Is your cost escalation clause enforceable?

Summary

The District Court of Queensland recently found a cost escalation clause in a domestic building contract to be void for uncertainty, in addition to being void for:

1. non-compliance with the statutory requirement which requires there be a warning and explanation of any cost escalation clause on the first page of the contract¹; and
2. being an unfair contract term under the Australian Consumer Law.

What happened?

In August 2022, Mr and Mrs Perera (Owners) entered into a standard form New Home Contract with Bold Properties (QLD) Pty Ltd (Bold) the construction of a new house for the lump sum of $645,370.

The contract relevantly included the following special conditions :

7. In the event that commencement has not taken place by the anticipated start date (as noted in item 14) the builder reserves the right, at the builder’s sole discretion, to increase the contract price to the current base price of the house type, which is the subject of this contract and identified in the Contract Tender, to the builder’s current base price for that house type.

11. The paragraph under the “Warning” in Item 2 of Schedule 1 is amended to read “The contract price is subject to change. The clauses that allow for changes to the contract price are clauses 9, 10, 11, 13, 15, 16, 19, 20, 21, 23, the Special Conditions and the Tender Conditions attached to this contract.

Relevant to Special Condition 7, the anticipated start dated under the Contract was stated to be 120 days from contract signing.

In October 2022, Bold informed the Owners that as a result of significant cost increases in the building industry, the price was to increase by $51,324.

In November 2022, Bold informed the Owners that it anticipated commencing site preparations in January 2023. As this was after the ‘anticipated start date’ under the contract, the trigger in Special Condition 7 was met for Bold to, in its discretion, increase the contract price to its ‘current base price’.

The Owners did not agree to the price increase and following an exchange of correspondence, Bold offered to terminate the contract by agreement. The Owners did not agree, affirmed the contract and commenced proceedings in the District Court of Queensland seeking a declaration that Special Condition 7 was void.

What did the Court decide?

Justice Barlow KCJ agreed with the Owners and found that Special Condition 7 was void because it:

1. was uncertain. In allowing Bold to increase the contract price, to an amount selected by Bold and without reference to any criteria for how such an increase would be calculated, Special Condition 7 was uncertain and therefore unenforceable;
2. did not comply with the requirement in the QBCC Act that requires a level 2 domestic building contract to include a warning that the price could be changed by the operation of Special Condition 7, with a ‘brief explanation of the effect of the provision allowing the change to the contract price’. The warning, amended by Special Condition 11, did not specifically refer to Special Condition 7, instead referring to all the Special Conditions, and also failed to explain the effect of Special Condition 7; and
3. was an unfair contract term pursuant to the Australian Consumer Law. The lack of transparency in how the higher price was calculated resulted in a significant imbalance in the parties’ rights in so far as it provided Bold with an unconstrained right to adjust the contract price and this right would cause detriment to the Owners if Bold were to rely upon it.

Why is this important?

This case demonstrates the importance of drafting cost escalation clauses to provide certainty, applying clear and certain criteria.  The provision cannot be based on a party’s arbitrary assessment of price changes, particularly where it may have contributed to the delay triggering the price change.

This decision also draws attention to a potential weakness in the mandatory warnings contained in a number of industry standard domestic contracts in Queensland. Even in circumstances where the ‘warning’ had effectively been amended by Special Condition 11, His Honour concluded that the special condition did not provide the level of detail required by the QBCC Act. In light of this, warning statements should be prescriptive until this issue is clarified by the courts or legislation.

Lastly, legislation relating to unfair contract terms needs to be borne in mind in preparing standard form contracts, particularly with consumers and small businesses.  The expansion of that legislation in November 2023 reinforces the need to review standard form contracts.

This article was written by Colin Harris, Partner and Kelly Brook, Associate.

¹ section 14 of Schedule 1B, Queensland Building and Construction Commission Act 1991 (Qld) (QBCC Act).