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Dealing with material cost increases
In this article
HIA is aware that industry is continuing to face price increases across both labour and materials.
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 contracts are used in the residential building industry:
Under a fixed price contract, the builder has agreed to carry out the building works for the agreed contract price, and any fluctuations in the cost of labour or materials (whether increases or decreases) are generally borne by the builder. There are limited circumstances in which a builder may adjust the contract price, such as where the client requests a variation or the variation is due to a change to statutory requirements, where adjustments are permitted for prime cost or provisional sum items, or where the contract otherwise expressly allows for an increase.
HIA standard fixed price contracts generally do not allow builders to pass on market‑driven cost increases to the client. If the contract does not expressly permit a price increase, attempting to pass on additional costs may place the builder at risk of breaching the contract. Events such as war, fire, industrial action or natural disasters do not, of themselves, give the builder a right to recover increased costs under a fixed price contract. Builders should seek legal advice before attempting to rely on any clause to pass on cost increases arising from such events.
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.
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?
| State | Rise and fall clause included |
| NSW | Yes |
| QLD | Yes |
| WA | No. where the works are valued from $7,500 -to $500,000. Such clauses are permitted in contracts for home building work over $500,000. |
| SA | Yes. There are certain pre-conditions that must be met in order to pass on additional costs after the agreed time for doing the work. |
| 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.
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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.
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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.
Costs imposed by statutory or other authority
Depending on the reason for the price increase you may be able to pass it to your client.
A number of HIA contracts include a clause that allows the builder to pass on a tax, charge or levy that causes the cost of the building work to increase.
Be aware that this clause will only apply in very specific situations and HIA recommends being able to point out to the client the statutory or government charge that has caused the price increase.
It is strongly recommended that you speak to your local workplace adviser before using these provisions.
How can you respond to price increases during construction work?
- 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 Contracts and Compliance team
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