Rise and fall clauses are one way principals and contractors are seeking to mitigate pricing risk in the current market. Despite being used rarely in the decades leading up to the COVID pandemic, they have since seen a resurgence in commercial construction contracts.
1. When should you use a rise and fall clause?
Rise and fall clauses allow adjustments to a lump sum contract price to reflect changes in the contractor's costs over time.
On the one hand, a rise and fall clause will reduce the principal's certainty around the final cost of the works. This is because those parts of the price subject to the rise and fall mechanism will remain fluid until the end of the project, once the final cost is known.
On the other hand, they will reduce the contractor's risk in relation to its price, which may lead to more competitive pricing. Contractors will not have to 'price in' the risk of price escalations if the contract allows rise and fall adjustments.
Although they are prohibited in some jurisdictions for certain residential contracts, their use on commercial construction projects is unregulated. And while some features of these clauses are more common than others, there is no standard wording and no 'one-size-fits-all' approach.
2. What should your rise and fall clause apply to?
Rise and fall clauses can apply to labour costs, or materials costs, or both.
Usually rise and fall clauses are targeted so that they only apply to specific trade packages or types of materials (eg steel, timber etc). This is to preserve the general intention of a lump sum contract, so that as much of the price is fixed as possible. Where the intention is for the contractor to be paid its 'actual cost', a construction management contract or other similar arrangement would be used instead.
3. How does the rise and fall adjustment work?
Rise and fall clauses work in two ways.
The first is for the mechanism to compare the contractor's tendered costs with the contractor's actual costs. Typically the contractor's tendered costs for the relevant items would be disclosed in the contract, to reduce the potential for argument later. Where the rise and fall clause allows an adjustment for changes to labour rates, the adjustment mechanism would typically follow changes to national award rates.
The second approach, is for the mechanism to be based on a published index. The mechanism is usually expressed as a formula, and allows adjustments to the contract price to reflect changes in the relevant index. The Producer Price Indexes published by the Australian Bureau of Statistics are the most commonly used. When choosing an index, it is critical that you are specific about which index is to apply. It is also a good idea to have a fallback index (even if it is as simple as the Consumer Price Index published by the Australian Bureau of Statistics), in case your preferred index ceased to be published.
An important drafting point is to consider when the comparison exercise is to be undertaken. For example, is the benchmark intended to be measured at the time of tender or the time of contract? This can make a big difference if there is a significant gap between the two.
Similarly, it is crucial to consider when, and how often, the adjustment mechanism is intended to apply.
It could be as regularly as monthly (if your chosen index is updated that often), quarterly, every 6 or 12 months or even as a one-off at the end of the project. Different permutations will have different commercial consequences and could produce significantly different outcomes, depending on market conditions.
Most contracts will contain barring provisions to prevent contractors from claiming additional costs outside of the agreed times.
4. Should there be a threshold before a rise and fall adjustment is allowed?
Principals who wish to limit the application of rise and fall clauses will often include a threshold before any adjustment can be made.
Two types of threshold are sometimes used.
First, some contracts will only allow rise and fall claims after a specified period has passed (eg 6 or 12 months after the contract has been signed).
Second, some contracts will only allow a rise and fall claim if there is a change in a relevant category of cost of at least [x]% and/or a change to the overall cost that may be the subject of rise and fall claims of at least [y]%.
If this second type of threshold is used, the rise and fall clause should specify whether the adjustment calculation is intended to apply to the entire cost, or just the amount that exceeds the threshold.
A percentage threshold that is too high (or a time threshold that is too long) can defeat the entire purpose of the rise and fall mechanism. Consequently, where a threshold is used, it is normally low.
5. What are the alternatives?
Although rise and fall clauses share some commonality with provisional sum mechanisms, they should not be confused.
Provisional sum clauses can seem initially attractive due to their simplicity, but dedicated rise and fall provisions are usually more precise. This tends to limit the potential for unexpected outcomes or future disputes. In addition, provisional sum mechanisms will often require adjustments to the contractor's margin, whereas rise and fall provisions generally do not.
Where principals wish to have greater transparency or control over project costs or are keen to avoid the potential for excessive risk pricing, early contractor involvement contracts are often used as an alternative to traditional lump sum engagements.
