Tackling cost escalation in international construction projects
By Freeths Construction & Engineering Partner Alex Johnson
The construction sector continues to face cost pressures driven by a volatile global landscape. From pandemic-related disruptions to geopolitical tensions and supply chain instability, the past few years have seen construction costs fluctuate more dramatically than ever before. As unpredictability persists, businesses involved in international projects must take a strategic approach to managing cost escalation.
Embedding flexibility into contracts
A proactive way to address cost increases is through well-considered contract terms. Widely used templates, such as those issued by FIDIC, offer mechanisms to account for price changes. These can be particularly useful in allocating risk between parties. However, where standard clauses are too rigid or broad, tailored provisions may be negotiated to address specific risks, such as volatility in steel or fuel prices.
One effective method is to define clear thresholds that, once crossed, trigger a review or adjustment of the contract price. This ensures that both parties understand when and how cost changes will be managed.
It’s important to note that under English law, any such clause must be clearly defined. Vague intentions to revisit pricing later, so-called “agreements to agree”, are not enforceable. A valid clause must include a specific formula or process for calculating adjustments.
Regional practices also vary. In some jurisdictions, particularly where contracts are awarded on a non-negotiable basis, contractors may have limited scope to include such protections.
Practical risk management
When contractual solutions aren’t feasible, contractors can still take steps to mitigate the impact of rising costs.
These include:
• Factoring contingency sums into pricing to absorb unexpected increases
• Procuring key materials early to lock in prices
• Entering fixed-price agreements with suppliers at the outset
• Prioritising local sourcing to reduce exposure to international supply chain risks
These measures can help maintain financial stability throughout the project lifecycle.
Legal avenues beyond the contract
If a contract lacks cost escalation provisions, legal remedies under English law are limited. Generally, a contractor cannot walk away from a contract simply because it has become more expensive to perform. The legal doctrine of frustration may apply in rare cases, such as when performance becomes impossible or unlawful, but cost increases alone are unlikely to meet this threshold.
In contrast, some civil law systems provide more flexibility. Where the economic assumptions underpinning a contract have fundamentally shifted, parties may be able to seek relief or renegotiation under local civil codes.
Managing exchange rate exposure
Currency fluctuations can also affect project costs, especially in cross-border contracts. If payments are to be made in multiple currencies, the contract should specify fixed exchange rates. While FIDIC contracts allow for multi-currency payments, failing to agree on rates in advance may result in reliance on central bank rates, which may not reflect commercial realities.
A cooperative outlook
Ultimately, the most effective way to manage cost escalation may lie in the mindset of the contracting parties. Viewing the project as a joint endeavour, rather than a zero-sum negotiation, can foster more balanced discussions around risk allocation. By identifying which party is best placed to manage specific risks, and agreeing on fair terms, both sides can protect their interests and support project success.
This article is informed by discussions from the “Navigating Construction Cost Escalation” webinar, jointly hosted by Gleeds and Freeths, with contributions from Chris Soffe and John Refaat (Gleeds), Alex Johnson (Freeths), and Chris Murphy (Consolidated Contractors Company).
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