Construction contracts typically stipulate the contract sum required to complete a defined scope of works within an agreed duration of time. In Singapore, construction contracts are usually structured based on a fixed lump sum since it is important for both parties to have certainty in the cost that they either had to pay or will be paid for the project. Parties are usually not at liberty to review and amend the contract sum after the agreement is formed since it defeats the purpose of having an agreement to begin with. 

Price fluctuation clauses therefore appear to be at odds with the fabric of this very principle. In essence, price fluctuation clauses allow parties to adjust contract sum if market price of certain specified construction material fluctuates during the construction period. For proponents of this mechanism, it provides an equitable financial relief for events beyond the control of the parties thereby avoiding excessive risk pricing on the part of the contractor which in turn would benefit the Employer as well. For critics of this mechanism, whilst price fluctuation clauses provide a veneer of an equitable risk sharing practice, the implementation details suggest that it falls short of the purported benefits. This article aims to critically examine the perceived shortcomings so that even if one is an ardent proponent of price fluctuation clause, it will help to enhance and improve the agreed mechanism. 

To be clear, it is quite common to require contractors to keep its tender price fixed for a period of time or to have its contract sum fixed for the construction period despite the fact that market prices are expected to vary organically due to natural function of demand and supply. However, price fluctuation clause usually comes into the picture when there is an expected significant swing in certain construction costs due to nation wide event that affects the industry as a whole. Examples of such events include pandemic related construction activities restrictions or export restriction of land sand to Singapore by neighbouring country that significantly affect the price of concrete. Under contract law, the term ‘frustration’ refers to an unforeseen event occurring after agreement is concluded that renders contractual performance by either party fundamentally different from what the parties originally intended. These events occur under exceptional circumstances where parties are released from their future obligations with no entitlement to damages apart from payment for work already done. Therefore, some may argue that if those nation wide events occur, the contract may well have been ‘frustrated’. Admittedly a contract can only be frustrated if those unforeseen event occurs after contract formation. However price fluctuation clauses are put in place in response to certain nation wide events happening prior to contract formation. Therefore construction contracts that are already in force at the commencement of those nation wide events are usually “encouraged” by the authorities to adopt a standardised price fluctuation clause as a means of dealing with what could have been contract frustration.

The Workings Of Price Fluctuation Clause And Limitations To Its Mechanism 

One of the first ingredient to implementing price fluctuation clause is identification of the type of construction costs that will be subject to price adjustments. This typically refers to the price of certain construction material incorporated into the works. The scope of price adjustment could be on a standalone basis or in a blend of several materials. By way of example in Singapore, the price of ready mixed concrete for public sector project is subject to price adjustments whereby it is essentially a combination or blend of cement, sand and aggregate. The choice of subject of price adjustment in this regard is important as it should be widely used in the project and has a significant weightage in respect of the overall construction costs. Structural works constitute roughly 20% -25% of the overall construction costs for most typical building construction projects. This structural costs could be further split somewhat evenly between cost of material (e.g. ready mixed concrete, reinforcement bars), concreting machinery and labourers. Therefore, the likely cost for ready mixed concrete may well be around the ballpark of 7%-8% of overall construction costs. If the price of ready mixed concrete fluctuates by 10%, the range of price adjustment relative to the overall construction costs may well be under 1%. Purely from a mathematical perspective it is understandable why different construction practitioners may differ on the significance of such price adjustments mechanism. It is therefore up to the parties to choose the cost component wisely so that the price adjustment effort commensurates with the benefit. As pointed out earlier in this article, sometimes the impetus behind price fluctuation clause is due to specific nation wide event that could involve a single type of construction material such as the cost of land sand. The practice of parties negotiating the scope of price fluctuation clause out of their own commercial volition is not quite common. Therefore, the choice of which cost component to have its price adjusted is usually not decided by the parties but driven by nation wide events outside their control. 

The second ingredient in the implementation of price fluctuation mechanism is an agreement on what constitute both the ‘base price’ and ‘market price’. The difference between ‘base price’ and ‘market price’ is essentially the range of price adjustment. By way of example, if the contractor submits its tender offer based on $100/m3 of certain grade of ready mixed concrete, this constitute the base price. Since contractors are paid on monthly basis, the market price of such ready mixed concrete for any given month constitute the market price. Assuming the market price for a particular month is $110/m3, the range of price adjustment is $10/m3 for every m3 of ready mixed concrete delivered to site for that month. As with most things in life, the devil is in the detail. Some have argued that the base price should be the price of ready mixed concrete at the commencement of construction period rather than the date of submission of tender offer. This is because tender offers are usually required to be fixed for a period of 90 days or 120 days. Therefore the tenderer undertakes the risk of a fixed price during this period. The next issue is whether the market price should be based on the date on which the specified material is delivered to site. This is because there is a general drive to improve productivity of construction industry by having prefabricated building components manufactured off site and only to have these components delivered to site when these are ready for on site assembly and installation. If the price adjustment only takes place at the point of site delivery, any hope for a timely equitable price relief is diminished significantly. In fact, this could reverse the incentive for contractor to adopt prefabrication of building components, compromising the productivity drive. Finally, there is a more fundamental question of what constitute ‘market price’? If there are ten established suppliers of ready mixed concrete in the market that compete with one another with the best price and have differing market share, how should an industry average price be derived? If the agreement is to refer to a published market price indices, it is likely to be derived based a statistical tool that utilises the element of volume weighted average price that takes into consideration market share and monthly transacted volume in deriving the average price. In reality however, the contractor concerned may have transacted with its supplier based on its very own bargaining power rather than based on a theoretical average price. There will be some statistical arbitrage depending on the actual bargaining power of the contractor. 

