Materials – unavailability and increasing costs: what is the contractual position?

In this article Hill Dickinson assess, in the context of JCT Design and Build 2016 and NEC4 Engineering and Construction Contract, the impact for existing and new contracts, what commercial solutions can be considered and how delays and increased costs can be managed.

JCT DB 2016

The starting point in the JCT DB 2016 is that the Contractor carries out works for an agreed price by reference usually to the Employer’s Requirements. The Contractor is not entitled to recover any additional costs or time for carrying out the works unless provided for within the express provisions of the contract. The specification typically states what materials are to be used.

Clause 2.2.1 states:

‘All materials and goods for the Works shall, so far as procurable, be of the kinds and standards described in the Employer’s Requirements or, if not there specifically described, as described in the Contractor’s Proposals or other Contractor’s Design Documents. The Contractor shall not substitute any materials or goods so described without the Employer’s consent which, if given, shall not relieve the Contractor of his other obligations.’ (emphasis added)

So what does ‘so far as procurable’ mean? Does it cover the scenario when materials are not procurable at a point in time or within the timescales required by the Contractor or does it only cover a total inability to procure materials at any time or cost? British Steel has assured the market the current intervention is a temporary suspension and given the contractor takes the risk for the time and cost of materials this looks like a problem for the contractor. We doubt, however, the matter will be clear cut. The question of whether materials are procurable is likely to be a matter of fact and degree, which depends on the length of the works and how long the order book remains closed. Significant commercial considerations may also play a part.

In contractual terms if there is no obligation to procure materials for the works there can be no obligation to progress the works but this must be read in conjunction with Clause 2.3 which places the Contractor under an obligation to proceed regularly and diligently. The Contractor must actively investigate alternative procurement routes and consider alternative sequencing in order to mitigate delays. But what happens if none of these avenues are open to the Contractor? Might there also be an obligation to actively explore substitution of materials? Contractually, this is tricky. Under Clause 2.2 the Contractor cannot substitute materials without obtaining the Employer’s consent.

Do the circumstances amount to Relevant Events under the Contract and entitle them to an extension of time?

Clause 2.26 provides relief for the contract where the delay arises from:

• Strike, lock-out or local combination of workmen affecting any trade employed upon the Works or engaged in the preparation, manufacture or transportation of any of the goods or materials required for them or any persons engaged in design work for the Works (Clause 2.26.11)
• The exercise after the Base Date by the United Kingdom government or any local or public authority of any statutory power that is not occasioned by a default of the Contractor or any Contractor’s Person but which directly affects the execution of the Works (Clause 2.26.12)

While, elements of the above may have affected the supply chain, there is no direct evidence that either of the above caused the British Steel order books to close.

In addition, relief is provided for:

• An Employer’s instruction for a Change or variation to the Works (Clause 2.26.1)
• An Employer’s instruction to postpone the Works under Clause 3.10 (Clause 2.26.2)
• Any impediment, prevention or default, whether by act or omission, by the Employer or any Employer’s Person (Clause 2.26.6)
• An event of force majeure (Clause 2.26.14)

Force majeure events are exceptional events that could not be contemplated by the parties at the time the contract was entered into, are beyond the control of the parties, and which make contract performance practically impossible. The fact that it is more difficult or costly to perform the contract is not enough.

Lockdowns caused by the pandemic have recurred for some time now and are therefore deemed to be within the contemplation of the parties for any contract dated March 2020 onwards. In addition, alternative materials or suppliers may be available (albeit perhaps at a greater cost) such that contracts will not be impossible to perform.

Consequently, there seems no obvious route to securing an extension of time in these circumstances but that does not mean the burden lays exclusively with the Contractor.

While there is no general obligation in the JCT to act in the spirit of mutual trust and co-operation, the Employer’s Agent’s role is to manage the contract and their professional duties should extend to encouraging the parties to take a pragmatic approach.  In circumstances where the Contractor cannot procure materials to progress the works the Employer’s Agent’s should, in conjunction with the Employer, seek a solution. This could be by way of instruction for the omission or postponement of works, or use of alternative materials. Such instructions would entitle the Contractor to an extension of time under Clause 2.26.1 (a change or variation to the works). If the Contractor requests substitution of materials which are not procurable and the Employer refuses consent or where the Contractor advises materials are not procurable and Employer offers no instructed solution this is arguably a be a Relevant Event under Clause 2.26.6: ‘any impediment, prevention or default, whether by act or omission, by the Employer or any Employer’s Person.’

Can the Contractor recover loss and expense?

The contractor may recover loss and expense under Clause 4.20 where the delay is caused by an instruction requiring a Change, an instruction to postpone works or any impediment, prevention or default, whether by act or omission, by the Employer or any Employer’s Person. Importantly, where an award for an extension of time is given following an event of force majeure there is no right to recover loss and expense.

NEC4 ECC

The underlying principle is ‘the Parties, the Project Manager and the Supervisor shall act in a spirit of mutual trust and cooperation’. (Clause 10.2).  Given that materials are so fundamental to the works it is highly likely that this provision will be at the fore of discussions about material availability and cost.

Increased cost

There are various pricing options under the NEC that include priced contracts (options A and B), target contracts (options C and D) and cost reimbursable (Option E). The effect of increased cost of materials will depend on the pricing option ie is it cost reimbursable or is there a pain/gain share in relation to any increased costs? In addition, any change depends upon the X options and any Z clauses. There may be an adjustment for inflation if Option X1 (Price Adjustment for Inflation) applies but it depends on which indices are used as a basis in the Contract Data. If Option X2 applies a change in law of the country where the Site is located is a compensation event if it occurs after the Contract Date. If plant and material are manufactured in another country and the laws of that country change which delays their manufacture etc that will not be caught by Option X2.

