Soaring construction materials – how do they impact already agreed fees?

Who picks up the tab – the client or the contractor – and to what extent? The answers lie in the type of contractual agreement. In the contract, the contractor and the client are free to agree on how fluctuations in market prices will affect the price of works in the contract, which price changes or market rates will be taken into account and how. 

If the client and the contractor have not agreed on a price change mechanism, the provisions of the Code of Obligations (hereinafter: “OZ”) or Special Construction Customs (hereinafter: “PGU”) shall apply, depending on the nature of the contracting entities. In accordance with Article 12 of the OZ, business customs, customs and practices established between the parties are taken into account in order to assess the necessary actions and their effects between business entities. The provisions of the PGU shall apply to a construction contract where the client and the contractor are business entities, unless the parties have expressly excluded their use. However, in the case of relations between parties who are not business entities (where one of the parties is a private individual who is not considered to be a business entity), PGU applies only if the parties have expressly agreed on its use. The provisions of both the OZ and the PGU provide for the option of requesting a change in the agreed fee to both parties in certain cases. Both arrangements are outlined below. 

When the parties have not agreed on a price change mechanism and the provisions of the PGU do not apply, the contractor may request a fee increase pursuant to the first paragraph of Article 655 of the OZ. The condition for this is that in the period from the conclusion of the agreement to its fulfillment, the prices of the elements on the basis of which the fee was fixed (which in practice will usually be evident from either the offer or the bill of quantities or sometimes from the type of fee agreement) have increased so that the fee should be increased by more than two percent. An additional condition for the contractor making such a request is that the contractor has fulfilled its obligation within the contractual time limit. However, if the contractor failed to carry out the work within the contractual time limit due to its own fault, it may request the fee increase only if the new prices for the elements should be increased by more than five percent – a less favorable distribution (from the contractor’s point of view) of the burden of the price increases shall penalize the contractor for delays in carrying out the works. In both cases, the contractor can only request a difference in the fee that exceeds two or (in the event of a delay) five percent. The risk of increasing the fee by up to two or up to five percent must be borne by the contractor, unless the parties have agreed otherwise. 

The client and the contractor can also agree on a fixed payment, which means that any increase in the price of materials after the agreement date does not affect the agreed fee. However, the first paragraph of Article 656 of the OZ allows the contractor to request a change of the agreed fee, despite such a contractual provision, if the prices for materials have increased so much that the fee needs to be increased by more than ten percent. This provision is mandatory, which means that it cannot be excluded from the agreement. Here again the same applies as above, namely that the contractor will only be able to request a difference in the fee that exceeds ten percent. 

From the aforementioned we can conclude the following: (i) unless otherwise agreed, then an increase in the fee payable to the contractor (due to the rising price of materials) by two or five percent of the overall fee due to the contractor is borne by the contractor, but a bigger increase is borne by the client; (ii) if the parties have agreed on a fixed price, then the client shall bear only an increase in the fee due to the contractor exceeding ten percent of the fee. 

However, in all the above-mentioned cases the contractor will not be able to rely on the materials cost increase for the elements on the basis of which the payment was fixed if the prices increased only after he was already late in completing the works. In that event, the contractor will bear the full increase in the cost of materials. 

How can a contractor request a fee change? The contractor may do so by a unilateral declaration of intent, namely by requesting a fee increase or requesting payment of the difference owing to the increase in the cost of materials, which it addresses to the client. Fee changes do not require the client’s consent, so there is no need to conclude a special addendum to the agreement. 

What options are open to the client where prices of building materials increase? The client can, in accordance with the first paragraph of Article 657, withdraw from the contract, if the agreed overall fee payable to the contractor substantially increases. The OZ does not define what the term substantially means, but in theory the view has been formed that the rules on the termination of contract due to altered circumstances apply. The client is entitled to withdraw if the fee increases to a such extent that it makes it difficult for it to fulfill its obligations, or if the agreement is no longer fit for purpose, to such an extent that it no longer meets the client’s expectations and it would be unfair to force the client to uphold it. Case-law is yet to provide an answer to the question of when exactly the agreed fee will be considered to have increased substantially and will be assessed on a case-by-case basis. However, given the sharp rise in prices we are currently witnessing in the building materials market, it can be concluded that the condition of a substantial increase in the agreed fee could be met in many instances. In this case, the client is, as already mentioned, entitled to withdraw from the agreement, but must pay the contractor the appropriate part of the agreed fee for the work performed so far and a fair reimbursement for necessary costs. 

What do the Special Construction Customs say regarding the payment change due to the increase in the prices of construction materials? Article 24 of the PGU (2020) stipulates that in the case of a price increase in the elements on the basis of which the fee was fixed (so-called calculation elements), the contractor may request an increase in the price of the item from the list of works or the jointly agreed fee: (i) if the price of one or more calculation elements increases to the extent that the price of the item in the description of the works increases by more than 2%, or (ii) if the overall fee is increased by more than 2% by a joint change of the calculation elements. Like OZ, PGU also stipulates that the contractor cannot request price changes due to altered circumstances that have arisen after the deadline for the fulfillment of obligations, unless the other contracting party is to blame for the delay. PGU further stipulates in Article 27 regarding the fixed price agreement, that even in the case of a fixed price, a change in the contract price may be required if it increases or decreases by more than 10% due to altered circumstances or a change in the consumer price index. In this case, only a price difference exceeding 10% may be requested. 

Article 28 of the PGU also regulates the issue of the impact of a (partial) fee advance. If the parties of the agreement have agreed on an advance to the contractor for the purchase of materials, the contractor may not request a fee change due to changes in the price of materials if it could have excluded the impact of the price changes on the agreed fee using the advance. We recommend that contractual parties agree on how changes in the price of individual elements will affect the fee when concluding the construction contract. Even where the contract makes no provision for price change risks, both the OZ and the PGU provide mechanism for adjusting the agreed fee. 

Author: Klavdija Kek, Senior Associate