The Renaissance of Rise and Fall Clauses
Kiri Parr
February 20231
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 is 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:2
The uncertainty as to the future price makes it almost impossible to quote in any industry, but more in especially in the iron and steel trade, without a sliding clause authorising the sellers to increase their prices, if cost of coal (or other raw materials) are increased on them.
And that:
1 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.
2 BUILDING AND CONSTRUCTION JOTTINGS. (1919, December 5). The Cessnock Eagle and South Maitland Recorder (NSW: 1913 - 1954), p. 2. Retrieved February 3, 2023, from http://nla.gov.au/nla.newsarticle99444713
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 man 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.
The second world war sees this pattern repeat with another significant housing boom emerging after its end. Evidenced in a report by Hobarts Mercury Newspaper from the 13 th of February 1947, it states that the Tasmanian State Government has 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 marker’. 3
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 in 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 drives the re-emergence of rise and fall clauses with the Canberra times reporting on the 3 rd of 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.’4
These examples clearly illustrate that instability in the prevailing state of the labour and materials markets, leads to the construction industry demanding rise and fall clauses are included in contracts.
What happens afterwards?
But this does not paint the full picture. What happens when stability returns?
3 STATE CONTRACTS TO ALLOW FOR COST RISES (1947, February 13). The Mercury (Hobart, Tas. : 1860 - 1954), p. 8. Retrieved February 3, 2023, from http://nla.gov.au/nla.news-article26396384
4 A.C.T. BUILDERS Cost changes in contracts (1974, May 3). The Canberra Times (ACT: 1926 - 1995), p. 9. Retrieved February 3, 2023, from http://nla.gov.au/nla.news-article110776449
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 of 1952. 5 State and local governments began to act. The Western Australia State Housing Commission dropped the clause in late 19526, closely followed by the Hobart City Council removing such clauses from its contracts in March of the following year.7
Simultaneously, the construction industry was locked in debate about the future of the clause.
In one corner is the Royal Australian Institute of Architects (RAIA), championing the owner’s position, the removal of rise and fall contracts. Opposite them is the Master Builders Federation of Australia (MBFA), defending the clause and the benefits it provides.
The RAIA’s arguments are 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.’8
The position of the MBFA is 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 full clause be included in the building contract.’ 9 The MBFA argues 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 question 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. 10
5 HOMES And BUILDING FIRM CONTRACTS ARE RETURNING (1952, December 16). The Sydney Morning Herald (NSW : 1842 - 1954), p. 7. Retrieved February 3, 2023, from http://nla.gov.au/nla.news-article18295140
6 Rise And Fall Clause Banned (1953, January 9). The Daily News (Perth, WA: 1882 - 1955), p. 8 (FINAL). Retrieved February 3, 2023, from http://nla.gov.au/nla.news-article266059045
7 Fall Clauses for Council Contracts (1954, April 22). The Mercury (Hobart, Tas. : 1860 - 1954), p. 17. Retrieved February 3, 2023, from http://nla.gov.au/nla.news-article27209805
8 HOMES And BUILDING (1954, November 2). The Sydney Morning Herald (NSW : 1842 - 1954), p. 10. Retrieved February 3, 2023, from http://nla.gov.au/nla.news-article18454690
9 HOMES And BUILDING (1954, December 7). The Sydney Morning Herald (NSW: 1842 - 1954), p. 11. Retrieved February 3, 2023, from http://nla.gov.au/nla.news-article18458390
10 Ibid
The MBFA’s protestations aren’t sufficient, and rise and fall clauses fade 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 clauses 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 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 parts, 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 is shift between stability and instability and our contracts becomes incompatible with the prevailing market.
Have you got a plan for the transition phase?