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Legal Update

Guiding Opinion on Cost Fluctuation Risks and Price Adjustment Provisions in Construction Contracts

10 July 2008
Mayer Brown JSM Legal Update
Summary
 
The continued escalation of construction material and labour cost in the PRC has a substantial impact on the cost of PRC construction projects. On 11 March 2008, the Construction Material Industry Administration Department of the Shanghai Municipal Government issued the Guiding Opinion on Cost Fluctuation Risks and Price Adjustment Provisions in Construction Contracts (the "Opinion") to provide guidance on dealing with construction cost fluctuations in the Shanghai market. This Client Alert summarises the major guidelines provided by the Opinion.
 
Full Update
 
1.  Cost fluctuations during the project design and tendering stage
 
The Opinion recommends that parties should make provisions in the construction budget to cover construction cost fluctuation risks which may arise during the construction period.
 
In addition, the tender and construction documents must clearly stipulate the price range of the construction material agreed between the parties in view of the anticipated cost fluctuation. Adjustment mechanisms dealing with situations where the actual cost of the construction material exceeds the agreed price range should also be included.
 
2.       Cost fluctuations during the construction stage
 
During the construction stage, when the cost of construction material exceeds the price range agreed by the parties, the Opinion suggests that the following adjustment methods should be adopted:
(a)   weighted average method;
 
(b)   arithmetic average method; or
 
(c)   other methods as agreed by the parties.
3.       List of construction material concerned
 
The Opinion provides a reference list of the construction material concerned:
(a)    Residential building projects: steel, cement, concrete, timber material, sand and stone, mortar, etc.
 
(b)    Municipal infrastructure projects: steel, cement, concrete, timber material, sand and stone, bridge columns, expansion joints, asphalt products, drainage pipes, pre-fabricated concrete components, etc.
 
(c)   Civil defence projects: steel, cement, concrete, timber material, sand and stone, mortar, etc.
 
(d)   Landscape projects: steel, cement, concrete, timber material, sand and stone, mortar, plants, stone material, construction material for classical architecture, etc.
4.   Cost fluctuations after the execution of construction contracts
 
If the construction contract does not contain cost adjustment mechanisms to deal with price fluctuations, the parties shall address the price fluctuations by entering into a supplemental agreement.
 
The Opinion suggests that a comparison should be made between the following cost figures:
(a)    the cost of construction material and labour published by the local construction cost administration for the month when the tender price or the contractual price was agreed; and
 
(b)    the weighted average or the arithmetic average of the cost of construction material and labour issued by the local construction cost administration for each month during the construction period.
The cost of construction material and labour should be adjusted if the difference between the above figures exceeds:
(a)   3% for labour cost,
 
(b)   5% for the cost of steel,
 
(c)   8% for the cost of all the other construction material mentioned above.
 
For further information, please contact Tom Fu ( tom.fu@mayerbrownjsm.com ).
 

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