Navigating cost escalation in international construction projects

The global construction industry is riding a turbulent period. From Covid and its effects to trade tariffs via blockages to the Suez Canal, a panoply of events have caused greater volatility in construction costs over the last 5 years than previously. With uncertainty likely to continue, this article sets out how companies might better navigate construction cost escalation.

Contract drafting

Industry standard forms, such as those developed by the Fédération Internationale des Ingénieurs-Conseils (International Federation of Consulting Engineers (FIDIC), allow parties to include cost escalation provisions. These should be used. Alternatively, if the standard form offers too much of a blanket approach for both parties to accept, they may seek to agree cost escalation / rise and fall provisions against commodities prone to greater volatility. For example, parties may agree trigger points at which the risk of escalation is shared should prices increase.

Under English law, parties need to exercise caution when drafting bespoke cost escalation / rise and fall provisions. An ‘agreement to agree’ is not enforceable, so contracts must include a mechanism for determining and making certain any adjustment to the contract price for cost escalation.

Cost escalation clauses are market-specific, however. In some jurisdictions such as the Middle East, contractors are unlikely to gain protection by cost escalation clauses particularly where contracts are awarded on a ‘take it or leave it’ basis. 

Practical steps

Where cost escalation provisions cannot be agreed in a contract, contractors should consider practical ways to protect themselves from the effects of cost escalation during the project. This may include

• building risk money into the contract sum 
• stockpiling commodities to benefit from more favourable prices
• contracting with key suppliers early with fixed price terms
• buying local’ where possible instead of, or in addition to, relying on international supply chains

Other forms of legal relief

If cost escalation provisions are not included in a contract, under English law there is unlikely to be any other form of legal relief. Unless the contractor can claim cost escalation under a contractual entitlement, options are going to be limited.

Generally, contractors have limited rights to terminate contracts. Those rights do not usually include the project becoming more expensive than first thought. A contract may be frustrated where it becomes illegal or impossible to perform or is transformed into a radically different obligation. The fact that the works have simply become more expensive than expected is unlikely to amount to frustration, however. Frustration remains a high bar to clear, and in any event leads to discharge of the contract.

In civil jurisdictions, parties may be able to rely on the relevant Civil Code for relief where the economic basis on which the contract was made has fundamentally changed.

Currency risk

Currency risk should also be dealt with in a contract if parties do not agree on the same currency for everything in a project. Again, the FIDIC standard forms permit parts of the contract to be paid in the local currency and other parts to be paid in a foreign currency. The parties should ensure the contract includes fixed rates of exchange otherwise conversion rates may default to the rate set by the central bank of the country in which the works are being done. 

Mindset

Although market approaches around the world differ, if taking the view that the project is an investment in which both parties have a stake rather than a battle from opposing sides, parties may be better predisposed to find common ground and agree who is best placed to take the risk of cost escalation and to what extent. Ultimately this benefits the project and protects both parties. 

This article was produced following the webinar “Navigating Construction Cost Escalation” presented by Gleeds and Freeths. It is the work product of Chris Soffe and John Refaat (Gleeds), Alex Johnson (Freeths) and guest panellist Chris Murphy (Consolidated Contractors Company (CCC). The webinar can be viewed here.