Residential Fixed Price Building Contracts – Cost Increases – who pays?
There is currently a great awareness in the industry around the continuing cost increases in building materials and labour. Whether its increases in the cost of steel out of China or a shortage in skilled labourers, the entire supply chain is feeling the effects and passing them on.
Many builders will be looking to sign up cost reimbursement contracts to pass on these cost increases to their client. But when a contract is fixed price or lump sum, as are many residential building contracts, can a builder still require the client to pay these cost increases after the price is agreed?
Below we look at this issue with respect to three of New Zealand’s frequently used building contracts: NZS3910:2003, the Registered Master Builders’ RBC1-2018 (New Build), and the Certified Builders Association of New Zealand Fixed price+ building contract.
NZS3910:2003
This form of contract (3910) is the most widely used construction contract in New Zealand. Although more commonly used with commercial/industrial builds and residential developers, it is still often used by clients for residential builds. Under a lump sum 3910 the “principal” (client) must pay the Contract Price to the builder. The Contract Price is the lump sum specified (usually in the Contract Agreement and/or attached pricing schedule) and is subject to any adjustments which the contract provides for. One of these adjustments is for “Cost fluctuations”. Clause 12.8 allows for the builder to claim cost fluctuations, unless Schedule 1 of 3910 specifically provides that cost fluctuations cannot be claimed.
If Schedule 1 allows for cost fluctuations, then they must be calculated in accordance with a set equation set out in Appendix A. This equation relies on Statistics New Zealand Labour Cost index and Producers Price index, rather than the actual cost increase to the builder.
NZ Certified Builders Association – Fixed Price + Building Contract
The Certified New Zealand Builders Association Inc (CBANZ) has developed its own form of residential fixed price building contract for its members’ use. The CBANZ contract is drafted on the basis that there is an original fixed price and a final contract price. The final contract price includes any adjustments to the original fixed price if the CBANZ contract provides for them. One of these adjustments (clause 5) is for increases in the costs to the builder after the contract is signed.
However, to be entitled to pass on these costs, the builder must satisfy three requirements:
1. The builder must have not been able to reasonably foresee such increase in costs; and
2. The increase in costs must actually erode the builder’s margin; and
3. The builder must be able to substantiate the increase by reference to the original pricing and subsequent price increase.
It is arguable whether a builder would be able to satisfy 1 above in today’s environment where the risk of an increase in costs is very real and known.
The essence of a fixed price contract is that the builder determines their profit margin which is not necessarily disclosed to the client, as they take on the risk of price increases. Some items of works may have much higher margins than other items. To satisfy 2 and 3 above a builder would likely need to disclose their margin and unless the cost increase relates to a specific priced line item, it may be too onerous for the builder to comply with these disclosure requirements.
RBC1-2018 (New Build)
The Registered Master Builders Association also have their own form of building contract for fixed price residential builds (RBC1). Like 3910, the definition of Contract Price includes the lump sum price and any adjustments that RBC1 provides for. However, unlike 3910 and the CBANZ contract, RBC1 provides a much simpler process for a builder to follow to enable them to pass on the costs of any increases.
If the builder suffers any additional cost as provided for in RBC1 (called an Adjustment), then the builder is entitled to add that Adjustment to the contract price.
Clause 46 provides that if the builder does suffer any increase in costs which result in them incurring additional expenses, then they are entitled to an Adjustment. There is no requirement for the builder to provide any evidence in pricing (before and after) or to have not reasonably foreseen the possible increase at the time of signing, as in the CBANZ contract. As a result, RBC1 allows for cost increases to the builder to be passed on to the client unilaterally and without reference to any evidence. There is some solace for clients who sign up to the RBC1 contract in that clause 22 does require the client and builder to attempt to agree a price for an Adjustment, and if agreement cannot be reached, then the Adjustment shall be valued at the actual and reasonable cost to the builder plus margin.
Summary
Once a fixed price or lump sum contract is signed, whether a builder is entitled to pass on increases in building costs to the client and how these are valued will be in the fine print. Despite the express cost escalation clauses found in building contracts, even where these clauses do not exist, there is still possibility for cost increases to be passed on to the client where certain delays have occurred. This will also turn on the specific wording in the building contract.
Tom Evatt & Co have written this article solely for information purposes and it is not a substitution for specific legal advice. All building contracts are unique and interpretation of them will also depend on the relevant facts. Please contact Prue Miller for further assistance.
E: Prue.miller@tomevatt.co.nz P: 021 023 80405