Cost Increases in General 

The construction industry has for some time been affected by significant cost increases – both as a result of COVID-19 and the war in Ukraine and, more recently, rising customs duties and the political situation in the Middle East. 

Unexpected cost increases have a significant impact on construction projects and constitute serious economic challenges for both employers and contractors. But who bears the costs associated with these circumstances? 

Contracts based on AB 18 

Under the Danish AB system, price increases are regulated by AB 18, clause 34. Under this clause, the contract price is fixed for the first 12 months from the tender date (the fixed-price period). After the expiry of the fixed-price period, the contract price is adjusted in accordance with the specific building or construction cost index agreed in the contract or, in the absence of such agreement, the index most relevant to the works. 

However, under AB 18, clause 35, the contractor is entitled to compensation for exceptional price increases, even during the fixed-price period. This may arise as a result of government intervention under clause 35(1), in which case both the contractor and the employer are entitled to demand that the contract price be reduced. Furthermore, the contractor may be entitled to compensation for exceptional price increases for material and fuel under clause 35(2). 

For the contractor to be entitled to compensation, it is a condition pursuant to AB 18, clause 35(3), that the price increases

  • occurred after the tender date and before any agreed indexation took effect (i.e. during the fixed-price period); 
  • were generally prevailing in the market; and 
  • are evidenced by official pricing data or can otherwise be documented. 

Furthermore, the price increase must amount to at least 10% of the price of the relevant material as at the tender date. To this percentage, 0.5 percentage points shall be added for each full month that has elapsed between the tender date and the purchase date. 

Only if these conditions are met will the contractor be entitled to compensation under AB 18, clause 35(2). The burden of proof in this respect rests with the contractor, and in practice, that burden can be difficult to unveil. 

Contracts based on THE FIDIC conditions 

For projects based on the FIDIC conditions of contract, such as the FIDIC Red or Yellow Book 2017, it is also important to understand how the FIDIC rules address price increases in the construction sector and how they may differ from the Danish AB Terms. 

FIDIC sets out various grounds on which a contractor may claim compensation in connection with cost increases. The most relevant are: 

  • Changes in Cost 
  • Changes in Laws 
  • Force Majeure / Exceptional Events 

Adjustments for Changes in Cost 

The FIDIC Red Book contains provisions on changes in cost in clause 13.7 (and correspondingly clause 13.7 of the FIDIC Yellow Book). These clauses provide for indexation. 

Unlike AB 18, however, the starting point under FIDIC contracts is that no indexation applies in the event of price increases. Indexation requires the parties to establish an agreement for adjustment to reflect cost increases, known as the “Schedule(s) of cost indexation”. 

If the parties have not agreed on this, the contractor will bear the financial risk of cost increases following the conclusion of the contract. This is stated explicitly in the introductory provision to clause 13.7: 

“If Schedule(s) of cost indexation are not included in the Contract, this Sub-Clause shall not apply.” 

In other words, at the tender stage the parties must decide whether the employer is to bear the risk of inflation and, if so, to what extent by way of the Schedule(s) of cost indexation. If the employer chooses not to bear that risk, the contractor will bear the risk of inflation.

Example: During construction, the cost of goods and materials increases as a result of an international trade war. No Schedule(s) of cost indexation has been agreed when the contract is concluded. In that case, the contractor cannot claim compensation for cost increases under clause 13.7. 

Even if the employer agrees to bear the risk of inflation (to some extent), it is worth noting that rises and falls in costs that are not covered by the agreed Schedule(s) of cost indexation will not alter the contract price. 

Adjustments for Changes in Laws 

Clause 13.6 of the FIDIC Red Book (and correspondingly clause 13.6 of the FIDIC Yellow Book) provides for adjustment or compensation in the event of price increases resulting from changes in the law. This also applies to changes in the interpretation of applicable law. 

However, it is important to bear in mind that the clause refers to the laws of the country in which the project is being carried out. The provision therefore does not apply to, for example, increases in customs duties in countries other than the one in which the project is being carried out. The same applies to trade restrictions and the like. 

Example: A contractor needs rebars for a project in Denmark. The rebars are bought from a manufacturer in a country other than Denmark. Due to international trade wars or trade restrictions, the cost of producing the rebars increases significantly and, consequently, so do the contractor’s expenses. If the increased production costs are not due to Danish law, then the situation falls outside the scope of clause 13.6. 

