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On 1 September 2022, the NSW Government published its “Commercial principles on escalation risk for infrastructure projects” (Commercial Principles) to guide contractors and government agencies through the current inflationary environment. The Commercial Principles recognise cost escalation as a foreseeable risk that can be managed. These are intended as a framework for government agencies to adhere to.

The Commercial Principles apply to infrastructure projects currently in the pre-procurement and procurement phase.

Contractors should take the following into account when negotiating tenders for infrastructure projects:

  1. Government agencies are encouraged to engage with industry as early as possible to identify and understand the potential impact of escalation risks and mitigation strategies. In practice, this may include identifying locally available construction materials that are easily accessible and unimpeded by supply chain constraints;
  2. The timing of procurement for materials subject to escalation risk should be emphasised;
  3. Government agencies are encouraged to develop projects in stages to create flexibility to sever and postpone project scope where there is a risk of price volatility.
  4. Government agencies should facilitate flexible designs and broader technical specifications in the design process to allow contractors to suggest alternative materials that are less likely to be impacted by escalation risk;
  5. Contractors may be required to identify additional scope which can run independently of the critical path, giving Government agencies more flexibility to pursue alternative scope during market disruptions;
  6. Government agencies should consult Contractors directly with respect to value engineering opportunities. This should be carried out during the pre-tender phase if possible in collaboration with Contractors, to identify variations to reduce scope at the earliest opportunity;
  7. Tender validity periods should be reasonable to allow tenderers to assess risk and price volatility and to ensure tighter pricing of construction items;
  8. Tenders should be evaluated with respect to a Contractor’s approach to mitigating cost escalation risk. Tenders should also be reviewed on the basis of design optimization, flexibility regarding contractual relief and the extent to which the tenderer is willing to accept escalation risk;
  9. Government agencies should conduct due diligence on the nature of escalation risk identified by tenderers, while also facilitating timely procurement decisions, to ensure tenderers may lock in accurate prices for the relevant period;
  10. Parties should consider applying a “Rise and Fall” contractual mechanism. See Vincent Young’s recent article on Rise and Fall clauses here for more details.

Due to the severe impact of cost fluctuations and materials shortages in recent years, government agencies are now expecting transparency from Contractors with respect to known risks and strategies for mitigating risk. Contractors should leverage the Commercial Principles as much as possible when negotiating tenders for projects in NSW.

The Commercial Principles can be downloaded here.

If you wish to discuss the Commercial Principles and how they affect your business, please call Brett Vincent or Michael Nahoum on 9261 5900.