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That escalated quickly! The impact of material cost rises on the Canadian construction industry and how contracts are dealing with the issue

26TH OCTOBER 2022

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The year 2021 saw costs in the construction industry rise significantly and this has continued well into 2022. This growth in prices has significant impacts on the overall delivery cost for projects, but how will this affect construction contracting? This article will briefly summarise the factors leading to these escalations in material prices, before going on to assess how escalation is dealt with in Canada’s most common construction contract forms and finally will look at potential initiatives we should take to manage the issue.

According to Statistics Canada, in the final quarter of 2021 the cost index for non-residential construction materials rose by 15.3% in Toronto, with price increases on all but two of the materials which are monitored[1]. This resulted from a variety of factors, including the continued effect of COVID-19, disruption of global supply chains and an increase in the number of construction projects being undertaken in the Greater Toronto Area, linked by Statistics Canada to the low interest rates available[2]. In the first quarter of 2022 There was a 17.3% rise in the building construction price index year on year, which was closely followed by a 12.8% rise in prices for the composite of Canada’s 11 metropolitan areas. While there was a slight drop in the material price index in the second quarter of 2022, we still saw a 17% increase from the previous year’s reporting period. These significant changes in prices are creating profitability issues and cost uncertainty for contractors across Canada. With rapid inflation, war and the residual impacts of the factors described in the analysis of 2021, it’s no surprise that these price increases have risen and this trend looks to continue well into 2022 and possibly beyond.

As many of North America’s most sizeable construction projects are planned or are currently progressing in these metropolitan areas, it seems inevitable that they are going to be affected by the rise in material costs. But the real question is how much will these projects be affected by the increases? The answer to this question is that currently most of Canada’s most common contracting types for construction projects do not deal with this liability in sufficient detail to achieve a fair and reasonable outcome.

While there was a slight drop in the material price index in the second quarter of 2022, we still saw a 17% increase from the previous year’s reporting period.

 

 

...Canada’s most common contracting types for construction projects do not deal with this liability in sufficient detail to achieve a fair and reasonable outcome

The Canadian Construction Documents Committee (CCDC)

The general conditions map out in clear terms the ability to claim for a change to the unit prices, but not an increase in the cost of materials. This is coupled with the proper invoice clause setting out that the contractor cannot include an amended unit price in their calculations unless it has properly been confirmed by the consultant. In short, there is no clear provision which sets out an ability for the contractor to claim escalation of individual unit prices.

Alternative Construction Contract Models

While the CCDC is the most common form of contract chosen for Canadian construction projects, many alternative models deal with the matter differently.

Whereas the CCDC is silent on the issue of escalation some alternatives make a clear statement that the contractor shall assume responsibility for escalation. Naturally in the current climate, this makes these contracting models seem more appealing to owners delivering larger projects, where the risk of price escalation is significant. However, it is important to consider whether a contractor will accept this risk allocation when selecting a contract model and given the current climate it seems unlikely that a contractor would be willing to assume all of the risk in respect of escalation.

In other alternative contract forms we will generally see a shared responsibility approach in relation to increases in material costs. A good example of this is found in contracts which state that the target price will only be changed if an adjustment event occurs as defined in the risk allocation schedule. Changes in material prices and escalation are not identified as adjustment events in most examples I have consulted, so will not result in adjustment to the target price. Contractors will be paid based on actual costs plus overhead and profit (often referred to as Fee) so it could be said that the owner will assume the risk of escalation as the work proceeds. However, in practice many of these alternative contract models will include some form of painshare/gainshare mechanism. This means that the risk is actually shared, as an increase to the cost of the works will most likely result in the pain share mechanism applying sooner; meaning the owner and the contractor will share that risk.

In short, there is no clear provision which sets out an ability for the contractor to claim escalation of individual unit prices.

an increase to the cost of the works will most likely result in the pain share mechanism applying sooner; meaning the owner and the contractor will share that risk.

Conclusion

The first question this article sought to answer is: how do Canada’s most common construction contracting models deal with escalating material prices? Generally, we do not see them deal with escalation of material costs so, in practice, contractors will find it difficult to successfully make a claim for such costs, unless they are explicitly entitled under the contract.

This answer raises another question: how fair and reasonable is this approach? It may appear to be unfair or unreasonable to expect the contractor to assume all of the risk of escalation when contracts are often delivered over several years.

Subsequent articles in this series will consider the issue from the perspective of other jurisdictions. But as an example, if we briefly compare the approaches described here to other forms of contract such as the FIDIC forms where we see an “adjustment formula” clearly setting out the calculations to follow in order to adjust the contract value as a result of escalation, then we begin to understand the potential for disputes and deteriorating relationships as a result of price rises. The FIDIC method does not need to be the exact approach taken for all construction contracts, however, it acts as an indication that allowing for material price increases is a reasonable approach to take. Particularly given the circumstances described in the introduction to this article, we may need to adjust our contracts to allow for material price escalation in order to keep contractors on-side in the face of runaway costs.

...contractors will find it difficult to successfully make a claim for such costs, unless they are explicitly entitled under the contract.

 

 

 

...potential for disputes and deteriorating relationships as a result of price rises.

References

[1]Building Construction Price Indexes, Statistics Canada, https://www150.statcan.gc.ca/n1/daily-quotidien/220204/t001c-eng.htm
[2]Building Construction Price Indexes, Statistics Canada, https://www150.statcan.gc.ca/t1/tbl1/en/cv.action?pid=1810013502