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Sat 4 Oct 2008 04:00 AM

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Cost escalation

Contractors may not be entitled to compensation for the increase in the cost of materials under the force majeure provision of the law.

Cost escalation

Cost escalation is one of the major issues currently affecting the construction sector in the region. There are regular press reports on the extent to which the costs of steel, cement and labour have risen.

The effects of these significant and unpredictable increases are more acute on large-scale projects due to their value and the time needed for construction. Often on such projects, developers remove the provisions in standard forms of contract that would entitle contractors to additional payments in respect of cost escalation thus allocating all of the risk to the contractor.

While contractors make some allowance in their tenders and some are able to manage the risk by purchasing materials in bulk, the exposure to the risk remains. In current market conditions, such exposure results in contractors’ profit margins being squeezed leading them to seek alternative ways of obtaining additional payment.

One current trend for contractors seeking additional payment is to contend that the recent cost increases constitute a force majeure event. Force majeure provisions in a contract compensate a party or relieve it from an obligation when it is prevented from performing an obligation by an extraordinary event or circumstance beyond the control of the parties.

Many standard forms of contract contain force majeure provisions, including Fidic’s 1999 Red Book. Under the Red Book, will a contactor succeed with a force majeure claim for the recent cost increases where it has no right for additional payment for cost escalation?

Sub-clause 19.1 of the Red Book defines of what would constitute a force majeure event. It states: “Force Majeure means an exceptional event or circumstance: (a) which is beyond a party’s control, (b) which such party could not reasonably have provided against before entering into the contract, (c) which, having arisen, such party could not reasonably have avoided or overcome, and (d) which is not substantially attributable to the other party.”

Sub-clause 19.1 goes on to list some types of force majeure events, such as war, terrorism and natural catastrophes.

It is arguable that the recent increases in cost of steel and cement could satisfy all of the conditions under sub-clause 19.1(a) to (d). Therefore, it might appear that the recent increases in cost could be considered as force majeure.

Although the recent cost increases might constitute a force majeure event, the contractor might not be entitled to any additional payment. Sub-clause 19.4 states: “If the contractor is prevented from performing any of his obligations under the contract by force majeure the contractor shall be entitled to: a) an extension of time for any such delay, if completion is or will be delayed, and b) if the event or circumstance is of the kind described in sub-paragraphs (i) to (iv) of sub-clause 19.1 and, in the case of subparagraphs (ii) to (iv), occurs in the country, payment of any such cost.”

Therefore, in order to have any entitlement the contractor must have been prevented from performing an obligation under the contract. This might have occurred if the contractor was unable to procure materials needed for construction due to lack of availability in the market. However, prevention will not have occurred simply because a task became more expensive to perform. Therefore, if the contractor was able to continue with the work no entitlement will arise under sub-clause 19.4.

Even if the recent events are considered as force majeure and the contractor was prevented from performing an obligation due to a shortage of materials, the contractor could face further problems with recovering additional cost.

Sub-clause 19.1(a) entitles the contractor an extension of time in respect of any force majeure event, whereas sub-clause 19.1(b) restricts the contractor’s entitlement to additional cost to where only the types of force majeure events listed in sub-clauses 19.1(i) to (v) have occurred. The recent volatile market conditions and cost increases do not readily fall under any of the types of natural disasters, public disturbances and military actions listed in clauses 19.1(i) to (v).

It appears that a contractor will have little success with claims for additional payment by contending that the recent increases in material costs constitute a force majeure event.

In my view, where the contract is clear that the contractor is responsible for the supply of materials and is not entitled to additional payment in respect of cost escalation, the contractor will have difficulty claiming a contractual entitlement by arguing that the recent cost increases are a force majeure or any other event.

Nevertheless, I would suggest that contractors discuss with their clients the problems they have faced and request that their clients share some of the burden of the increases in construction costs. Developers need to be sympathetic to the plight of contractors as any reduction in contracting capacity will create further problems in the industry and in the development of the region.

Chris Larking is the associate director of Brewer Consulting.

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Michael Malas 11 years ago

Dear Chris, Your article would have been more appropriate during the first half of this year when by end of June 2008, the prices of steel deformed bars reached the levels of AED 6,500.00 per ton,and many developers paid for whole project in advance at this level and since July until nowthe prices have reached as low as AED 3300. In this case I will be interested to hear your views if the AED 3000- per ton (the difference in drop of price) would be refunded back to the developer for the material not delivered for the project. We are talking big money here and in some cases almos the cost of another 50 storey building.