THE RENAISSANCE OF RISE AND FALL CLAUSES

By Kiri Parr

Seminars, articles, and LinkedIn posts have become saturated with discussions of rise and fall clauses – the contractual mechanism to adjust a contract price when the costs of labour and materials fluctuate. This clause is by no means new, and we are experiencing its latest renaissance.

However, can an examination of this clause’s past tell us anything new?

Set out in this article is the simple and uncontroversial story of the history of rise and fall clauses in Australia. Like clockwork, they emerge in response to periods of high inflation and price uncertainty, often driven by war. As inflation falls and the market stabilises, rise and fall clauses fade into disuse.

But in researching this history, a second story emerged. History reveals our industry’s repeated struggle with the transition from low to high inflation periods and back again. This story, what it means, and what we can do about it is discussed below.

The takeaway message - plan for the transition phase.

The History

The first reference to rise and fall clauses can be found unsurprisingly after the First World War and the subsequent housing boom. This boom was driven by the introduction of the War Homes Act, designed to assist returning servicemen build affordable homes. The instability of prices and the emergence of the clause is reported in the Cessnock Eagle and

South Maitland paper, which records: The uncertainty as to the future price makes it almost impossible to quote in any industry, but more especially in the iron and steel trade, without a sliding clause authorising the sellers to increase their prices if the cost of coal (or other raw materials) are increased on them.

And that:

An acute stage has been reached in the shortage of artisans in the building and construction trade, and this position is felt at Cessnock, as well as in the cities. Men in Sydney, it is stated, who have spent years in acquiring their craftsmanship, walk out of the building trade, and take jobs on the wharf or in other occupations where bodily strength is their main asset because the wages are better. On account of the future uncertainty of the markets and labour shortages and conditions, builders and contractors are not disposed to tender for work without certain conditions in the contract. These conditions include a rise or fall.¹

The Second World War saw this pattern repeat with another significant housing boom emerging after its end. Evidenced in a report by Hobart's Mercury Newspaper from the 13th of February 1947, the Tasmanian State Government opted to include rise and fall clauses as a means of encouraging tendering, its justification being that, "it is impossible to secure tenders for large works as contractors found it difficult to assess their future costs with the obscurity of the labour market".²

It would be remiss to leave our history lesson here and suggest that only the exceptional conflicts of the first half of the twentieth century could drive such change. A similar result emerged from the 1970s oil crisis. Western oil production had peaked the decade prior, most notably in the United States in 1960, and there was a general decline in global per capita oil production. This left the Western world more reliant on oil from the Middle East and susceptible to disruptions to that supply, including the OAPEC embargo relating to the Yom Kippur War and changes in oil exports after the Iranian Revolution. These events led to massive petroleum shortages and rapid oil price inflation. This contributed to a decade of stagnant economic growth and price inflation. This unsurprisingly drove the re-emergence of rise and fall clauses, with The Canberra Times reporting on 3 May 1974 that "many Canberra builders are inserting rise and full clauses in contracts for building private houses, the move undertaken because of what the builders consider to be increasing uncertainty about future rises in the price of materials and wages".³

These examples clearly illustrate that instability in the prevailing state of the labour and materials markets leads to the construction industry demanding that rise and fall clauses are included in contracts.

WHAT HAPPENS AFTERWARDS?

But this does not paint the full picture.

What happens when stability returns?

There is an enlightening example from 1954. Now a decade after the disruptions caused by the Second World War, lump sum contracts were again returning as the primary means of contracting. A credit restriction policy, introduced by the commonwealth government as a means of lowering housing demand, occurred in tandem with a recession that had begun in June 1952.⁴ State and local governments began to act. The Western Australia State Housing Commission dropped the clause in late 1952⁵, closely followed by the Hobart City Council, which removed such clauses from its contracts in March of the following year.⁶

Simultaneously, the construction industry was locked in debate about the future of the clause.

In one corner was the Royal Australian Institute of Architects (RAIA), championing the owner’s position, the removal of rise and fall contracts. Opposite them was the Master Builders Federation of Australia (MBFA), defending the clause and the benefits it provided.

