Fluctuation clauses in construction contracts and (possible) implications of Brexit

Fluctuation provisions in construction contracts deal with the effects of inflation and changes in costs. They can be particularly important on large projects where contractors may be asked to tender based on current prices (i.e. at the “base date”) and the terms of the construction contract will determine any fluctuations and how the contractor will be reimbursed for changes in price over the duration of the project.

Brexit - predicting the unpredictable!

Brexit will almost certainly have an impact on the construction industry and the cost of construction projects.

Usual practice (from the Employer’s point of view) is to delete fluctuation clauses in order to provide greater certainty in relation to cost and to allow tenders to be compared on a like-for-like basis. This may be crucial to the success of the project, especially where there is a finite amount of funding available.

Contractors must therefore attempt to anticipate market forces and price in the risks accordingly. This is generally not a problem where inflation remains stable (as it has over the past few years), or where price increases have been largely predictable.

However, since the Brexit vote and the possibility of a “hard Brexit”, fluctuation option clauses have become relevant once again. Firstly, immigration controls and visa requirements may affect contractors’ access to EU workers. Secondly, goods and services coming from the EU could be hit with import duties and tariffs. Tariffs may also increase for goods and services from outside of the EU, depending on new deals negotiated by the government since trade will not benefit from existing EU trade deals. These are factors that may influence an employer’s decision to utilise fluctuation provisions to anticipate any changes in costs and to avoid premiums in a fixed priced tender exercise.

So what are the options?

Fluctuations are usually calculated by reference to published price indices, such as the government inflation index, Consumer Prices Index (CPI) or other industry published bulletins. Depending on the project, the fluctuation provisions can be very simple, such as allowing price increases in line with CPI or very complex by using specific indices for individual cost items and materials. They can also be relatively unsophisticated such as discretionary provisions allowing relief based on increases in the market rate for labour or materials. In practice there may have to be much greater wriggle room for negotiation between the parties in terms of fluctuation options.

It is interesting that fluctuation options B (labour & material costs and tax fluctuations) and C (formula adjustment) have been deleted from the JCT Design and Build 2016 edition. Whilst Options B and C remain available, only option A (contribution levy and tax) is set out in the standard form.

What to look out for?

Developers and contractors will need to make sure they become familiar with the fluctuation provisions and how they operate. A range of factors may be considered when preparing the initial draft of the construction contract. This may include: what items are subject to fluctuations, be it labour or materials or specific components; indices and formula that may be used; how these details are logged and monitored; and who will manage any adjustments.

The potential benefit for employers in the post-Brexit world is that contractors may be prepared to bid low in the knowledge that they will be compensated for any significant price rises. The employer therefore avoids any significant premiums contractors may include in their bids to anticipate effects of a hard Brexit.