Navigating a Perfect Storm – Iran, Inflation & Insolvency

Part One: Pre-contract risk management in construction projects amid ongoing market volatility

Practical tips to help your project succeed despite the current chaos

The Australian construction sector is operating under sustained and compounding pressures arising from fuel and energy price volatility, skills shortages, commodity price escalation, supply chain disruption, persistent delays and ongoing inflation. These conditions have fundamentally altered the commercial assumptions on which many traditional procurement and contracting models are based.

In this environment, pre-contract risk management has become a critical determinant of project viability rather than a formality. Courts will generally hold parties to the risk allocation they have agreed, even where market conditions deteriorate sharply. As a result, projects are increasingly failing not because of defective performance, but because volatility and insolvency risk were inadequately addressed before contract execution.

This article examines key pre-contract risk management challenges facing the construction industry, with particular emphasis on cost escalation, program risk, supply chain fragility and insolvency exposure. It outlines how contractual mechanisms and procurement strategies can be used to allocate risk more sustainably and support project delivery.

Key takeaways

• Pre-contract risk management is now critical — Project failure is increasingly driven by misallocated risk at contract formation rather than defective performance.
• Price volatility must be addressed up-front — Fuel, labour and commodity escalation risks should be priced realistically or managed through clearly defined adjustment mechanisms – including risk shares.
• Program assumptions require stress-testing — Lead times, labour availability and sequencing should be validated before contract execution.
• Insolvency risk is a pre-contract issue — Unrealistically low pricing, limited contingencies and excessive risk transfer are key indicators of insolvency exposure.
• Supply chain risk must be managed holistically — Contracts should allow escalation and delay relief to pass through the supply chain.
• Disclosure carries legal risk — Tender representations must be accurate and current to avoid misrepresentation or misleading conduct exposure.
• Collaborative procurement may reduce risk — Early contractor involvement and target-cost models may better support solvency where volatility cannot be priced.

Introduction

The Australian construction industry continues to operate in a period of sustained volatility. Persistent fuel price instability, chronic skills shortages, commodity price escalation, global supply chain disruption, delays and ongoing inflation have fundamentally altered the commercial assumptions underpinning construction procurement and contracting.

In this environment, pre-contract risk management is no longer a preliminary exercise. It has become a core project governance function that materially influences project viability, solvency and dispute outcomes.

Accepting the need to change to the current market and adapting standard risk allocation to account for ongoing uncertain market is a starting point.

We need to fundamentally rethink how we allocate risk in the prevailing market. This includes being aware of new legislation, including in respect of unfair contracts under the ACL which can dramatically impact on parties’ intended risk allocation.

1. Managing cost and price escalation risk

Tender pricing must be grounded in realistic assumptions and stress-tested against escalation scenarios. Where volatility cannot reasonably be priced, escalation and adjustment mechanisms should be considered as tools to manage insolvency and delivery risk. Rise and fall clauses were boilerplate until the early 2000s – and made a brief come back during COVID19. Why aren’t such clauses used more? If a rise and fall clause does not work for a project, a risk share on particularly stretched items can be adopted.

2. Program assumptions and delay

Program assumptions should be critically reviewed and validated prior to execution. Extension of time and cost relief regimes must align with foreseeable delay drivers and inflationary pressures. Force majeure clauses should be considered carefully – as ultimately a right to terminate may not be in your interests. Consider alternatives such as an extension event, perhaps with no entitlement to delay costs – as a compromise up to a certain period of delay.

3. Subcontractor and supply chain risk

Head contractors should assess subcontractor pricing, escalation exposure and labour availability. Risk should be allocated holistically rather than concentrated at a single contractual level. Losing a subcontractor in the current skills shortage can delay a project for months – especially in remote areas and this can be far worse than a small overpayment to a distressed subcontractor.

Insolvency risk frequently originates at the pre-contract stage. Unrealistically low pricing, limited contingency and aggressive risk transfer are strong indicators of financial distress. Security and guarantees mitigate risk but cannot substitute sustainable risk allocation.

4. Disclosure, representation and misleading conduct risk

Representations made during tendering regarding pricing, material supply and programme feasibility must be accurate and current. Failure to manage disclosure risk may expose parties to statutory and contractual claims.

5. Collaborative procurement as a risk response and alternative procurement models

Where volatility cannot be priced with confidence, collaborative procurement models may provide greater flexibility and resilience. The use of NEC4 contracts by government bodies such as Sydney Water has resulted in considerable success.

Full wrap EPC is a risk few head contractors are willing to accept. Particularly in the New Energy space, split contracting models where the Principal takes the lion share of procurement risk has become the norm.

6. Frustration doesn’t mean frustrating

Alike force majeure, parties often grossly over estimate when a frustration event enables a party to be released from a contract. Absent precise drafting, frustration will only occur when an unforeseen event, occurring after formation and without fault of either party, makes performance impossible, illegal, or radically different from what the parties originally agreed, so that it would be unjust to hold them to the contract.

This is a very narrow doctrine at common law.

7. Scope of Variation Power

Especially where a subcontractor is distressed, ensuring a head contractor has broad powers to issue a Variation to omit works from a subcontractor’s scope can be a very powerful risk management tool. This can often lead to win-win outcomes – where a struggling subcontractor can ill afford to undertake such works.

8. Early notice can mean a problem shared

Notice and time bar provisions need not be combative. Early notice of an issue enables the parties to consider how best to manage an issue prior to incurring significant costs. Notices need not be combative- indeed early notice of issues can foster trust on a project. Be noticeably nice!

Conclusion

Current market conditions have exposed the limitations of traditional construction risk allocation models. In an environment of fuel volatility, skills shortages, commodity inflation, delay and insolvency risk, effective pre-contract risk management is central to sustainable project delivery.