Managing building costs in a time of uncertainty within the Commonwealth Procurement Rules

07 June 2022

The collapse of a fourth major building company, coupled with Australia’s largest home builder denying rumours of imminent bankruptcy1, highlights the undeniable strain the construction sector is experiencing and should be taken into consideration by anyone entering into negotiations with building contractors.2

Jon Davies, chief executive officer of the Australian Constructors Association was quoted in the Guardian on 25 February 2022 as saying, ‘ongoing absenteeism because of Covid and rising costs of labour and materials means more construction firms may soon follow Pro-build into administration’. The collapses have been attributed to the ballooning costs and delays caused by COVID-19, but also the inability of construction companies to absorb increased costs within their notoriously thin margins.

The public sector, as a substantial purchaser of building services, must be conscious of the pressure building companies are experiencing when approaching the market and negotiating contracts for building works, to safeguard against cost blowouts and project delays caused by the collapse of construction companies or their subcontractors.

In response to changing market conditions, we expect contractors will increasingly favour cost-plus models that allow for price changes in supplies to manage their price risk. Failing this, contractors forced into fixed price contracts will seek to manage price risk through the inclusion of higher contingencies to protect against cost escalation, potentially undermining attempts by the Commonwealth to achieve value for money.

One approach to manage the risk of unforeseen cost increases is by expanding the application of the provisional sum clauses to allow for select elements of the building works to be priced at the relevant stage of the build.

To reiterate, provisional sums allowances are an amount of money allocated in the initial contract sum to cover goods or services that cannot be accurately priced at the tender stage. Provisional sums facilitate a more flexible approach to managing the overall project cost by allowing price flexibility for certain supplies to meet unpredicted price fluctuations.

The inclusion of provisional sums could be viewed as decreasing the overall cost certainty for the works and negatively impacting the drive to achieve value for money under division 1 clause 4 of the Commonwealth Procurement Rules.

However, that view mistakenly assumes that provisional sums provide the contractor with discretion in relation to the costs of the provisional sum items. In an approach to market, tenderers are required to provide an estimate for the provisional sum item in their tender response, and this estimate can consequently be evaluated as part of the overall tender response. So a tenderer ‘low-balling’ a provisional sum item may be adversely evaluated when compared to other tenderers who provide more reasonable estimates.

Moreover, it could be argued that provisional sums provide a more robust and transparent method to determine the cost of provisional sum items when compared to a lump sum with a built-in contingency. This is because provisional sum allowances are ‘firmed up’ during the performance of the works by the contractor having to demonstrate the actual cost of the item in an open book manner, meaning the purchaser is essentially paying for a cost plus item.

In March this year the Department of Infrastructure, Transport, Regional Development and Communications released its report titled “The Government Procurement: A sovereign security imperative”, which put forward 8 recommendations relating to improving procurement practices. Recommendation 2 called for a more ‘sophisticated assessment of value for money’ in order to secure ‘good project outcomes’.Expanding the application of provisional sum clauses adopts this recommendation in that purchasers are encouraged to adopt more effective approach to contract pricing in order to secure good project outcomes.

We suggest that the proper use of provisional sum allowances increases value for money in that it prevents the purchaser overpaying for works quoted for by contractors (with a contingency) seeking to avoid the perilous consequences of unforeseen price increases in an uncertain market.

On this basis, when properly used the expansion of provisional sum allowances in building contracts will not prevent the purchaser securing value for money, nor significantly affect the cost certainty the purchaser is operating under. Given the turbulence the building sector is experiencing and the rumoured collapse of more building companies in the months ahead this is, in our view, a sensible, risk adverse approach to adopt.

Takeaway points

While lump sum building works contracts provide the most obvious mechanism to obtain price certainty for a procuring officer, with increased volatility in the supply of goods, services or materials, contractors will seek to mitigate their risk by including additional contingency within their pricing.

During a period of market uncertainty, provisional sums can improve value for money by avoiding the risk of paying an overestimate the contractor may quote to cover any unforeseen price fluctuations, and instead the purchaser is simply paying the actual costs of that provisional sim item when the item is acquired.

This article was written by Fabio Fior, Partner and Philippa Arnott, Solicitor.

12022.”Metricon at Centre of a Perfect Storm” Finical Review. May 19
2Greg Jericho, “Not in good shape: more construction industry collapses could follow Probuild,”The Guardian, February 25, 2022
3Commonwealth of Australia, Government Procurement; a sovereign security imperative, (The House of Representatives Standing Committee on Infrastructure Transport and Cities, March 2022), pg 69.

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