAS

Yes

VIC

Only for works over $500,000 or if the clause complies with the regulations (there is currently no regulation providing for a clause at this time).

ACT

Yes

Prime costs and provision sums

Depending on the nature of the work it may be possible to use provisional sum or prime cost items for specific trades to give an element of protection against cost increases. 

  • Prime cost items are a fixture or fitting that has not been selected, or the price of which is not known when the contract is entered into. 

    Under the contract the builder must allow a reasonable allowance for such an item however the end price may change depending on the items final cost. 

    Example: The supply and installation of tiles is part of the builder’s scope of work but the homeowner has not made a final selection as to which tiles will be used. The price can be adjusted accordingly and no variation to the contract is needed.
     
  • Provisional sum items are an estimate of the cost of providing particular contracted services for which the builder cannot state a definite amount when the contract is entered into. 

    Example: There is currently a shortage of roofing subcontractors in the industry. Generally the installation of a roof may not be a provisional sum item and would be a fixed component of the overall contract price. However, given the large demand for roofers and price uncertainty a provisional sum may be the supply and install of a roof for a particular home. 

While you should always provide a reasonable estimate for a prime cost or provisional sum item over-utilising prime cost and provisional sum items may make some clients uncomfortable.

How can you respond to price increases during construction work? 

It depends…

  • Under a fixed price contract, unless there is a contractual provision which allows you to, you cannot pass on a price increase.
  • Under a cost plus contract, you can pass on price increases as you are charging the client for the actual cost incurred, at the time you incur it.

To find out more, contact HIA's Workplace Services team

Email us

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