Entitlement to time and money

Clause 60 (Compensation Events) sets out the basis on which the Contractor is entitled to additional time and money. The following compensation events may be relevant.

• Clause 60.1(1) – a Project Manager gives an instruction changing the Scope. A change in Scope may be agreed by the parties as a result of unavailability of materials. Also, under clause 17.2, the Project Manager and the Contractor must notify the other as soon as it becomes aware the Scope includes an illegal or impossible requirement and if that is the case the Project Manager gives an instruction to change the Scope appropriately. Depending on the facts, this may cover the situation where plant and materials manufactured overseas cannot be delivered to site
• Clause 60.1(4) – a Project Manager gives an instruction to stop or not to start any work or to change a Key Date
• Clause 60.1(19) – act of prevention. There is no reference to force majeure in NEC4 ECC, but clause 19 (prevention) and 60.1(19) deals with force majeure type events. The event must stop the Contractor completing the whole of the works either completely or by the date for planned Completion on the Accepted Programme. It must be an event neither party could prevent and an experienced Contractor would have judged to have had such a small chance of occurring it would be unreasonable to have allowed for it. The Project Manager gives an instruction to the Contractor setting out how the event is to be dealt with. This objective test will make it very difficult to assess amid the perfect storm of Brexit and Covid. This could only apply to issues of material availability resulting in delay to the works or preventing the works altogether and not to increased costs of materials

Notices, early warning and risk reduction meetings

Parties must ensure they comply with the notice provisions in NEC ECC. Clause 15.1 (early warning) requires the Contractor and Project Manager to give early warning to the other as soon as they become aware of a matter which could increase the total of the prices, delay completion, delay meeting a Key Date or impair the performance. This risk should then be reflected in the risk register and the parties discuss how to deal with it collaboratively in a risk reduction meeting and manage any time or cost implications. Failure to issue an early warning notice can have a negative impact on the assessment of a compensation event (Clause 61.5). In addition, compensation event notices must be made within eight weeks of becoming aware of the event or the claim will be time barred (Clause 61.3).

Pandemic/Brexit clauses

Your contract may include a pandemic or Brexit clause that restricts or removes entitlement to time and/or money, but as can be seen by the broad nature of the statement issued by British Steel it may be difficult to prove that the unavailability of materials and/or increased costs is ’caused’ by the pandemic and/or Brexit.

Is the contract frustrated?

The doctrine of frustration applies where after a contract is entered into a catastrophic or fundamental change of circumstances brings the contract to an end because the contract is incapable of being performed. In Davis Contractors -v- Fareham [1956] an unanticipated shortage of labour and materials, which caused a 22-month delay and increased costs of £17,000 was not enough to frustrate the contract. Therefore, it is unlikely that any temporary closure of the order books, delays to procurement or cost increases will frustrate a contract unless it can be shown that the change will stop works completely such that the contract becomes impossible to perform.

Ongoing contracts – what to do?

• Look carefully at the contract terms and check if standard terms have been amended. What is the entitlement for time and/or money? Is there a pandemic and/or Brexit clause and what is its scope?
• Unless catered for in the contract, the risk of price fluctuations remain with the contractor
• Communication is key. Parties need to work together, a pragmatic approach is probably best given the complexity of the issues.  It may be possible to agree to vary or renegotiate the contract terms
• The Employer and Employer’s Agent should engage with the Contractor and consider whether contract instructions can assist eg to vary materials, resequence the works or order a temporary postponement of works until materials can be procured
• Comply with any contract notice requirements (including early warning)
• In relation to NEC4 ECC, early warning to be followed by an update to the risk register and a risk reduction meeting
• When looking for solutions the parties should be mindful of contractual consequences and whether there could be a contractor claim for an extensions of time and/or loss and expense. The contractor is often subject to an obligation to use reasonable or best endeavours to mitigate delay and/or loss and expense. Consider what practical and commercial steps can be taken. For example, early and regular discussion with the supply chain, considering alternative suppliers, storing materials and exploring reasonable alternative materials
• For contractors, involve and consider the issues from the perspective of subcontractors. From a commercial perspective there may be a danger that subcontractors renege on the terms or promises previously made

Negotiating new contracts

• If issues with material availability and cost are anticipated this should be expressly dealt with in the contract. Discussions on the availability of materials should be started at an early stage
• Contractors must consider the terms they will be able to obtain from their subcontractors. Many subcontractors may find themselves unwilling to accept the risk of material unavailability and price increases and contractors need to consider how to mitigate these risks
• Contractors should consider how price risk can be managed given supply issues for example by requiring the inclusion of fluctuation provisions or pricing on a cost reimbursable basis
• Consider whether the drafting of the specification of materials can be widened to allow for flexibility
• The programme and cost budget should factor in issues with availability and cost of materials
• Consider a liquidated damages holiday or reduced liquidated damages in certain circumstances outside the contractor’s control
• Consider specific drafting to deal with current difficulties. For example, define what the parties mean by ‘so far as procurable’ and in what circumstances materials would be considered not procurable
• Ensure drafting clearly details the circumstances in which the parties consider a claim for an extension of time and/or recovery of loss and expense would be permitted as a result of procurement delays in the supply chain.

The issues discussed in this article are complex and any amendments to the standard forms must be drafted carefully and with legal advice. Please contact the writers or your usual contact in the Construction team with any queries and we are happy to help.