Other Provisions That Also Offer Price Adjustments Relief

How common do contractors get financially aggrieved by getting paid based on contract prices when these are lower than prevailing market prices? This is one of the objective measures on the necessity of implementing price fluctuation mechanism. Where there are existing contract provisions that offer similar price adjustment financial relief, are contractors genuinely dependent on price fluctuation mechanism? As variations to the scope of works are often instructed in projects, most construction contracts have fairly detail and established valuation mechanism. Under rules of valuation of variations, there are allowances for contractors to be paid above and beyond its contract rates under specified circumstances. By way of example, where the variation works are not executed under similar conditions as originally contemplated under the contract, the contract rates may be extrapolated to account for fair allowances due to differences in conditions. There are also situations where contractors are paid based on its actual cost incurred for the deployment of plant, materials, labour and other additional equipment necessary for the said variation works. It should be noted that where the contractors are afforded compensation beyond its contract rates, they are permitted to adjust and increase their pricing beyond its original bargain. As most price fluctuation mechanism are specific to construction material such as ready mixed concrete or reinforcement bars, it is arguable that valuation of variations are more generous and all encompassing in that it compensates not only material costs but also inclusive of labour costs and equipment costs. This is because, the contract rates are usually composite rates which consist of a blend of material, labour and equipment costs. 

Since valuation of variations are not confined to one or two specific construction materials identified under price fluctuation clauses but includes all costs necessary for the variation works, can it be considered an equivalent substitute in so far as price compensatory provision? Some may argue that price fluctuation mechanism is neither equivalent nor comparable to valuation of variations. Firstly, price fluctuation mechanism is triggered regardless of whether any instruction for variations had been issued. It is essentially a compensation provision where works are done in accordance with the originally agreed scope. Secondly even if variations are indeed instructed, not all such varied works would qualify for additional compensation beyond the contract rates. Additional compensations are only applicable on a case by case basis. Others however may disagree with the perspectives set out above in that price fluctuation mechanism are usually implemented for projects that are executed over a considerable duration of time, which meant that it involves projects of considerable size and scale. These large projects are usually subject of frequent variations in scope of works because design developments are usually complex and could continue to take place even after project is awarded. These variations are effectively post contract design developments. Whether variations are subject to additional compensation beyond unit rates are primarily benchmarked against the approved baseline programme. This is because any deviation from original schedule is an objective measure of carrying out works under different conditions. Unfortunately large projects are rarely carried out in strict accordance with the approved baseline programme from inception to completion, therefore opening up various opportunities for valuation of variations that could utilise prevailing market prices instead of contract prices. Price fluctuation mechanism on the other hand are usually in operation over a shorter period of time where it only applies to specific types of construction material such as ready mixed concrete. Once the structural works are completed, the mechanism is no longer applicable. 

Since the two competing views above have its own merits, it behooves the contractor to view any price compensatory clauses such as price fluctuation mechanism or valuation of variations based on contract as a whole. Even if the price fluctuation mechanism proposed may not be up to the commercial satisfaction of the contractor, it should balanced its view with alternative provisions that may offer similar pricing relief. Such commercial flexibility is essential in navigating negotiations effectively. 

Do Quantities Of Works Matter Under Lump Sum Contract’s Price Adjustments? 

Under traditional lump sum contract, quantities of works are measured by the tenderers based on tender drawings, specifications and descriptions of scope of works included in the tender documents. The tenderers do so at their own risk because if the quantities that the selected contractor relied on is erroneous due its own measurement mistakes, there is no entitlement for additional payments based on the actual quantities. This is in stark contrast to tenders with bills of quantities where the Employer and its consultant measure the quantities for the tenderers to rely on in their respective pricing exercise. In this case, the quantities formed part of the contract and the contractor is entitled to additional payment in case of under measurement. Such bills of quantities form of procurement is anecdotally less commonly adopted due to the risk it presents to the Employer. 

