Global Vantage: Price escalation clauses in the current market

Price escalation clauses are contractual provisions that allow for adjustments to be made to the agreed contract price where there are fluctuations in the costs of certain elements of the works. Such clauses are particularly relevant in the current market, with Covid-19 causing significant economic volatility and creating difficulties in the supply of labour and raw materials.

For contractors, price escalation clauses can help to mitigate some of the risk posed by the unpredictability of the market, as they allow for some of the economic risk associated with the project to be absorbed by the employer. In theory, they should also benefit the employer, as in recognition of the greater element of risk retained by the employer, contractors will generally tender lower bids for the works.

As such, price escalation clauses can be mutually beneficial for the employer and the contractor.

Unsurprisingly, price escalation clauses are common in international construction contracts, where even a small increase in the price of the works could have a dramatic impact upon the financial viability of a project. Indeed, some standard form contracts have introduced wording to give effect to the demand for price escalation clauses. For example, the FIDIC Red Book 1999 provides for ‘Adjustments for Changes in Costs’ at Clause 13.8.

Contractors that have suffered as a result of the economic volatility caused by Covid-19 should review their contractual documents to determine whether a price escalation clause is present, and, if so, whether reliance upon such a clause may be of assistance in the circumstances. Even where both of these questions are answered in the affirmative, any party seeking to rely upon the clause must also ensure that any notification requirements are satisfied before attempting to enforce the provision.

Parties should also consider whether the use of a price escalation clause can be avoided, for example, by selecting alternative products where previously specified materials are unavailable / difficult to procure. Such steps can help to mitigate the impact of shortages and assist in the maintenance of commercial relationships which may otherwise suffer as a result of a contractual dispute.

In the wake of the Covid-19 pandemic we anticipate a surge in the number of parties to international construction contracts seeking to rely upon price escalation clauses. Whilst these clauses can be of significant benefit to contractors, their use should be managed carefully given the potential legal and practical consequences of their enforcement.