The construction industry within Australia is in a very complicated place. We are currently seeing a massive increase in the number of construction projects that have been unable to proceed, leaving houses unfinished and homeowners facing uncertainty regarding the construction of their homes. This is due to a number of reasons, but namely, builders are finding that they are experiencing massive increases in costs due primarily to material and labour increases that they did not foresee. This increase in costs may erode a builder's profits and could leave them engaging in work for which they would be operating at a loss. To protect a builder's interests and profitability they should ensure that they include clauses within their contracts that allow them to claim for this increase in costs, namely in the form of a cost escalation clause (aka a rise and fall clause).
WHAT IS A COST ESCALATION CLAUSE?
Cost escalation clauses are interchangeably referred to as rise
and fall clauses. Cost escalation clauses are contractual
provisions with the primary purpose of ensuring that the contractor
the current market rate or is able to pass on a price increase related to its contractual obligations. Contractor costs that are generally covered by cost escalation clauses are:
- material costs; and/or
- other expenses that may be incurred by the builder in completing its obligations under the contract.
Cost escalation clauses must be clearly drafted to explain the:
- types of costs which are captured by the clause;
- method for deterring or calculating what amount can be claimed; and
- the process for passing on the price increase.
WHY SHOULD I INCLUDE A COST ESCALATION CLAUSE IN MY CONTRACT?
The primary purpose of a cost escalation clause is to ensure
that the contractor is paid the market rate (or something similar)
for their work. This is especially important for projects that may
last for several years, during which there may be considerable (and
unpredictable) fluctuations in costs. We acknowledge that builders
may be hesitant to implement cost escalation clauses into
contracts because of the cost uncertainties that it may create for owners. However, in the absence of a cost escalation clause, the contractor may end up taking receiving all of the risk for rises in
variable costs which very well may be out of their control.
WHAT MUST BE DONE TO ENSURE A COST ESCALATION CLAUSE IS COMPLIANT?
Three noteworthy considerations to keep in mind to ensure that your cost escalation clause is lawful and enforceable are ensuring that the clause is:
- drafted in a way to be workable;
- drafted in compliance with the Australian Consumer Law (namely making sure that the clause is not unfair or unconscionable); and
- complaint with your state's residential construction legislation.
Building legislation in Australia is not uniform and some States place regulations upon the use of cost escalation clauses whilst other States prohibit the use of such clauses. It is therefore incredibly important that you contact a legal professional to make you informed of your rights and obligations under your specific state's building legislation. The following states allow the use of cost escalation clauses in construction contracts:
- New South Wales;
- South Australia;
- Northern Territory; and
- Australian Capital Territory.
The construction industry is currently in a turbulent situation and cost escalation clauses act as a solution in ensuring that builders are not losing profits or potentially making a loss on the complete performance of their contractual work due to increased costs, they may have experienced. While cost escalation clauses are an undeniably powerful tool, it must be understood that each State places a number of different restrictions upon cost escalation clauses. The effect of noncompliance with your State's specific laws and regulations may result in fines and/or the potential voiding and unenforceability of the cost escalation clause. Therefore, it is fundamental that you seek a legal professional to assist you in the drafting and implementation of such a clause.