Inflation can significantly affect the profitability and affordability of a construction project. Increases in labour, materials, fuel, plant and transport costs may occur between tender submission, contract award and the actual delivery of the works.
Who carries this risk depends primarily on the contract. Under a fixed-price arrangement without an inflation mechanism, the contractor will generally carry the risk of price increases. Contractors must therefore understand the available contractual protections before agreeing their price.
Index-Linked Pricing
Index-linked pricing allows the contract sum or amounts paid to be adjusted using a published inflation index. Rather than requiring the contractor to include a large contingency at tender stage, the parties agree a formula that adjusts prices as inflation occurs.
Metroun LearningShort courses with structured CPD, 20 minutes eachStart ›Under NEC contracts, secondary Option X1 provides a price-adjustment mechanism using indices identified in the Contract Data. The calculation compares the relevant indices against their values at the base date and applies the resulting adjustment to payments.
JCT contracts also include fluctuations provisions. Broadly:
- Option A covers changes in certain contributions, levies and taxes.
- Option B can cover changes in labour, materials, taxes and statutory contributions.
- Option C provides formula-based adjustments using published indices.
The chosen index should reflect the cost being adjusted. General measures such as CPI may not accurately reflect movements in construction materials or specialist labour. The Office for National Statistics publishes Construction Output Price Indices intended to estimate inflation within the UK construction industry.
The contract should identify the base date, applicable indices, adjustment frequency and whether any part of the price remains fixed.
Provisional Allowances
Provisional allowances can be used where the cost of a package, product or activity cannot be established with sufficient certainty when the contract is entered into.
For example, an allowance may be included for a specialist package that will not be procured until later. Once the scope is developed and market prices are obtained, the provisional allowance is replaced with the properly assessed value.
This can reduce the need for the contractor to price an excessive inflation contingency. However, a provisional allowance does not automatically transfer every price increase to the client. The contract must explain how the allowance will be adjusted, what evidence is required and whether overheads, profit or fees may be added.
Contract Amendments
Parties may amend the standard contract to create a project-specific inflation mechanism. This could allow adjustments where particular materials increase beyond an agreed threshold.
An amendment might provide that the contractor absorbs the first 5% increase, with increases above that level shared between the parties. It could also include caps, exclusions, open-book evidence requirements and restrictions on materials purchased later than reasonably necessary.
Amendments must be clear. Simply referring to “exceptional inflation” without defining the trigger, calculation and evidence requirements is likely to create disputes.
Public-sector clients must also consider procurement rules before changing an existing contract. A significant post-award amendment may need to satisfy one of the permitted grounds for modifying a public contract.
Where the contractual position is unclear, Metroun Consultants can assist with reviewing the relevant provisions, assessing entitlement and preparing or reviewing inflation-related submissions.
Supply-Chain Price Increases
A supplier or subcontractor increasing its price does not automatically entitle the main contractor to additional payment from the client. The contractor’s entitlement depends on the main contract, not merely on the terms agreed lower down the supply chain.
The risk can be managed through early procurement, fixed-price supply agreements, extended quotation validity periods, advance purchasing and vesting agreements for off-site materials. Contractors should also align subcontract inflation provisions with the main contract wherever possible.
Where a client instructs a change, delays procurement or prevents the contractor from ordering materials as planned, associated price increases may form part of the valuation of that event. The contractor must still comply with the contract’s notice and substantiation requirements.
Ultimately, inflation risk should be allocated to the party best able to manage it. Clear drafting, appropriate indices, early procurement and aligned supply-chain terms can help prevent inflation from becoming a major commercial dispute.
