Builders in Victoria who undertake residential work of less than or equal to $500,000 in value will continue to be forced to absorb any unexpected cost increases which occur on projects after the Victorian Government rejected a proposal to allow cost escalation clauses in domestic building contracts below that threshold.

Releasing its response to the Final Report on Addressing Supply Chain Challenges prepared by Commissioner for Better Regulation Anne Cronin, the Government said it supports nine of the ten recommendations which were outlined in the report.

But it refused to support a recommendation which would have enabled builders to include cost escalation clauses in new contracts which are equal to or below $500,000 in value (see below).

As a result, builders who perform residential work which is equal to or below this threshold will continue to be prohibited from passing on any unexpected cost increases under the Domestic Building Contracts Act (see below).

Commissioned by the Victorian Government last June, the review was undertaken to identify regulatory barriers in the building product supply chain and to make recommendations to remove these barriers.

It comes as the construction sector both nationally and in Victoria has been impacted by cost and time blowouts which have occurred amid shortages of materials and labour.

These shortages have seen wait times for mesh and pods, windows and frame and trusses blow out from two, four and four weeks to six, eight and fourteen to sixteen weeks respectively, according to data from Master Builders Victoria.

Meanwhile, ABS data suggests that nationwide, prices for many building products are increasing at double-digit annual rates.

In addition, shortages of construction professionals and building tradespeople across exist across almost every category.

According to the report, challenges are being driven by a combination of supply bottlenecks and record levels of demand.

On supply, imports have been affected by lockdowns, shipping delays and a global shortage of shipping containers.

As well, domestic timber supplies have been impacted by the 2019 bushfires.

This has coincided with record activity levels in single detached house building.

As of December 31, ABS data indicates that a record 101,022 single detached houses were under construction throughout Australia.

In Victoria, that number sits at 28,047 – a record for any quarter other than the record September quarter (28,971).

For builders, this is presenting challenges as opportunities to pass on cost increases are restricted under the Domestic Building Contracts Act.

Where contracts are valued at less than or equal to $500,000, the Act prohibits the use of any cost escalation clause within building contracts.

The only exception is where the clause has been approved by the Director for Consumer Affairs – something which has occurred only once following the introduction of the GST.

Accordingly, builders who undertake work which is below this threshold must absorb the full amount of any cost escalation which occurs on their projects.

(Subject to conditions, escalation clauses are allowed on contracts worth more than $500,000.)

As part of its ten recommendations, the Commissioner suggested that Consumer Affairs Victoria develop a cost escalation clause which could be applied on contracts worth $500,000 or less.

Suggested by the Master Builders Association of Victoria, such a clause would enable builders who enter into new contracts to pass on some or all of any unexpected cost increases which occur during a project to consumers in the form of a varied contract price.

The proposed clause would have been based on an equitable sharing arrangement, which would have considered any impact on consumers’ financial obligation and their financing capacity.

The clause would have applied to new contracts only and would not have affected existing contractual arrangements.

To ensure consumer protection, it would have included important considerations.

These include caps on allowable increases, limiting the clause to apply only for a fixed period, allowing the clause to apply only where there is a price increase for specific materials (such as timber or steel), preventing builders from charging extra margins on top of the price increase and requiring builders to provide receipts to confirm actual material costs.

In its rejection of the recommendation, the Government argued that a clause would unfairly increase uncertainty for consumers who enter into contracts.

It drew a distinction between consumers who enter into contracts above the $500,000 threshold beyond which cost escalation clauses are allowed and those who enter contracts worth less than or equal to this amount.

Whereas many consumers within the former category are likely to be more sophisticated and more familiar with the construction process, those in the latter are often less experienced and less able to understand potential ramifications of any cost increases which may incur.

Such consumers are also more restricted in their capacity to absorb cost increases.

At any rate, the Government points out that such a clause would have applied to new contracts only.

Accordingly, they would not alleviate current challenges with unexpected cost escalation on existing contracts.

With current challenges now being well-known, the Government says builders are now in a position to factor in further price increases into cost estimates for new contracts.

“The Government acknowledges that supply constraints have caused challenges for the building and construction industry,” the Government said in its response to the report.

“However, the Government does not support the development of a cost escalation clause for domestic building contracts (below $500,000).

“A cost escalation clause would unfairly increase uncertainty for consumers entering domestic building contracts, where it is unlikely that consumers would be in a financial position to absorb any cost escalation.

“The Domestic Building Contracts Act 1995 is designed to protect consumers and including a cost escalation clause would fail to protect their interests.”

However, the Government has expressed support for the other nine recommendations.

These include:

  • Having the Government use its international networks to help the building industry source from new markets
  • Sourcing of any surplus timber held in storage or any mature softwood timber due for harvest
  • Development of further softwood plantation projects
  • Support for greater use of steel for house framing.
  • Further research and development of new building materials
  • Development of communication materials to improve consumer awareness of the complexities and time and price impacts of the supply chain shortages.

The Government will also establish a working group to discuss supply challenges and to identify potential measures to mitigate their impact.

Building industry lobby groups expressed disappointment at the rejection of the cost escalation clause.In a statement, Master Builders Victoria Acting CEO Michaela Lihou welcomed the Government’s adoption of nine of the recommendations but says the rejection of the escalation clause was disappointing.

“We had hoped that the Victorian Government would support the inclusion of a cost escalation clause into new contracts, which effectively allows builders to vary a contract price to reflect these unprecedented increased costs of labour and materials, rather than being locked into a fixed price agreement when increased costs are beyond their control,” Lihou said.