Relief in sight for contractors on public sector projects?

In May 2022, the Office of Government Procurement (OGP) introduced a new Inflation/Supply Chain Delay Co-operation Framework to provide some relief to contractors experiencing increasing pressure due to sustained high levels of inflation and delays due to a shortage of raw materials, writes Angelyn Rowan, partner at Philip Lee.

The Framework, which must be voluntarily agreed to by both the contractor and the employer, acts as a side agreement to the standard unamended form of contract for public works under the Capital Works Management Framework and can see relief being granted to the contractor involving the employer contributing up to 70 per cent of the increased cost of materials, fuel, and energy, and allowing the contractor to avoid the application of liquidated damages through an ‘ex gratia extension of time’. The level of relief that a contractor can avail of depends on the version of the public works contract that was used for the project and the date of the contract.

The January 2022 contract

Throughout 2021, the construction industry saw steady inflation in the price of raw materials as mandatory lockdowns around the world due to the Covid-19 pandemic shut down manufacturing plants and factories, reducing the supply of materials such as steel and timber. When Government restrictions were eventually lifted, a backlog of projects that had been delayed due to the pandemic resulted in a rush of demand for construction materials that couldn’t be met by supply. The effects of Brexit compounded these problems as contractors were faced with price increases, shipping delays, and additional red tape. While contractors can generally expect price increases of between 3 per cent and 5 per cent over a 12-month period (and this is usually priced into their tenders), the rate of inflation for the construction industry was reportedly over 13 per cent in 2021.

To combat this, in January 2022 the OGP introduced a new version of the public works contract with updated price-variation clauses that provide for a far greater contribution from the employer where the contractor experiences hyper-inflation during the fixed-price period. Contractors using the January 2022 contract are entitled to recoup any additional costs for materials, fuel, or energy inflation during the fixed-price period over 15 per cent (previously 50 per cent).

In addition, the fixed-price period was reduced from 30 months to 24 months, after which a contractor can reclaim additional costs for inflation over 10 per cent.

The main issue with this measure was that it did not apply retrospectively; it had no effect on contracts entered into prior to January 2022. Thus, this was of no benefit to projects that were already underway. The January 2022 contract only applied when the contractor’s tender for a project was submitted on or after 18 January 2022.

Director General of the Construction Industry Federation (CIF), Tom Parlon, aired these concerns in March 2022, commenting: “There is a necessity for a fair, simple price inflation mechanism to balance the risk for both the State and the contractor.”

The war in Ukraine

Soon after the introduction of the January 2022 contract, it became apparent that the materials shortage and resulting inflation would be aggravated by Russia’s invasion of Ukraine on 24 February 2022. Ukraine is one of Europe’s top producers of uranium, titanium, manganese, iron and mercury ores and Russia, which is now the subject of strict importation/exportation sanctions, controls around 10 per cent of global copper reserves and is a major producer of nickel and platinum.

Certain materials were more affected than others with rough timber costing 64 per cent more in March 2022 than it did 12 months previously, plaster costing 33 per cent more, and steel and reinforcing metal costing 27 per cent more, according to RTÉ.

For the many contractors operating under older versions of the public works contract, the onerous obligations of the fixed-price model were proving unsustainable. In March 2022, one of Ireland’s largest contractors, Roadbridge Limited, entered receivership.

In a survey conducted by the CIF in April 2022, it was found that nine out of 10 construction companies were unwilling to take on fixed price contracts. With 91 per cent also expecting a further increase in the cost of materials, it was clear that government intervention was needed.

The Framework

On 20 May 2022, the OGP published the Framework, along with a guidance note explaining how the Framework operates. The Framework envisions the contractor and employer discussing the actual impact of inflation and agreeing a percentage contribution (up to a maximum of 70 per cent) that the employer will make towards inflation costs on an ex gratia basis. For contracts dated on or after 7 January 2022 this will be confined to the recovery of energy/fuel price inflation only.

The Framework also allows for the liquidated damages for delay being applied, if the contractor can show that supply chain delays caused by the war in Ukraine or Covid-19 have actually delayed the completion of the project. No ex gratia extension of time will be granted, however, if the delay was the contractor’s fault or could have been reasonably overcome or avoided.

To recognise the fact that these issues have been affecting the industry for a prolonged period of time, relief granted under the Framework to address inflation costs or delays experienced can be assessed from 1 January 2022 onwards.

Commenting on the publication of The Framework, Minister for Public Expenditure and Reform, Michael McGrath said: “We have developed a comprehensive and agile response to the risk posed by exceptional levels of inflation and supply disruptions that create a challenging and uncertain environment for project delivery… It will facilitate engagement and a speedy determination of the impacts of exceptional inflation and supply chain disruption.”

The Framework was welcomed as a “positive step” by the CIF, but it said that it does not go far enough. Given the extended period of disruption, Tom Parlon expressed his disappointment that the measures only apply from 1 January 2022 onward.

He also called for “more collaborative contracts, which manage risk in a more balanced and sustainable way”.

It is not clear at this juncture what level of uptake the Framework will receive. Any ex gratia payments made under the Framework must be made out of the contracting authority’s own budget – there is no additional Exchequer funding being made available. As contracting authorities must freely sign up to the Framework, some may have already allocated budgets for the year and be unwilling to revise these allocations.

The OGP have taken steps to allow contracting authorities to share the burden of the volatile state of the current market. To what extent contracting authorities will avail of that opportunity remains to be seen.

Detailed guidance, template workbooks, video tutorials and a worked example are available at constructionprocurement.gov.ie

The author wishes to acknowledge the contribution of Cilian Macnamara to the preparation of this article

Angelyn Rowan
E: arowan@philiplee.ie
T: +353 1 237 3700
W: www.philiplee.ie