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There has been a noticeable uptick in Victorian domestic builders seeking to have owners under domestic building contracts agree to “price escalation” percentage increases while works are underway.

It is understandable that builders would seek this, given the unusually challenging industry paradigm in this post pandemic world.  This involves barriers to meeting budgets in the form of local and worldwide shortages and delays on building material supply, shortages of labour both with manufacturing and with subcontractor availability, and resultant price hikes and delays.

This has resulted in lead times for supply of timber, steel, tiles, and a wide range of building products blowing out exponentially from lead times encountered prior to COVID.  When you combine this with artificially stimulated demand from industry boosters such as the Home Builder Grant, the industry is met with “boom without profit” conditions.

As a consequence, there is a substantial increases in time and cost in many projects, which pose significant challenges for builders and owners alike in existing domestic building contracts. This was not foreseen when project cost and time was originally agreed to.

However, unless the parties executed a Cost-Plus Contract (which is rare, and only allowed in certain circumstances), the builder will be faced with the contract price they originally agreed to when the Fixed Price Contract was signed, save for narrow exceptions such as:

• Agreed Variations to the works where the parties have signed the requisite Variation notices; or
• Adjustments associated with Prime Cost or Provisional Sum estimates being exceeded.

In circumstances like this, the strict consumer focussed requirements of Fixed Price (or Lump Sum) contracts that are specified in the Domestic Building Contracts Act 1995 (“the DBCA”) will not work for builders and may also leave owners in a quandary.

So how are builders striving to avoid these industry problems?  More commonly, some builders feel they have no option but to ask their owner clients to agree to a percentage price increase, across the board, to be added to their existing contract price. 

These price escalations are generally referred to as “variations”, and might be phrased, for instance, as a written request that an owner agree to a 7% increase to the overall contract price.

In truth though, to refer to these cost escalation agreements as variations may be a misnomer.  There are strict rules governing variations, including the need for the builder to estimate additional cost and time in a written notice, and to obtain the owner’s signed consent to that change.  More than that though, a variation should involve a change in the nature of the actual building works, as to the description of those works or a part of them, extra works to be added or some change to part of the intended building work.

In other words, a legitimate variation will result in a specific change to the contract price and not a percentage hike and must relate to tangible “bricks and mortar” works. It is not merely a general price increase on materials or labour since the contract was signed that is not referrable to any specific part of the project.

As well, such “variations” if claimed by a builder could be in breach of section 15 of the DBCA.  That section of the governing law prohibits “cost escalation clauses” in domestic building contracts except in only limited, defined circumstances. 

This is an important prohibition in the Act that has penalty provisions attached, so it would not be permissible for a builder to attempt to circumvent this prohibition by artificial means.

Any contract provisions that contradict the consumer protections in the DBCA would be regarded as null and void if the matter was to be decided in a court or tribunal, because it is not possible for the parties to “contract out” of the provisions in the DBCA.

To an extent then, the consumer protection sections in the DBCA (like section 15) exist to “save owners from themselves” if they are tempted to agree on onerous provisions in contracts or attempted side agreements sought by builders.

Section 15 of the DBCA reads:

(1) In this section a cost escalation clause means a provision in a contract under which the contract price may be increased to reflect increased costs of labour and materials or increased costs caused by delays in carrying out the work to be carried out under the contract, but does not include a provision that enables the contract price to increase to reflect –

(a) unforeseeable cost increases resulting from changes to government taxes or charges; or(b) prime cost items or provisional sums.

(2) A builder must not enter into a domestic building contract that contains a cost escalation clause unless –(a) the contract price is more than $500,000 (or any higher amount fixed by the regulations); or(b) the clause is in a form approved by the Director and complies with any relevant requirements set out in the regulations.

Penalty: 100 penalty units.

(3) A cost escalation clause in a domestic building contract is void unless-(a) before the contract was entered into, the builder gave the building owner a notice in a form approved by the Director explaining the effect of the clause; and(b) the building owner places her, his or its signature or seal or initials next to the clause.

Restrictions concerning cost escalation clauses

Of course, if a builder approaches an owner mid-contract and requests their agreement to a price escalation, in theory that could be acceptable if the owner agrees to this.  After all, the problem for owners is that they won’t be able to find another builder to complete the works for less than a significant “mark-up” or margin for risk, if their current builder does not have the means to continue.  This is the quandary for owners that I mentioned earlier. 

Any agreement at the time to the cost escalation “variation” may be illusory though.  If the parties were to subsequently fall into dispute for any reason, it may be the owner will then challenge the price escalation.  It is then that the builder could find that their attempted price escalation will be open to challenge and will not be supportable under the DBCA.

If one looks at section 15(1) of the Act, this sets out the reasons why a builder may want to suggest a cost escalation clause when the contract is first entered into.  This makes perfect sense, and it is for if and when this is necessary to “reflect increased costs of labour or materials or increased costs caused by delays in carrying out the work”.

Pursuant to subsection (2), the cost escalation clause can only be used in new contracts where the contract price is more than $500,000 or any higher amount fixed by the regulations and if the clause is in a form approved by the Director of Consumer Affairs.

As well, according to subsection (3), the cost escalation clause will be void unless before the contract was entered into, the builder gave the owner a prescribed notice in a form approved by the Director of Consumer Affairs explaining the effect of the cost escalation clause (and the owner has signed their agreement to the clause).

In July 2021 there was a review into Victorian supply chain barriers conducted by “Better Regulation Victoria”.  It was noted that the limit on the use of cost escalation clauses in domestic building contracts provided no flexibility and was outdated given the emerging supply chain barriers in the industry.

In April 2022 the State Government responded to BRV to argue that cost escalation clauses are already contemplated in s15 of the DBCA for contracts valued over $500,000, but only in certain circumstances (as described above and in the relevant section).

Clarification has been sought by industry groups from Consumer Affairs Victoria (CAV) because a cost escalation clause in a contract must be accompanied by a prescribed notice under section 15(3), and it is understood that this notice has not yet been drafted and approved.

It is to be hoped that soon there will be a government approved prescribed form, available from CAV, that can be used with new domestic building contracts that contain a cost escalation clause.  Until that prescribed notice has been issued for use, the advice from CAV has been that a cost escalation clause would not be enforceable.

This is a Lovegrove and Cotton publication, authored by Justin Cotton.

Disclaimer

This article is not legal advice and discusses it’s topic in only general terms. Should you be in need of legal advice, please contact a construction law firm. The experienced team at Lovegrove & Cotton can help property owners and building practitioners resolve any type of building dispute.