When the Greek philosopher Heraclitus of Ephesus said, ‘The only constant in life is change’, it is doubtful even Heraclitus could envisage how volatile pricing and supply chains would be come in a modern world.

In these uncertain times principals and contractors are increasingly considering how to best manage the risks of price increases for materials during extended contract periods.

This article considers some options to managing pricing risks.

The ‘Golden Rule’ of Contracting

Firstly, the best contracts are fair contracts.  Fair contracts are achieved when the parties carefully consider risk and allocate the responsibility of mitigating each risk to the party in the best position to managing the risk.

Under the “Golden Rule’ contractors and principals can share pricing risks by introducing some flexibility into the agreement compared to a fixed price agreement.

Cost Plus Contracts can be a suitable agreement, however frequently owners can experience challenges obtaining finance when using a Cost Plus Contract and of course owners can be concerned that the Cost Plus Contract does not ensure the efficient and effective delivery of works under the Contract.

Contracting parties in the current economic climate are increasingly seeking to find a middle ground between Cost Plus and Fixed Price Contracting. Using Rise and Fall clauses for agreed classes of materials and trades, is an option to formulate the optimum balance of risk sharing between the parties.

Will I rise or fall under using flexible pricing clauses?

Whilst there is no one size fits all approach due to different industry and contractual positions, there are ways to use rise and fall clauses to support varied situations.

In most circumstances, a blended approach of fixed priced items, cost plus items and rise and fall items will work well.

For rise and fall clauses we suggest you consider the following tips for success;

• It is preferable to target high-risk materials, such as fuel or steel.
• Transparency on pricing is critical. Effective risk sharing clauses rely on contractors providing detailed cost breakdowns so principals can assess exposure and ensure fair allocation.
• Capping contract price adjustments is an option (for example 5% – 25% of the base tendered price). It is also important to ensure there is agreement on the baseline price.
• For fairness, it is important to allow both parties to benefit from cost decreases as well as compensate contractors for increases, preventing one-sided windfalls.
• Using indices (e.g. CPI or commodity indices) and verifiable actual costs provides clarity and reduces disputes over how price adjustments are calculated. However, consideration should be given to the operation of the index.  Indexes can lag the actual costs and maybe too broad when compared to the context of the project.
• Poorly drafted clauses risk being invalid or be unenforceable for uncertainty if they lack clear criteria or objective mechanisms for calculating price adjustments.

Perera v Bold Properties (QLD) Pty Ltd [2023] QDC 99 (‘Perera’)

Perera is a recent case where the Court considered the validity of a special condition in a contract that allowed a builder to unilaterally increase a fixed price.

The special condition proposed the builder could increase the price if commencement did not take effect by an anticipated start date.

The Court decided that the special condition was invalid because it was uncertain and there was no reference as to what the price increase could be.

The Court also found the special condition was an unfair term under the Australian Consumer Law because it did not give guidance as to how the higher price was determined and the clause resulted in a significant power imbalance in the builder’s favour.

Perera reinforces the need to ensure clauses that vary the price of a contract provide sufficient certainty regarding when and how adjustments are to be calculated and applied.

Alternatives

We recommend rise and fall clauses for high-risk commercial projects as typically these projects are long-term, material-heavy, or supply-constrained projects where contractors face significant exposure to cost escalation.  Also, commercial parties should have the capacity to properly turn their mind to the risk allocation process suggested under the Golden Rule. Variable pricing terms however can still also be relevant for smaller residential projects.

Provisional sum items are typically a very efficient and effective way to introduce a good balance between fixed and flexible pricing in a contract.

Another option is for the Principal to procure goods and materials as unfixed goods and materials.  This option may only be available if the site can provide proper storage.

Statutory Warnings for Pricing Variability

For residential projects in NSW and Qld, the statutory frameworks explicitly state that if the contract price is not known, or may be varied under the contract, the contract must include a warning to that affect.  Additionally, the contract must provide an explanation of the effect of the provision allowing the variation of the price.

Accordingly, it is essential the drafting of residential contracts ensures that the pricing terms comply with the relevant Acts.

Conclusion

The fair allocation risk will assist parties to achieve their project objectives.  Contracts that consider a mixture of fixed pricing and variable pricing will typically respond best to the current economic climate and uncertainty.  Rise and Fall clauses need to be properly drafted to avoid uncertainty, ensure transparency and reduce the risk of disputes in responding to a world of constant change.