Rise and fall clauses (also referred to as cost escalation clauses) in construction contracts have been a highly discussed topic in the past few months, given prices for material such as timber, steel and concrete have been on the rise since early last year. There are various contributing factors as to the reason why these price increases have been observed, including the effects of the COVID-19 pandemic on the global commodities supply chain.
This article will outline the nature of rise and fall clauses and how these clauses may affect your construction contract as well as outline the elements to keep in mind when drafting a rise and fall clause to suit your construction contract.
Rise and Fall Clauses at a Glance
Rise and fall clauses essentially increase or decrease the price of a fixed-price or lump sum construction contract depending on the varying price of the materials to be used in completing the works under the contract. For example, if the price of timber rises during a construction project, and timber is a material that is to be used to complete the works under the contract, a rise and fall clause in the contract could mean that the contract price would increase correspondingly to accommodate for this rise in timber prices. Surveying the “price” of any given material is therefore crucial and, in Australia, is often done by reference to the indexes published by the Australian Bureau of Statistics (discussed below).
Rise and fall clauses were at their height during the inflation of the 1970s and 1980s. Since then, we have seen their relevance recently after the effects of the COVID-19 pandemic and the Russian-Ukrainian war.
Putting Together a Rise and Fall Clause
If you are considering a rise and fall clause to be included in your construction contract, you should first be aware of relevant legislation that may impact its legality.
The following table sets out whether a rise and fall clause in your residential or domestic building contract can be implemented based on the State or Territory in which the construction works are to be performed:
|Legality of Rise and Fall Clauses in Different States|
|WA||No, if the contract for works is less than $500,000|
|VIC||No, if the contract for works is less than $500,000|
Rise and fall clauses implement mathematical formulas to calculate the change in contract price. The following are some of the more common elements implemented in rise and fall formulas:
a) Affected Material and Price
The affected material is essentially the specific material or commodity which is subject to fluctuating price. Considering rise and fall clauses typically do not apply to the entirety of a contract sum, the clause will apply to parts of the contract. The critical component of this element is to ensure the affected material is defined clearly and precisely.
b) Applicable Price Index
Price indexes record the value in the fluctuating price of a certain material/commodity. In the Australian setting, the price index most often referred to is the Producer Price Indexes (PPIs) published quarterly by the Australian Bureau of Statistics (ABS). The ABS provides a measure of the movement in the prices of the materials/commodities over a period of time. Other price indexes which are published by the ABS, and that may be of relevance to construction contracts, include:
- the Consumer Price Index (CPI) which measures inflation;
- The International Trade Price Indexes (ITPIs) which measures fluctuations in the prices of goods imported into Australia and exported from Australia; and
- the Wage Price Index (WPI) which measures changes in Australian employee wages.
Visit the link below for the ABS factsheet with further information on each of these indices.
c) Risk Buffer
A risk buffer functions to apportion the risk of increasing material prices between the owner and the contractor. For example, a risk buffer may operate such that the first 3% increase in a commodity or material is borne by the contractor, any percentage above this amount will be subject to the rise and fall clause.
d) Reference and Adjustment Dates
Reference (or base) dates concern the specific date from which the rise and fall of price of a specific commodity or material is to be calculated under the contract. The reference date may be any of the below:
i. the date of tender;
ii. the contract date; or
iii. a date some months following the date a Contractor is given access to a site.
Adjustment dates, as the name suggests, concern the date at which the price of any given material/commodity is to be adjusted under the contract. This may be monthly or yearly, depending on the scope and timeline of the construction project.
If you are considering including a rise and fall clause in your construction contract, it is important to take into account all constitutive elements of a rise and fall clause, particularly reference dates and jurisdictional limitations. A rise and fall clause must be certain and specific in order to avoid ambiguity and operate correctly. If you are contemplating including a rise and fall clause in your contract, consider the specific requirements of your project and seek legal advice.