The cost of inflation

Associate director Michael Jolly.

Michael Jolly, associate director of Hill International, discusses on the importance of the price escalation clause in labour and materials project site contracts.

During an ongoing project the cost to the contractor of labour and materials used in the works usually alters during the contract period. It may fall, but more usually it will rise. In the absence of any provision in the contract, the contractor would have to take the risk.

In order to cover itself the contractor would probably make an estimate of the likely rise in costs before inserting his prices in his tender, and higher tender prices result for the employer.

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If the employer is to carry the risk then the contract needs to have within it a clause to cover price escalation. It is often thought to be of overall advantage to the employer, as well as giving the contractor some guarantee of recovering his costs, to insert a clause in the contract to recover some or all of the increases if and when they occur rather than price the risk.

Most standard forms of contract allow for this to be done by providing clauses which may be included or deleted as the contracting parties agree.

FIDIC, upon which most local forms of contract are based or generated, consider that any project lasting for longer than a year should contain a price escalation clause. FIDIC generally provides for three alternative methods of dealing with the escalation issue.

Firstly, a clause allowing no adjustments at all. Secondly, a clause where adjustment is based on the difference in cost between base prices and the current price of local labour and specified materials. And thirdly, where adjustment is made by the use of indices in a formula.

Invariably, in most local forms of contract it is the first method that is adopted with the contract allowing for no adjustment to be made to the contract sum for price escalation in respect of labour or materials and the contractor to carry the risk and financial burden.

So, what are the contractors’ options in such a case. Firstly it could pursue an ex gratia or sympathetic claim. As their name implies, these are not really claims at all but requests, usually for money on the basis that although there is no contractual entitlement it would be inequitable to pay the contractor only what was provided for in the contract.

The employer may in practice have good reasons for paying such claims. For example, there may be concern about the contractor’s financial stability if some extra financial help was not forthcoming.

The employer may be concerned about the future commercial relationship between the parties. And if the contract contains an arbitration clause entitling the arbitrator to disregard the strict rights of the parties and decide on broad equitable principles. It is possible that even a sympathetic claim may ultimately prove to give rise to an entitlement.

The second option that a contractor may choose to follow is that in certain countries where the civil code forms the administrative law, of which the UAE is one, and whereby under certain articles of the civil code if exceptional and unforeseen events render the contractor’s obligation excessively onerous, threatening it with exorbitant loss, then the contractor’s excessive losses may be reduced to reasonable limits by way of compensation ordered to be paid by the employer.

In certain instances the contractor could be completely relieved of responsibility. This however would again be dependent on a legal judgement whereby all the events and circumstances would be taken into account.

In view of the current financial turmoil a prudent contractor would examine all possibilities of increasing its income potential and pursue claims in respect of inflation and cost increases in respect of labour and materials.

CURRICULUM VITAE

Michael Jolly has more than 39 years of mixed professional and contracting experience embracing building, civil, mechanical, electrical and petrochemical works. Mike has extensive experience worldwide having worked in the United Kingdom, Europe, the Middle and Far East, South America and Africa.

Jolly has an honours degree in quantity surveying obtained in 1974 and was elected as Fellow of the Association of Cost Engineers in June 2006. He is also a full member of the Association for Project Management and an Incorporated Member of the Chartered Institute of Building.

Since joining Hill in 2005, he has worked for the construction claims group and has completed various assignments principally in respect of time claims with the attached quantum entitlement.

Before joining Hill, he operated his own consultancy in Hong Kong for 10 years working principally in the airport, rail and road and viaduct sectors of the market. Prior to setting up his own business, he was a managing quantity surveyor for a large construction company in Kuwait carrying out various civil and prestigious building contracts.

Jolly was a regional quantity surveyor responsible for two of four regions, operated by a specialist piling contractor, with a total of 120 piling rigs.

Contracts ranged from small housing to hospitals, shopping complexes and civil works. He also spent time in Paris working on various infrastructure projects and was involved in the early cost planning for the Eurodisney project.

Mike has experience in cost planning, preparation of tenders and contract documents, valuations for interim payments, monthly and quarterly financial reconciliations, final account preparation and settlement, cost analysis, claim identification, analysis, preparation and settlement and the preparation of dispute, mediation and arbitration briefs.