Managing rising costs and the impact of inflation continues to have a dramatic (and often catastrophic) impact on the construction industry.
The media headlines continue to present news of long-standing companies falling into insolvency and then of course, the domino effect begins to impact the supply chain.
It is very rare that construction contracts make provision for termination under such circumstances and in my opinion quite rightly so (just imagine the impact of parties to a contract being able to terminate because prices are too high… Estimating would suddenly become a very low risk role).
All of that being said, undoubtedly, the industry currently faces exceptional circumstances in terms of inflationary increase.
So is termination an option?
Terminating a contract in any situation is a high-risk strategy and requires expert advice (prior to any steps being taken). This is largely because if the termination party gets it wrong (thus terminating the contract unlawfully) they remain at a high risk of being pursued for repudiatory breach.
Consequent of such unlawful actions, damages will include (but are not limited to) the additional costs for completion of the works by others. In addition, costs and expenses incurred due to the wrongful termination of the contract will also form part of the claim.
At the risk of repeating what has been said, if a party is considering termination of a contract, they should seek expert advice on all aspects of the position and the associated action.
Are there circumstances when a party can terminate due to exorbitant rising costs?
Whilst each situation should be assessed on its own merits, there may be certain circumstances when a party has a contract route to consider.
- Force Majeure – Where there is an express force majeure clause stated within the contract which expressly provides for a price increase, a party may have the opportunity to address any such matter as the contract provides.
It must be noted that such clauses often provide for events which were not reasonably foreseeable by the parties at the point of contract. Therefore, contracts entered into after high inflation was a known event are likely to be excluded.
Often the courts will be reluctant to conclude that force majeure applies unless the event substantively undermines the commercial objective of the contract.
- Express Contractual Provisions – On occasions the parties may have agreed express provisions for a vast array of events. Under the NEC contract, where agreed, the Secondary X1 Clause provides for inflationary price increase. In such circumstances, this clause would be invoked. Further, there may be bespoke provisions the parties have incorporated for such events (inclusion of quotation provisions which often include remedies in such circumstances).
- Frustration – Following commencement of the works, a contract may become frustrated in circumstances under which the performance has become radically different to that set out within the contract.
Again, this will be judged upon whether the circumstances defeat the commercial purpose of the contract and the legal threshold is exceptionally high in this regard (hardship and financial loss in isolation are usually insufficient to meet the threshold). Again, expert legal advice should be obtained in such circumstances.
Finally, it is important to consider if the contract provides express remedies for events such as materials shortages, delayed deliveries and price increases? If so, the courts are unlikely to be sympathetic in respect of arguments surrounding termination as being appropriate.
For contracts that are currently in the stage of negotiation, the relevant express terms should be agreed by the parties including inflationary increase provisions and mechanisms for the interruption or delay to supply.
Does work insurance cover an increase in costs if a claim is made?
Contractors’ All Risks (‘CAR’) policies may include escalation and inflation clauses which account for the increases in the value of works undertaken during a construction contract.
It should be noted that CAR policy terms will vary depending upon the contract, therefore the contract and CAR policies should be carefully reviewed to establish if such provision is included, and if so, whether it adequately covered both current inflation and the high rates of inflation during the life of the project.
Where the insurance cover is not sufficient for the loss caused, the policy may contain an ‘average clause’ that will proportionately reduce the sum recoverable to align with the policy.
Again, obtain expert advice from the relevant insurance broker or provider to understand the cover provided as each policy will be different.
Given the current climate, it is no surprise that funders and therefore employers will need surety of fixed prices for budgeting and forecasting.
It is therefore necessary to consider the consequence of fixed prices against a pre-determined programme over the contractual period and the inclusion of inflationary change contractual provisions where necessary.
As was the case with COVID-19, when it comes to exceptional circumstances, all parties are always advised to collaborate to find solutions. The key to successful cost management is committing time to planning and strategically assessing procurement routes and risks.
Please note. The information provided on this website is NOT LEGAL ADVICE and is for information purposes only. No action or inaction should be taken due to this information, or any reliance placed upon this information. Please note where legal advice is required this should be obtained by an appropriate qualified legal practice and no information provided within this website should form the basis of any legal, contract, or commercial decision. K J Taylor Consulting Ltd. is a commercial quantity surveyor and not a construction legal advisor.