Supply Chain
Supply chain issues
"Due to supply chain issues some products may be temporarily out of stock."
DOES this look familiar? Whilst shortages in chicken and milkshakes grab the headlines, the construction sector is experiencing widespread issues in its supply chain.
Why is this happening now?
The global pandemic has created an inconsistent demand on manufacturing chains as well as impacting on productivity. In turn this has resulted in a slump and spike pattern of demand. Along with a shortage in global shipping capacity, Brexit, carbon targets and the change of CE marking to UKCA [UK Conformity Assessed] there is an unprecedented mismatch between supply and demand.
What is the impact?
Certain products are less available than usual. There is an increase in the cost of materials flowing through from the increased cost on the manufacturer. Generally, there is volatility in pricing and delivery times.
What is the consequence?
The most obvious effect is that it slows down works on currently active sites. It also increases costs on those active works, either passing to the client or the contractor bearing the costs increase with a decrease in margin. For works that are not yet on site some clients are choosing not to proceed with these at the moment. Indeed last month the Scottish government advised: “Where contracting authorities consider it may not be economically viable to commence [ ], they may wish to reassess which [projects] proceed to market and which do not.”
Other than an apology for the inconvenience, what can you do?
Even if supply chain risk is clearly allocated to one party it very quickly becomes a risk for delivery of the project. Keeping the supply chain solvent and keeping goods coming to site are essential and cashflow continues to play a key role in construction.
Is it as simple as ordering ahead?
Booking advance manufacturing slots and stockpiling goods provides some practical advantage. If you are ordering goods ahead and paying for them before delivery to site, you need to be aware of a few key points (aside from specification and quality assurance). What are you getting for your money? If never delivered how do you get your money back? If the supplier becomes insolvent and local insolvency law applies, what rights do you have? Who is responsible for shipping? When will you own and insure the goods? If not delivered by the agreed time, can you get your money back and go elsewhere?
There are many different contractual options for contracting with the supply chain and applying these challenges is important to have a clear understanding of your risk. Some contracting comfort may be provided by vesting agreements, off-site materials agreements or advance payment bonds.
We are on site and experiencing these issues. What is the impact on our contract?
Under the New Engineering Contract 4th edition Engineering and Construction Contract, a supply chain issue which might increase the prices or delay completion should be notified as an early warning under clause 15. The parties then attend an early warning meeting where they decide who is taking which action so the risk can be avoided or reduced. If a decision needs a change to the scope, for example use a different product, this would trigger a compensation event under clause 60.
Even if supply chain risk is clearly allocated to one party it very quickly becomes a risk for delivery of the project.
There are also options at clause 19 prevention and clause 17 requirement for instructions and each of these has a high and specific threshold to be met before they trigger a compensation event. For example, a clause 19 prevention event must stop the works being completed by the date of planned completion and neither party could have prevented it and an experienced contractor would have judged it so unlikely that it would have been unreasonable to allow for it. These are high hurdles. In each of these cases the consequence compensation event is assessed under clause 63 and it will be for the project manager to assess the impact of the change on the defined costs.
Under the Joint Contracts Tribunal (JCT) Design and Build 2016 there is an ability to substitute materials at clause 2.2.1 and this must be done with the employer’s consent. There are few options in the standard JCT wording to give the contractor relief for supply chain issues unless the contractor was able to link these to change in law (cl 2.26.13) or possibly force majeure (cl 2.26.14). However, schedule 7 provides for fluctuations.
What are fluctuations?
Fluctuations are generally known as that wording at the back of the standard form that no one has read in the last 15 years, so much so that JCT includes only option A in its hard copy contracts with options B and C being accessible on its website. Fluctuation provisions allow adjustment of the contract sum where there are changes to pre-agreed costs during the construction works. Option A allows for adjustment of the contract sum in relation to changes in contributions, levies and tax that a contractor has to pay in respect of labour and materials. Option A applies unless expressly deselected in the contract particulars. It provides little comfort for the general supply chain pricing shifts.
Option B allows the adjustment of the contract sum for changes in labour and materials cost, and tax fluctuations including (B3.1) in respect of increases or decreases to the market prices which were current at the base date of the materials, goods, electricity, fuels or any other solid, liquid or gas necessary for the execution of the works.
Option C allows for adjustment in accordance with formula rules specific to the category of work being carried out. This is a rarely selected option and without the right experience it can be tricky to apply.
Summary
Going forward it is likely that some concepts from these fluctuation options will become more common. For example option C includes a specific provision for change in tax payable for materials being imported into the UK which would allow contractors to pass increased import duty to the employer as a project cost. Where option B extends to all materials and goods it may be more palatable for a limited version of that to apply to a specified list of items. For the moment where supply chain issues have become project risks, the project parties should be aware of their legal position but also of the need to mitigate the risks and what is achievable in the circumstances.
Christine Worthington, Partner in Construction and Energy, CMS Cameron McKenna Nabarro Olswang
christine.worthington@cms-cmno.com www.cms.law @cms_law