By Alex Johnson, construction & engineering partner at Freeths
The construction industry has been grappling with a period of sustained disruption. Over the past five years, a series of global events from the Covid-19 pandemic and shifting trade policies, to supply chain interruptions like the Suez Canal blockage, have contributed to unprecedented fluctuations in construction costs. As uncertainty continues to shape the market, this article explores how businesses can proactively manage cost escalation through legal mechanisms, practical strategies, and collaborative thinking.
Contractual approaches to cost escalation
One of the most effective ways to address cost volatility is through careful contract drafting. Standard forms such as those published by FIDIC (Fédération Internationale des Ingénieurs-Conseils) include provisions that allow for cost escalation. These clauses can be a valuable tool for allocating risk between parties. However, if the standard language is too broad or not suitable for both sides, bespoke clauses may be negotiated to target specific commodities or materials known for price instability.
For example, parties might agree on defined thresholds or “trigger points” that activate shared responsibility for increased costs. This allows for a more tailored approach that reflects the realities of the project and the market.
Under English law, it’s essential that any cost escalation clause is clearly defined and enforceable. Vague agreements to negotiate future adjustments, often referred to as “agreements to agree”, are not legally binding. Therefore, contracts must include a precise mechanism for calculating and applying any changes to the contract price.
It’s also important to consider regional differences. In jurisdictions such as the Middle East, contractors may have limited ability to negotiate cost escalation clauses, particularly when contracts are awarded on a non-negotiable or “take it or leave it” basis.
Practical measures for risk mitigation
Where contractual protections are not feasible or agreed upon, contractors can adopt practical strategies to reduce exposure to cost increases during the life of a project.
These include:
- Including contingency allowances in the contract sum to absorb potential cost increases
- Purchasing and storing key materials early to take advantage of lower prices
- Securing fixed-price agreements with suppliers at the outset of the project
- Sourcing locally where possible to reduce reliance on volatile international supply chains
These steps can help contractors maintain control over their budgets and reduce the impact of market fluctuations.
Legal relief outside the contract
If a contract does not contain cost escalation provisions, options for legal relief under English law are limited. Contractors generally cannot terminate a contract simply because it has become more expensive to perform. The doctrine of frustration may apply in extreme cases, such as when performance becomes illegal or impossible, but rising costs alone are unlikely to meet this threshold. Frustration is a high bar and, if successful, results in the contract being discharged entirely.
In contrast, civil law jurisdictions may offer more flexibility. Some Civil Codes allow parties to seek relief if the economic foundation of the contract has fundamentally changed, providing a potential avenue for renegotiation or adjustment.
Managing currency risk
Currency fluctuations can also have a significant impact on project costs, especially in international contracts. If parties agree to use multiple currencies, the contract should specify fixed exchange rates to avoid uncertainty. FIDIC forms allow for payments in both local and foreign currencies, but without agreed rates, conversions may default to central bank rates, which may not reflect market conditions.
A collaborative mindset
Finally, the way parties approach risk allocation can influence the success of a project. Viewing the contract as a shared investment rather than a battleground can foster more constructive negotiations. When both sides are open to discussing who is best positioned to bear certain risks, and to what extent, they are more likely to reach fair and sustainable agreements. This mindset not only protects individual interests but also supports the overall success of the project.
This article draws on insights from the webinar “Navigating Construction Cost Escalation” hosted by Gleeds and Freeths. Contributors included Chris Soffe and John Refaat (Gleeds), Alex Johnson (Freeths), and guest panellist Chris Murphy (Consolidated Contractors Company (CCC)).
