Given the current economic times and the well-documented shortage of building materials, the industry is asking whether price and labour increases can be ‘passed on’ to home owners. Paul Cott answers.

Wit the shortage of building materials and increased (post-pandemic) building industry activity a very common issue being grappled by industry players is whether price and labour increases can be lawfully ‘passed on’ to home owners.

This is a critical question. If the answer is no, there are sometimes real live questions of whether a particular business is still viable, particularly where there are multiple price ‘locked in’ contracts.

Fixed-price contracts

If the tradie or builder has an actual fixed-price contract, then there is limited scope to pass on an increased cost after the contract is signed that is, to the owner.

As with everything in life however and certainly in the law, there are exceptions.

As a matter of basic contract law, contracts can only be varied by mutual consent and so if the owner was to agree (albeit unlikely) on a price hike to the contract by way for example, of a contractual variation, then a price increase could be (theoretically) covered in that way. Such a variation (as with all variations) needs to be processed correctly, in the sense of the contractual procedure for their needs to be followed as strictly as possible to the letter of the law.

That is, in summary, the variation is initiated by a written request to the owner, who then consents to it in writing, and where full disclosure as to the reason for and the cost (and the resultant delay to the project) of the variation needs to all be set out.

Many building contracts have clauses in them which specify that on a change in relevant laws, fixed-price contracts can be varied in respect of extra costs incurred by the builder as a result. This does not apply though to the current extra costs in materials and labour being experienced.

If there are extra costs being incurred say, as a result of strikes or natural disasters then if those things result in extra costs in labour and materials, then those costs can be passed on to the owner. But this only applies to quite exceptional circumstances.

Generally, the law says that builders and tradies should have (albeit often an impossible task) anticipated or at least contemplated possible material and labour price increases when contracts are being priced. So often, the risk then lies with the builder for subsequent price increases.

Cost plus contracts

With a cost-plus contract, the situation is different. The owner then agrees to take on the risk of price increases after signing and it is as a result of this that many construction lawyers advise owners against entering into such contracts.

For the owner, there is that ever-present risk of the price increases and thus certainty in the financial obligation entailed for the owner is not achieved.

Rise and fall clauses

The law here varies from state to state but what can be said is that in Victoria, such clauses (the definition of which we will get to) can only be used the works have a contract price which is over $500,000. Other states allow them but they are not common generally.

Such a clause allows a rise in contract price (and a fall, as the name of them suggests) where material prices increase. They need to be carefully worded and in the interests of full disclosure to the owner, both how the price increase is worked out should be disclosed and what also should be disclosed is what the evidence is of the particular price increase.

The standard HIA and MBA for example, do not include such clauses and costs can be incurred in having such a clause drafted, say by a construction lawyer well versed in the use of such clauses.

Prime cost and provisional sums

A prime cost item is where an item (such as certain fixtures and fittings) in the job has not yet been selected and so its price is not yet known at the time of contract entry. The builder, therefore, makes a reasonable estimation or allowance in the contract to deal with the unknown element. A markup element or profit allowance can be allowed for in the price of such an item.

A provisional sum is an estimation of the cost of doing certain work where it cannot be precise, at the time of contract entry, stated with certainty what the cost of that work will be.

It can relate to both or either of labour costs and materials costs. There is generally a duty of fuller disclosure on the builder or tradie as to these items in the sense that how the estimation (and the estimation must always be reasonable) is made needs to be well set out. They are not overly common items in the domestic building sphere perhaps because of the extra work involved in them in respect of the fuller disclosure, in particular, the work involved in providing substantiation of figures.

Prime cost items and provisional sums items are referred to in the suite of standard building contracts across Australia but they are not commonly used. Perhaps now they should be. Owners though need their own advice as to these items for many reasons, chief among them their need often to budget for such items.

Prevention is often better than cure

As a way to potentially avoid under-quoting on a job due to the current situation, there are certain things people can do. One is that industry players should regularly (even more regularly than usual) review their contracts.

They should also regularly review their pricing practices and structures so that they do keep up with current economic conditions. In addition, people should where possible reduce the time from contract signing to construction commencement to avoid shifts in prices in labour and materials in that interim period.

Finally, having regular open and honest and transparent conversations with owners as to the situation builders and tradies are facing can help to ameliorate some of the pushback from owners where industry players are thinking about, or actually passing on price increases.

Conclusion

This is a tricky area and unfortunately, as occurs often in a federation of states such as we have in Australia, the laws can vary (at times quite significantly) from state to state.

Expert advice should be sought for people who have queries as to the issues in this article, so that certainly as to the true legal situation in the particular state can be achieved.