With builders suffering financial distress from material price increases related to fixed-price contracts, cost escalation clauses might be the saviour for eligible contracts. Drafted appropriately, a cost escalation clause is an effective mechanism that can account for unexpected costs. A cost escalation clause enables the price of works to be increased for rising material or labour costs, or increased costs caused by the delay of the builder.
Victoria
Unfortunately, cost escalation clauses (also known as a "rise and fall" clause) are prohibited in domestic building works contracts for works valued under $500,000. However, variations for additional works which are outside of the scope of work remain permitted.
If the domestic building work exceeds the value of $500,000 then a cost escalation clause can be incorporated into the respective domestic building work contract. However, the clause must comply with any requirements provided in the Domestic Building Contracts Regulation 2017 (Vic) and the owner must be given a notice in the approved form.
Notably, there are no legislative cost escalation requirements or prohibitions imposed on commercial building contracts. In this regard, cost escalation clauses can be incorporated into any commercial building contract.
Queensland
By contrast, in Queensland, cost escalation clauses in residential building contracts are not expressly permitted or prohibited. Given that there are no requirements regarding cost escalation clauses, the validity of a cost escalation clause will turn on its drafting, the relevant circumstances and interpretation of how the clause operates.
What can builders do to safeguard your business from price increases?
In Victoria, builders that enter into domestic building works should carefully consider fixed priced contracts as price escalation clauses are prohibited. However, if there is a change to the scope of work for that domestic building work, it should be clearly communicated to your client to improve the prospects of it being accepted.
Otherwise, for Victorian builders that enter into domestic building work that exceeds $500,000, a carefully drafted cost escalation clause may assist you should material and labour costs increase. The cost escalation clause will need to be drafted in a way that avoids it from being unfair, as it could be rendered void. These considerations may include addressing the process of the increase and the permitted percentage amount of the increase compared to the total contract price.
