The Great Inflation

February 27, 2023

Helen Batter looks at how the JCT and NEC standard form contracts can be used to address difficult market conditions.

Brexit, COVID-19 (yes, we are still feeling the effects!) and political instability have all had a hand in the tumultuous market conditions that the construction industry has faced in recent times. In a sector marked by tight profit margins and high insolvency rates, it is unsurprising that contractors have been responding with caution.

A number of contracting authorities have experienced a resultant drop in the level of interest from contractors for their projects and increased negotiations on pricing from those who do submit a bid. Neither of these situations are ideal in the public sector where there are important governance and reputational factors at play.

Ultimately, this is a problem that can only be dealt with in the same way as any other commercial uncertainty, namely through risk allocation between the parties. Although there is sadly no “one size fits all” solution, the JCT and NEC standard form contracts contain a number of clauses that can be used or adapted depending on the nature of a particular project.

So, what are these and how can they help?

JCT 2016

Starting with the JCT, the following provisions can potentially assist depending on the particular contract within the suite:

Fluctuations Provisions – there are five possible options which can be summarised as follows:
1. Standard Options A-C – which are a set of three “off the shelf” provisions that can allow adjustment to the sum payable under the contract:
  1. Option A – adjusts the tax, levies and contributions that the contractor is required to pay. Absent of any other provision being selected, this is the default position;
  2. Option B – operates more widely to adjust the cost of labour and materials (as well as goods, fuel, gas etc.) and tax fluctuations; and
  3. Option C – employs the use of the JCT’s Formula Adjustment Rules which differ depending on the type of work being carried out under the contract. These are largely seen as quite extensive and complicated which can be quite off-putting to the parties and those administering the contract.
  In general, our clients are typically finding that these provisions are either too limited in application or would require some amendment in order to make them suitable for their particular purposes.
2. Bespoke Fluctuations Provision – this option allows parties to draft a tailored set of adjustment provisions to reflect an agreed risk allocation for a particular project and is an option that a number of our employer clients have elected, allowing them the freedom to delineate the specific circumstances in which an adjustment can be made and the necessary parameters around such adjustment being claimed.
3. No Fluctuations Provision – if this is selected, the contractor will take the risk of any fluctuations. This may remain reasonable in certain circumstances where, for example, projects are of a short duration or there is a two-stage tender.

Provisional Sums – a number of the JCT contracts already contain drafting for provisional sums and it is possible to include a specific provisional sum for inflation, drafted by reference to a schedule of agreed materials/packages. This may, however, be difficult to define and would need to be capped to give certainty as to the possible amount that can be incurred.
Listed Items – these clauses allow for a contractor to claim payment for materials that are stored off-site. This can help with securing items at a specific price but comes with the drawback that because materials are being stored off site, there can be issues if the employer for any reason needs to prove title to and collect these items (e.g. if the contractor becomes insolvent). In these circumstances a vesting certificate can be helpful but is not infallible and the standard JCT drafting would need to be amended to make this a requirement.
Advance Payments – which allow payment of an initial sum to a contractor which can be used as a means to secure certain materials/suppliers or to place early orders. These provisions are not, however, available for public or local authorities.

NEC4

Under the NEC4 contracts, the following options are available:

Pricing Options – the NEC contracts are lauded for their flexibility when it comes to pricing. Their target cost options (C (activity schedule) and D (bill of quantities)) share financial risks between the parties in an agreed proportion, through a pain share / gain share mechanism aimed at motivating the contractor to deliver the works in the most cost-efficient way. A target cost is agreed between the parties and throughout the works the contractor is reimbursed for the defined costs plus a pre-determined fee and minus any disallowed costs. If the final price is less than the target cost the contractor will receive a share of the saving at an agreed ratio. Conversely, if the final price is greater than the target cost, the contractor will pay a share of the difference, again at the agreed ratio.
Secondary Options – there are additionally certain secondary options that can potentially assist with market volatility:
1. Secondary Option X1 (Price adjustment for inflation) – the drafting works by setting a ‘base date’, normally set to be a couple of weeks before the tender submission date. A price adjustment factor is then calculated based on the changing values of a prices index or a series of indices and weightings, chosen by the parties at the outset of the contract. An extra amount for inflation is then added in each assessment (Options A and B) or to the target (Options C and D) and the clause separately deals with the impact of inflation on the assessment of compensation events. Market feedback on this approach, as well as any other option that involves the use of indices, is that it is considered that certain indices do not necessarily reflect the reality of what is happening in the market and so it can be difficult for parties to settle on the indices to be applied.
2. Secondary Option X3 (Multiple currencies) – this secondary option gives the parties the ability to set the exchange rates to be applied where the contractor is to be paid in different currencies and to also set a limit an any amounts that can be paid in different currencies.

Conclusion

There are a number of options available to users of the JCT and NEC forms of contract that can be used or adapted to suit requirements. What is or may be required for a particular project has potential to change drastically between projects. It is therefore essential that consideration is given at the outset to what is or may be acceptable from a commercial perspective, bearing in mind any budgetary, governance or procurement constraints. In addition, a number of the options detailed above either do or can be made to allow for adjustment in either direction which is an important consideration given the anticipated downward trajectory of the rate of inflation over the next 12 months or so.

Helen Batter is a Senior Associate at Sharpe Pritchard LLP.

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