What is a rise and fall clause and why might you use one?
By Michael Cope
Special Counsel, Cornwalls Brisbane
The most common type of building contract is the lump sum contract under which the contractor agrees to complete the works for a lump sum. In such contracts, there is no room for the price to be changed because of fluctuations in costs.
The risks to contractors in fixed price and schedule of rates contracts
This means, that if the cost of materials or labour significantly increases between the date the contract price was agreed and the finalisation of the work, the contractor has no mechanism for recovering that increase in the costs.
This is an issue of particular concern to contractors currently because of supply chain difficulties and the return of inflation more generally.
This situation can be avoided by making the contract subject to “rise and fall”. In such contracts a clause is inserted which permits the price to be varied by reference to any actual cost increases during the period of the contract. Such clauses are commonly known in Australia as rise and fall clauses but are known elsewhere as “fluctuation”, “variation of price” and “cost adjustment” clauses.
In more recent times they have come to be referred to as cost escalation clauses. This change in terminology reflects the fact that such clauses do not allow for the price to fall when the cost of materials or labour falls.
For the purposes of this article, we will use the traditional formula of “rise and fall” clause to cover all these types of clause.
Such clauses can be applied not only to lump sum contracts but also to schedule of rates contracts. However of course they are not relevant to provisional sums or prime cost items, because those items are already subject to adjustment to reflect the actual price of the work or the item.
Types of rise and fall clauses
Rise and fall clauses go back at least until the Second World War but were at their height during the inflation of the 1970s and 1980s.
There are two types of rise and fall clause. The first provides for the price to be adjusted by the amount of the actual variation in the costs of materials or labour which occurred during the relevant period. The second type provides for the price to be adjusted not by reference to actual costs but by reference to a formula set out in the contract.
Rise and fall clauses also vary as to at what point in time the cost increase is to come into play. Some of them will provide for the possibility of price adjustment throughout the time of the contract and others will only allow for it from a certain point in time after the contract has been signed or the tender was delivered.
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Difficulties with rise and fall clauses
Rise and fall clauses went out of fashion for a number of reasons. No doubt the principal reason was the fact that inflation came under control in the early 90s. However, we did experience an increase in interest in these clauses amongst electrical contractors in the mid-2000s when copper prices were going through the roof.
Another reason that they went out of fashion is that they are not without legal difficulties. The clauses can become quite complicated. Complications in a legal document can result in long and costly legal disputes before a court to work out what the clause means.
The other risk is that, if the clause is not carefully drafted, it could be held by a court to be void for uncertainty. That is, the court concludes that it cannot make any sense out of the clause. This is rare if the clause is properly drafted given that the law requires courts to take every effort to give a contract meaning.
However, the effect of a court finding that a rise and fall clause is void for uncertainty could be that either the contractor relying on the clause is restricted to the lump sum or in some more “fortunate” cases, that the contractor is entitled to a quantum meruit, that is a reasonable sum for the work performed.
Recommended rise and fall clause
In today’s climate we anticipate that contractors will be wanting to use rise and fall clauses in relation to materials and if the trade unions are successful in gaining further increases in hourly
rates for workers, likely labour costs as well. Many commentators have acknowledged that it is difficult to draft a clause which operates both fairly and precisely but is not open to abuse
because of difficulties in identifying the cost of materials at the time the contract is entered into or any predictability as to future labour costs.
In our view, the method most used in the past is the best one to use in these situations. That is to draft a contract which includes a list of the materials which are subject to the rise and fall clause
and to state in the contract the price of those materials as at the date of the contract or the date of tender, whichever is considered to be relevant.
The same applies to labour costs where the usual approach would be refer to increase of rates under the relevant EBA or similar. The contractor then claims a price increase to cover the difference between those prices/costs and the price/costs actually paid for the items or labour.
Restrictions on use of rise and fall clauses
It should be noted that there are restrictions on the use of rise and fall clauses in the context of domestic or residential building work. In general terms “domestic work” means carrying out work
for homeowners in relation to their residence as distinct for example, to carrying out work on a dwelling owned by a landlord or doing work for a builder who is building homes.
We set out below whether you can use rise and fall clauses in the various States when you are performing domestic work:
WA: Rise and fall clauses are illegal for contracts valued at less than a set amount, currently $500,000.
SA: Yes, if a domestic building work contract stipulates that the work is to be completed within a specified period, it is lawful to include a rise-and-fall clause in the contract.
VIC: Only for works over $500,000 and if the contract contains a fair and reasonable estimate of the amount of money the builder is likely to receive.
In an era of rapidly rising materials prices and what some predict will be substantial increases in labour costs, a rise and fall clause could save many a contractor. However, it is important to have the clause carefully and properly drafted by a lawyer experienced in construction law, as otherwise it might not be valid and be unenforceable.
If you have any questions about this article, please get in touch with any member of our Building & Construction Team.
This information and contents of this publication, current as at the date of publication, is general in nature to offer assistance to Cornwalls’ clients, prospective clients and stakeholders and is for reference purposes only. It does not constitute legal or financial advice. If you are concerned about any topic covered, we recommend that you seek your own specific legal and financial advice before taking any action.