Cost Escalation Risk in Construction Procurement & Contracts

In a Q&A session with Legalwise Seminars, Christine Gordon, Senior Associate at Simpson Grierson, addresses key questions in relation to cost escalation risk. Hear more from her at the Construction Contracts: Critical Updates and Elements webinar taking place on Wednesday, 17 May 2023.

What are the challenges currently facing the construction sector in NZ?

 Contractors and subcontractors are reporting that cost escalation is one of the key challenges currently facing the sector. Cost escalation is being driven by personnel/labour shortages, high interest rates, increased shipping costs, supply constraints and the impact of adverse weather events in 2023.

What steps should parties, and their advisors, take to address these challenges?

The default position is that a Contractor bears the risk of cost escalation. However, it may not be in the interests of the Principal if the Contractor becomes insolvent part-way through the project due to increased costs of performing the contract.

The contractual tools that can be used to allocate and mitigate price escalation risks include: 

• Cost escalation clauses which provide a mechanism to adjust the contract price to reflect changes in the cost of materials, logistics and labour during the project. This type of clause can also benefit the Principal because it accounts for a decrease in the contract price when costs decrease (i.e. it is a ‘pain share / gain share’ arrangement).
• Cost reimbursable contracts which allow the Contractor to be paid for the work plus agreed allowances for overhead and profit.
• Provisional Sums (for elements of the works) and Prime Cost Sums (for materials valued at the net purchase price plus a reasonable allowance of profits).
• Payment for Off-Site Materials
• Principal supply items, depending on the circumstances.

Economic trends are likely to continue

Given that the challenging economic conditions look set to continue, we expect that parties to construction contracts (and their advisors) will need to use the available tools to manage, and allocate, price escalation risks.

Christine has more than 12 years’ experience as a specialist construction lawyer at leading firms in New Zealand and London. Christine advises a broad range of construction parties from principals, contractors and sub-contractors to engineers, architects and insurers on issues arising both during and after construction. She has experience with New Zealand and international forms of construction contracts and consultancy services agreements. Christine’s experience extends to acting for parties in resolving complex and high value disputes through arbitration, mediation, adjudication, court, expert determination and other dispute resolution forums. Christine is a member of the Society of Construction Law and the Auckland Women Lawyers’ Association. Connect with her via LinkedIn