Navigating the intricacies of construction contracts demands a nuanced understanding of various provisions aimed at managing uncertainties and mitigating financial risks. Among these provisions, two key concepts often discussed are provisional sums and cost escalation clauses. While both serve essential roles in addressing unforeseen costs within construction projects, they operate distinctly and cater to different aspects of contractual arrangements. In this article, we explain what of these are and their differences.
WHAT IS A PROVISIONAL SUM?
Provisional sums in construction contracts represent estimates of the costs associated with specific work, including the supply of necessary materials, that a builder, despite reasonable inquiries, cannot determine definitively at the time the contract is to be entered into. These sums are employed in situations where the final scope of work has yet to be fully defined, allowing for the commencement of projects even when certain elements, particularly design aspects, remain unresolved. The adjustment of provisional sums, is typically based on the actual costs incurred by the contractor in executing the provisional sum work, along with applicable overheads and profit considerations. Ultimately, provisional sum items represent estimates of costs for contracted services where a definitive amount cannot be determined at the contract's outset.
WHAT IS A COST ESCALATION CLAUSE?
Cost escalation clauses are interchangeably referred to as rise and fall clauses. Cost escalation clauses are a contractual mechanism that essentially allow a builder to pass on increased costs (e.g. labour or material costs) that they may have incurred in fulfilling their contractual obligations, onto the party that they were doing the construction work for. Noting that if costs were to decrease this clause would also be used to decrease the amount of costs owed to the builder.
For further information regarding cost escalation clauses and their need in the construction industry, please read our full article here: https://rcrlaw.com.au/cost-escalation-clause-guide/
THE DIFFERENCE BETWEEN PROVISIONAL SUM AND COST ESCALATION CLAUSES
Cost escalation clauses are designed to address fluctuations in costs over time, allowing for adjustments to the contract price based on changes in factors such as material prices, labour costs, or market conditions. These clauses provide a mechanism for both parties to account for unforeseen increases or decreases in expenses, thereby mitigating financial risks associated with volatile market conditions. Cost escalation clauses are used when the scope of work remains the same but costs have been increased or decreased.
On the other hand, provisional sums are used in fixed price contracts to accommodate uncertain elements of the project as the scope of work may not necessarily be finalised. They allow for the commencement of work even when certain details remain unresolved, enabling progress while uncertainties are clarified. The adjustment of provisional sums, is typically based on the actual costs incurred by the contractor in executing the provisional sum work, along with applicable overheads and profit considerations.
By enlisting the expertise of Rostron Carlyle Rojas Lawyers to navigate the complexities of construction contracts, including the intricate provisions of provisional sums and cost escalation clauses, you can effectively mitigate financial risks and safeguard your interests. Our team is equipped to guide you through the intricacies of these contractual elements, ensuring that your agreements are meticulously drafted and implemented to address uncertainties and fluctuations within the construction industry.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.