The RAIA’s arguments were well summarised by then president of the NSW chapter, Mr Moline, who stated, "Nothing did more harm to the building industry than contracts under which a client did not know the extent of his commitment".⁷ The position of the MBFA was well articulated by their resolution on the subject, from the 1954 MBFA Convention in Hobart, that "tenders for new works should be submitted only with the proviso that a rise and fall clause be included in the building contract".⁸ The MBFA argued that builders have two choices to cover themselves as a means of dealing with the risk of cost increases: the inclusion of a rise and fall clause; or, the loss of the tender. They questioned why the builder should be asked to gamble with their contracts, stating:

The gambler harms his client, the industry, and his fellow builders, because he destroys the stable basis of tenders and, to that extent, makes it impossible for architects to estimate the cost of a building. Every architect and building owner should aim to eliminate the gambler from the building industry.⁹

Unfortunately, the MBFA's protestations weren't sufficient, and rise and fall clauses faded amidst market stability and builders’ willingness to take on this risk again.

HISTORY’S LESSONS

If we are to accept history, whether a rise and fall clause is present in a contract depends mainly on the inflationary pressure at the time of contracting. In periods of stability, there will be no rise and fall clause; there will be in times of high instability.

This means that our contracts contain an implicit assumption that inflation will behave consistently from the time the contract is written.

The consequence of this assumption is that our contracts fail to handle inflation risk during a time when the market is transitioning from low to high inflation markets, or vice versa.

For the most part, our contracts do not plan for the transition phase and our industry consistently suffers for it.

This requires us to consider strategies that can effectively navigate these transition states.

Here are four possible strategies presented in increasing levels of effectiveness:

1. Build structures into your contract that identify and manage risks early to resolve those issues without a formal dispute. This is commonly seen in early warning notices and dispute avoidance boards, such as those found in the NEC and FIDIC suites. This does not actually remove the risk but can at least create a pathway for its identification and resolution.

2. Owners can choose to be first movers on the issue and provide relief when circumstances change. The Australian Department of Defence exemplified this through the introduction of a pandemic relief clause into its Head Works contract, HC-1 2003, in 2020. While owners legally have the benefit of a lump sum price, they are still faced, in the absence of action, with the substantial risk of claims from the contractor who must find some means of recovering loss. Or worse still, the owner faces the possibility of an incomplete project if the builder becomes insolvent.

3. Always include a rise and fall clause within the contract. The argument for this is the same as that of the MBFA conclusion in 1954 – the owner pays one way or another. It is beyond the scope of this article to discuss the drafting of these clauses, however, it is worth noting that such clauses are found in most industry standard contract suites, including NEC, GC21, and the FIDIC Yellow Book.

4. Use collaborative contracting models. These models contain more nuanced approaches to risk identification, management and mitigation, and the financial models can treat the risk in more sophisticatedly through the pain share/gain share and adjustment event mechanisms.

Conclusion

Rise and fall contracts have proven necessary at times of high inflationary risk. As inflation stabilises, these clauses slowly fade away.

What we don’t manage well is this risk when the market shifts between stability and instability and our contracts become incompatible with the prevailing market. Have you got a plan for the transition phase?

This article is based on a presentation given by Kiri Parr on 16 February 2023 for the Australian Institute of Quantity Surveyors and sponsored by Bond University.

¹ ‘Building and construction jottings’, The Cessnock Eagle and South Maitland Recorder (NSW: 1913-1954), 5 December 1919, p. 2 accessed 3 February 2023, <https://nla.gov.au/nla.newsarticle99444713>.

² ‘State contracts to allow for cost rises’, The Mercury (Hobart, Tas: 1860-1954), 13 February 1947, p. 8, accessed 3 February 2023, <http://nla.gov.au/nla.news-article26396384>.

³ ‘A.C.T. builders cost changes in contracts’, The Canberra Times (ACT: 1926-1995), 3 May 1974, p. 9, accessed 3 February 2023, <http://nla.gov.au/nla.news-article110776449>.

⁴ ‘Homes and building firm contracts are returning’, The Sydney Morning Herald, 16 December 1952, p. 7, accessed 3 February 2023, <http://nla.gov. au/nla.news-article18295140>.

⁵ ‘Rise and fall clause banned’, The Daily News, 9 January 1953, p. 8, accessed 3 February 2023, <http://nla.gov.au/nla.news-article266059045>.

⁶ ‘Fall Clauses for Council Contracts’, The Mercury, 22 April 1954, p. 17, accessed 3 February 2023, from <http://nla.gov.au/nla.newsarticle27209805>.

⁷ ‘Homes and building’, The Sydney Morning Herald, 2 November 1954, p. 10, accessed 3 February 2023, from <http://nla.gov.au/nla.newsarticle184545690>.

⁸ ‘Homes and building’, The Sydney Morning Herald, 7 December 1954, p. 11, accessed 3 February 2023, from <http://nla.gov.au/nla.newsarticle18458390>.

⁹ Ibid