Previous Practice

After the COVID-19 pandemic, the war in Ukraine, which has been ongoing for more than a year without an end in sight, and the resulting steep increase in both construction costs (which skyrocketed over the last 18 months) and interest rates, have fundamentally changed the construction industry in Austria.

Particularly in the case of construction projects that regularly run over several years, planning security has been one of the most important criteria up to now. For many years, therefore, construction contracts with fixed prices for the entire construction period, and often even lump-sum prices, have been the norm. Contractors have calculated the risk of changes into their prices and thus ultimately assumed the risk vis-à-vis the owner that they were wrong in forecasting price developments, but also had the comfort that safety cushions would not be needed. However, they have passed on this risk to their subcontractors, among whom competition has been ruinous in some cases.

Subsequent Claims and Delays

Construction companies are trying to use the argument that the COVID-19 pandemic and the war in Ukraine constitute force majeure events and that they are therefore entitled to a change in – ie, an increase of – agreed lump-sum prices and fixed-unit prices, as well as an extension of the construction period, even for existing contracts. It is highly probable that the risk of force majeure in construction contracts based on the Austrian General Civil Code must be borne by the construction company, whereas if the Austrian standard B2110, which is customary in Austria, has been agreed for the construction contract, this risk must be borne by the owner.

However, this reasoning was only viable at the beginning of the pandemic. For construction contracts concluded thereafter, the necessary element for being able to successfully claim a force majeure event, namely the unforeseeability of the event, is missing. Therefore, the COVID-19 pandemic does not qualify as a force majeure event any longer.

Even the war in Ukraine – as terrible as it is – was, at the time of its outbreak, not per se an event of force majeure for Austria. There have always been wars in the world, also in regions that are important for the supply of raw materials to the global economy, without constituting a force majeure event.

If a low, single-digit percentage of the world production of steel in Ukraine fails or may not be imported from Russia due to the sanctions, there is still more than 90% of the steel available on the world market and it is still possible to meet demand – albeit possibly at higher prices. In addition, the fact that construction companies have (also) employed workers from Ukraine who now cannot leave for the time being, was the free decision of the contractor and does not change the fact that workers are available in other (EU) countries.

After more than a year of this war, the element of unforeseeability is no longer an argument for newly concluded construction contracts.

Furthermore, the effect of inflation rates which, for over a year, have reached peaks in the two-digit figures (where Austria has significantly higher inflation than the rest of Europe) is used as an argument to claim higher prices than agreed. In addition, an increase in the price of raw materials, and especially energy and higher wages (be it due to the fact that a cheap workforce from other countries is no longer available, or due to a general increase in wages) is also not per se and in itself a reason to invoke force majeure. A building contractor will likely only succeed with this line of argument if the prices have increased in such a way that the fulfilment of the order would endanger the existence of the building contractor and if such rise was unforeseeable for the contractor.

The same applies to the increase in interest rates; where the contractor has always had to take into account a flexible interest rate, it is not unforeseeable that interest rates could increase.

Finally, the past practice by many general contractors of often awarding subcontracts only one year after receiving the general contractor’s order is now taking its toll. In this case, changes may well occur in the meantime, which may even actually qualify as force majeure. However, if the construction company could have awarded the contract to the subcontractor earlier, and if a diligent construction company also would and should have done so, the fact that it has now become more difficult to find subcontractors for the respective works with sufficient capacity, and at prices that are acceptable to the general contractor, cannot be argued as having been unavoidable and hence cannot be held against the employer as an argument for having to pay for increased construction costs.

The fact that the risk of substantial price increases, which the construction companies have assumed, is materialising, is currently leading to an increase in disputes between employers and construction companies. Construction companies are trying to get employers to compensate them at least for a part of the risk assumed by the construction companies in the form of higher prices, even under the threat of construction stoppages or at least considerable delays. This is also increasingly occupying lawyers and courts.

New Forms of Contract

Due to the high volatility on the commodity markets in 2022, construction companies were not willing to conclude fixed-price agreements. This resulted in the risk of price increases, as well as the opportunity for falling prices to be shared between the employer and the construction company.

Here, based on a partnership model, the total price of the general contractor is also split into the costs that the construction companies expect for the individual trades to be awarded to subcontractors. As soon as the actual award to the subcontractors then takes place, any negotiation success of the general contractor is split between the construction company and the employer – usually in a ratio of 50:50. On the other hand, any increase over the prices disclosed for the subcontractors (usually up to a maximum amount) is split in a ratio more favourable to the employer (for example, 80% of the increase is borne by the construction company and 20% by the employer).