Force Majeure / Exceptional Events 

The FIDIC Red Book provides a basis for compensation to the contractor in the event of “force majeure”/“exceptional events”. 

The legal basis for this is found in clause 18 of the FIDIC Red Book in cases of force majeure (and correspondingly in clause 18 of the FIDIC Yellow Book), and in clause 19 in cases of exceptional events (and correspondingly in clause 19 of the FIDIC Yellow Book). However, FIDIC has stated that financial force majeure or economic hardship, such as inflation, does not constitute force majeure or an “exceptional event” entitling the contractor to financial compensation (FIDIC policy and membership position pieces, Scenario 2, page 10 f.).

War is an “exceptional event” under the FIDIC conditions. However, this does not necessarily mean that the Contractor is entitled to financial compensation. 

FIDIC itself has stated that it is likely to be relevant whether the situation renders performance of the contract, as contemplated by the parties when the contract was concluded, impossible, or merely makes performance more difficult. In the former case, there is likely to be a greater prospect of the contractor being able to obtain financial compensation if more expensive materials must be purchased as a result of impossibility (FIDIC policy and membership position pieces, Scenario 5, page 14). 

Example 1: A contractor requires rebars for a project in Denmark. The rebars are intended to be purchased from a manufacturer in the EU. The manufacturer uses raw materials from Ukraine. As a result of the war in Ukraine, the cost of the raw materials has increased significantly; however, it is still possible to obtain them. In this case, the war in Ukraine does not prevent the contractor from performing its obligations under the contract, which means that the contractor may not be able to recover compensation for the increased costs with reference to “exceptional events”.

Example 2: A contractor requires rebars for a project in Denmark. The rebars are intended to be purchased from a manufacturer in the EU. The manufacturer uses raw materials from Russia. As a result of the war in Ukraine and, consequently, the EU trade ban on Russia, the manufacturer is unable to produce rebars, and the contractor must purchase rebars from another manufacturer at a higher cost. In this case, the contractor may be able to recover compensation on the basis of impossibility. This may also be an example falling within the scope of the clauses for “changes in laws”.

The scope of compensation due to force majeure/exceptional events is not clear. However, based on FIDIC’s guidance, it appears that a great deal must occur before a contractor can receive compensation as a result of force majeure or exceptional events – such as impossibility. Consequently, a contractor may, in most cases, not succeed in claiming cost increases under force majeure.  

Statutory law 

Finally, it is important to note that the applicable law may affect the contractor’s ability to obtain compensation for cost increases beyond the rules set out in AB 18 and the FIDIC contracts.  

Under Danish law, this may, for example, be founded on broader considerations under section 36 of the Danish Contracts Act concerning unfair contract terms, or on the doctrine of frustration, both of which are recognised in legal scholarship, but have not yet been confirmed by the courts. 

Conclusion and our recommendation: 

Under the FIDIC conditions, the general rule in many cases is that the contractor must bear the financial risk associated with cost increases during the construction project. This corresponds well with the fact that it is also the contractor who, as part of its tender price, can factor in the financial implications of potential unforeseen risks. 

However, given the challenges that have emerged in recent years, it is uncertain how similar cases will be dealt with in future.

We therefore recommend that the client and the contractor address the issue of cost and price increases when the contract is signed in order to ensure effective collaboration and an efficient construction process. Among other things, we recommend that the parties address the following: 

  • The extent to which the project in question is exposed to external circumstances and associated price increases, including whether the project requires special materials or involves high energy consumption. 
  • Agreement on adjustment mechanisms, indexation models, and clauses to manage cost and price increases and economic hardship during the project. 
  • Ongoing notifications regarding economic hardship, including, as far as possible, proactive measures in light of the geopolitical situation, as well as guidance on statutory law. 
  • Ensuring that the necessary documentary basis is in place to substantiate price increases in the market and their specific impact on the project. 

 Do you want to know more about international contraction law or FIDIC contracts? 

If you would like to learn more about how we can assist you with your FIDIC contract or about our experience in this area, we would be pleased to help. Please contact Attorney-at-Law, PhD Nicolaus Falk-Scheibel by email NIF@mowe.dk or by phone on +45 25 10 05 90, or Attorney-at-Law, Joachim Riis Jensen by email JRJ@mowe.dk  or by phone on +45 31 20 30 33. 

You can also start by seeing some of our recorded online-briefings here: