Is Your Fixed Price Construction Contract Actually Fixed?
In construction, a ‘fixed price’ contract rarely means that the contract price is fixed in an absolute sense. Through this article we will show how a ‘fixed price contract’ is only ‘fixed’ subject to the contractual mechanisms that allow the price or project cost to move.
That distinction is especially important in the current market. The ongoing conflict in the Middle East is contributing to cost increases on projects. It is important to note that rising freight, fuel, shipping and procurement costs do not themselves change the contract price, but they can cause the contract price to change if the contract contains a pathway for that adjustment.
Prime Cost Items and Provisional Sums
The most common reason a ‘fixed price’ contract stops being actually fixed is that the headline figure often includes allowances for Prime Cost Items and Provisional Sums. Prime Cost Items and Provisional Sums are built-in contractual mechanisms allowing for price movements based upon the principal’s selection after the contract has been signed.
The ‘Contract Price’ is often described as inclusive of those allowances and ‘subject to’ adjustment under the contract. In other words, the fixed component may be fixed, but the total contract price may still move because the Prime Cost Items and Provisional Sums prices may change. That is why a contract can honestly be described as ‘fixed price’ while still leaving real cost exposure sitting in the allowances schedule. It is important to note that the risk of Contract Price movement associated with Prime Cost Items and Provisional Sums can be even more pronounced where the costs of construction inputs are rising.
Variations
The next major pressure point is variations. In practice, many cost overruns do not arise because the original price was false, but because the scope changes after the contract is signed. Once the scope changes, the price usually changes with it. Variations can arise from design development, authority requirements, coordination issues, site discoveries, substitutions, or the need to bring the works into line with what is actually required on the ground. It is not just a case of the principal simply ‘changing its mind’.
The best way to avoid Variations is to ensure sufficient and appropriate time is spent at the outset to get the scope right, before the contract is signed. There will at times be external reasons to hustle contract signing, but this should be weighed up against the risk that the price will not truly be ‘fixed’.
Delay, Time Risk and Project Cost
Time is another place where the concept of ‘fixed price’ can be undermined. Even if the contract sum itself does not automatically rise, delay can still affect the economics of the project through extensions of time, prolongation costs, revised preliminaries, or disputes about liquidated damages.
In the current environment, shipping delays, fuel price volatility and procurement disruption may have real time consequences. Whether those consequences translate into an entitlement for additional time or cost will depend on the drafting of the delay, extension of time and notice provisions in the contract. Again, time and care should be spent at the contract drafting and review stage to ensure these mechanisms are appropriately considered.
How can I ensure my Contract is as ‘fixed price’ as possible?
Parties seeking genuine cost certainty should look beyond the label and examine the contractual machinery carefully.
Particular attention should be given to:
- the treatment of prime cost items and provisional sums;
- the scope of the variation clause;
- whether escalation or supply chain risk is addressed expressly;
- delay and extension of time entitlements; and
- the notice requirements for preserving claims.
Early legal advice can make a material difference. A careful review of the pricing mechanism, variation regime, escalation wording, notice requirements and delay provisions may identify whether additional costs can be recovered, resisted or more effectively managed before positions harden.
Our Construction Law Team advises principals, developers, contractors and subcontractors on contract drafting, risk allocation and project disputes. Please contact our Construction Law Team for assistance in ensuring your construction contract’s risk allocation reflects your intentions.