Given the above and how traditional lump sum contracts are widely used in the construction industry, these beg the question of how does the absence of contractually binding quantities affect the mechanism of price fluctuation clauses? Mathematically, the range of price adjustments are multiplied against the relevant quantities of works carried out over the construction period so as to effect the price fluctuation mechanism. By way of example, if the total quantity of ready mixed concrete for the entire project is 1,000m3 and the average range of price adjustment is $10/m3, the contractor is entitled to additional $10,000 in consequence of the price fluctuation clause. What if the contractor had under measured during tender the quantity of ready mixed concrete at 900m3? Should the contractor be responsible for such under measurement and be entitled to additional payment only at $9,000 based on the average range of price adjustment of $10/m3? Under most traditional lump sum contract, the contractor is not required to disclose its measured quantity that it relies on since such quantity is “non binding” contractually. However, the practical application of price fluctuation clause requires a disclosure of the nett quantity of work for the project in hand that will be subject to price adjustment. This is because the Employer is unlikely to agree to pay additional money via price adjustment relief for quantities above and beyond the project’s scope of works. Price adjustments are usually applied to nett quantity exclusive of any wastages. Therefore quantities included in delivery invoices are usually not relied upon for the purposes of price fluctuation clause. The sensible compromise appears to be an agreement between the consultant quantity surveyor and the contractor on the applicable quantity of works based on their respective measurements. This however meant that there is effectively an avenue for the contractor to amend its quantities of work, reversing its risk of any under measurement of quantities, which should not be the intention of any price fluctuation clause. 

To most construction practitioners from non quantity surveying background, the issue of quantity of works appear unnecessarily complex since measurement based on tender or contract drawings is an objective exercise where different parties should arrive at the same figure. In reality, difference in quantities between parties is quite common particularly for larger project and parties do spend considerable amount of time trying to reconcile their differing figures. This is why under certain circumstances, the Employer is willing to adopt a tender using bills of quantities to eliminate the prospect of different tenderers relying on their own measured quantities that are likely to differ.

Price Fluctuation Adjustment Pending Any Grant of Extensions of Time

Apart from providing relief payments to contractors for fluctuation in market prices, price fluctuation clauses also serve an important function of assisting with the contractors’ cashflow. As regards cashflow, the key is ensuring payments to contractor for price adjustments are made in a timely manner, typically on a month by month basis. To the extent that contractors genuinely rely on these relief payments to support their project cashflow, any delay in access to these payments defeats the very purpose of having these clauses to begin with. The quantum of payment is just as important as the timing of payment. To this end, it is useful to note that most price fluctuation clauses cease to apply after the time for completion or any extension thereof. In other words, to the extent that the project remains incomplete after the original (or extended) practical completion date, the price of the specified material or construction works will no longer be adjusted upwards or downward. In essence, the contractor under such circumstance is deemed to be in culpable delay. Presumably the contractor’s breach of its obligation negates or nullifies its entitlement to assistance of payment. These arrangements raised a few interesting observations.

Firstly whilst the wording of most price fluctuation clauses expressly state that its mechanism cease to apply either upward or downward in price fluctuation, contractor’s only receive relief payments when market price moves upwards. By contrast, the contractor is required to pay credit to the Employer to the extent that the market price moves downwards. Since the mechanism is strictly speaking a double edged sword, why should it cease to apply when the contractor is deemed to be in culpable delay? Why should the Employer not benefit from the price fluctuation clause in this regard? Some may argue, quite validly that in essence price fluctuation clause are primarily aimed at providing payment reliefs to the contractor than it is for the Employer’s cashflow benefit. This is why price fluctuation clause comes into the picture when there are nationwide events that are likely to drive the price of the specified materials or construction works upwards. In other words, the wording of such clauses are not entirely reflective of the actual motivation. 

The second observation is that most extensions of time clauses under standard forms of contract are retrospective in nature. This mean that the certifier appointed under the contract is not under a mandatory requirement of performing its delay analysis prior to project completion. The certifier may well, grant any extension of time if any after the project is completed but prior to closing of the project final accounts. The certifier typically favours such approach in that he can refer to all evidence, site diaries, records, correspondence, programmes etc to make a holistic assessment based on complete set of facts. Therefore, the actual culpability of the contractor in case of schedule overrun is not determined, at least from the perspective of the certifier until the project is in its defects liability period or maintenance period. Consequently, the contractor that may be deserving of extensions of time is not entitled to payment reliefs from price fluctuation clauses until the tail end of the project. This raises doubt on whether price fluctuation clauses could genuinely assist the contractor in so far as project cashflows are concerned if the extension of time clauses are at odds with it.

Conclusion

The financial construct of price fluctuation clauses is usually aimed at providing equitable payment relief but its effectiveness is rarely cut and dry. There are various details that parties ought to be paying attention to so as to ensure that the provisions work in accordance with the altruistic intentions. There is nothing standard about standard clauses.




Koon Tak Hong Consulting Private Limited