In addition, fixed prices are also increasingly being split into the individual cost types on which the calculation of the unit price or lump sum price is based. Fixed prices continue to be agreed for components that can still be calculated in principle, such as wages and central overheads (even if it has also become more difficult to anticipate future wage increases here due to the extreme rise in inflation since 2022). In contrast, for materials, where prices have been very volatile in the past, only price escalators will be agreed. This allows price changes for the items being the most difficult to estimate to be passed on to the employer, who also has the chance that the market, which is currently overstated for some materials, will calm down again.

This is the first time that (unfortunately only due to, and forced by, the complete change of the economic environment) a long-discussed model of co-operation in partnership has been implemented in Austrian contractual practice. Here, on the one hand, the construction companies have given up their reluctance to disclose their calculations – at least as far as subcontractors are concerned – and to share advantages and disadvantages in this area of subcontracting with the employer. In contrast, the employers – due to market conditions – have been willing to assume a risk of price development. This model could also be a solution for the future after the current crises have ended because there is an incentive for both parties to reduce costs.

However, times change quickly: as the employers are faced with cost increases (see below) the demand for construction has decreased sharply. Therefore, construction companies are again taking more risks and have again begun to offer fixed-price contracts.

Rising Construction Costs Threaten the Creation of Housing

The Austrian federal states promote the construction of residential buildings with the aim of apartments being available at a capped rent for those that do not exceed a defined income limit. However, according to the respective laws on these subsidies, only a maximum amount specified in the individual subsidy regulations may be spent on the property and construction costs when the building is constructed. As a result of the sharp increase in construction costs, it is no longer possible for many non-profit housing associations to comply with this maximum amount, leading to them/their projects no longer qualifying for subsidies. In addition, when variable prices are agreed, there is the uncertainty that during the construction project the respective maximum amount will be exceeded due to price changes during construction phase and thus the subsidy can no longer be achieved for a project that is already under construction – a worst-case scenario for a non-profit housing association. Many of these non-profit housing associations have therefore decided not to embark on any further projects at present.

Vienna was the first federal state to react to this and announced an increase in the respective thresholds, accordingly. It is to be hoped that the other federal states will follow suit. With regard to subsidised housing, it is particularly important that calm returns to the market, because the co-operatives need planning security and can only assume the risk of changing prices to the extent that it is ensured that the costs do not exceed the respective subsidy guidelines. In order to end the current standstill in the construction of subsidised housing it is, however, not sufficient to simply increase the limits. These limits should be changed in such a way that they must be complied with as per conclusion of general contractor contracts/construction agreements, but may change according to agreed price escalation clauses (and are thus not “breached” in case of price increases).

Although this problem primarily arises with non-profit housing associations, other investors also face similar issues. First, they are faced with sharply increased construction prices and – still in a considerable part of construction projects – are not able to provide the financing banks with clear cost estimates for the construction of the building and completion of financed projects, and thus only finance the basic costs. The owners thus must use higher equity to cover increases in the variable construction prices. Second, the investors face a sharp increase in interest rates – both fixed as well as flexible interest rates. On the other hand, the prices for building plots have not decreased, but remain on the high level of the boom times. In addition, market prices for the final product – be it sold to a fund as investment or to an individual for living and/or wealth-building purposes – have not increased. Institutional investors reduce their exposure in real estate and individuals do not get bank financing. This has led to the fact that developers do reduce their activities. For Vienna alone, the construction of new apartments is expected to decrease until 2025 by over 50% (and this despite the fact that the city is still growing).

EU Taxonomy Regulation

The requirements for the careful use of natural resources are implemented on a large scale, especially in buildings. Existing buildings, as well as new buildings to be constructed, must be as resource efficient as possible over their entire life cycle. This is required on the one hand by legal regulations coming from the EU, but also increasingly by potential tenants. Accordingly, buildings begin to lose value simply because they are not energy efficient. Owners are therefore prepared to accept additional costs with respect to refurbishing existing buildings as opposed to selling those buildings at a discount.

In addition, this investment has the potential to pay immediately as the operating costs will be reduced and tenants look more and more to overall costs instead of just calculating rent. Even if this is not yet reflected in higher rents at present, easier letability and therefore better occupancy, make such an investment worthwhile.

The segment of upscaling energy efficiency will therefore partly offset the decrease in activities with respect to erecting new buildings.

Summary

The turbulent times for the construction industry caused by the pandemic and the war in Ukraine and the economic consequences for prices and availability of raw materials not only affect the industry negatively but may also lead to opportunities for construction companies and employers to work together more closely and in a more trusting manner in the future. The mutual understanding of the requirements of the other side and the accompanying willingness to jointly bear risks coming from the outside, but also to jointly exploit opportunities coming from the outside, could bring about a turnaround in the concepts of construction contracts commonly used in Austria.