By: Daniel E. Fierstein
It is no secret that the prices of construction materials and equipment have been skyrocketing. The costs of lumber, steel, copper, glass, and PVC, for example, have increased dramatically since the beginning of the COVID-19 pandemic and through the reopening of the global economy. According to some indices, the prices of select commodities have increased by more than 100%. Fear and uncertainty abound. Vendors are unwilling or unable to sell their materials at lower prices. Owners have no desire (and perhaps no funding) to exceed their project budgets. And contractors and their subcontractors are wedged in the middle of the resulting vortex.
Throughout the crisis, our firm’s construction lawyers have fielded different iterations of these two key questions: how can I minimize my company’s risk exposure to price increases on projects already underway; and how can I protect my company on projects that are not yet awarded?
Considerations for Existing Contracts
In the event of a dispute over escalation, there are a few provisions common to construction contracts that are likely to be front-and-center: material price escalation, force majeure, and change orders.
Material Price Escalation Clauses
Though less common in private, vertical construction projects, a material price escalation clause allows contracting parties to adjust the price based on an agreed-upon metric or conditions. Such clauses are common in public projects like highway construction in which price volatility of construction materials (such as asphalt, fuel, and cement) is expected. These clauses can help keep contractor bids closer to market prices because contractors are less incentivized to submit inflated bid prices as a hedge against future price increases.
A material escalation clause in a fixed-price contract might look something like this one:
8.7.1 Escalation Clause. In the event of significant delay or price increase of material, equipment, or energy occurring during the performance of the contract through no fault of the contractor, the contract sum, time of completion or contract requirements shall be equitably adjusted by change order in accordance with the procedures of the contract documents. A change in price of an item of material, equipment, or energy will be considered significant when the price of an item increases 20% between the date of this Contract and the date of installation. The amount of the increase shall be capped at five percent (5%) of the original budgeted price for the item.
Here, the provision allows an increase to the contract price when the price of material increases at least 20% from a past date. In an effort to allocate risk more evenhandedly between the contractor and its customer, this provision places the first 19% of a material price increase on the contractor and places a cap on the amount of an allowable increase to the contract price.
Force Majeure Clauses
In the absence of a material price escalation clause, companies and their advisors must consider whether the construction contract contains a force majeure clause. Force majeure is a French term that literally translates as “greater force.” These clauses are intended to capture uncontrollable events (e.g., war, labor stoppages, epidemics, and extreme weather) and traditionally limit a party’s relief to extensions of time only.
The force majeure clause contained within the American Institute of Architects’ (AIA) A201-2017 General Conditions provides a classic example:
8.3 Delays and Extensions of Time
8.3.1 If the Contractor is delayed at any time in the commencement or progress of the Work by an act or neglect of the owner or architect, of an employee of either, or of a separate contractor; by changes ordered in the work; by labor disputes, fire, unusual delay in deliveries, unavoidable casualties, adverse weather conditions documented in accordance with Section 184.108.40.206, or other causes beyond the contractor’s control; by delay authorized by the owner pending mediation and binding dispute resolution; or by other causes that the contractor asserts, and the architect determines, justify delay, then the contract time shall be extended for such reasonable time as the architect may determine.
Under this provision, a contractor’s relief for unforeseeable supply issues would be limited to an extension of time. In the case of a price escalation crisis like the one before us, additional time may help owners and contractors weather the impact of longer material lead times (e.g., avoiding a liquidated damages assessment for late completion). However, additional time may be less helpful if a contractor has already purchased the materials or prices continue to rise after an extension of time has been granted.
If the construction contract in question lacks a material price escalation clause and does not afford monetary relief for force majeure events, then a dispute over price escalation is likely to focus around the contract’s change order clause. A change order is a modification to a contract’s scope of work that does not invalidate the rest of the contract’s terms. Depending upon the nature of the modification, change orders can include adjustments to the contract price (increase or decrease) or the time for performance (increase or decrease).
In the absence of clear contractual relief, contractors have been and are likely to continue requesting adjustments to the contract price as a change order based on the commercial impracticality of price increases. Owners and general contractors may be within their rights to require subcontractors to complete their work without relief.
As a practical matter, however, owners and general contractors may face the reality that major material price increases can bankrupt subcontractors and that the replacement will be unlikely to procure materials at lower prices any time soon. In other words, for projects already underway, owners, general contractors, subcontractors, and suppliers may be wise to share the risk with each other to avoid unnecessary losses, delays, and attorneys’ fees down the road.
Considerations for Future Projects
What about construction projects that have not yet been designed or awarded? The current crisis offers important lessons and reminders to construction industry members and the professionals who advise them. With regard to the price of materials, there is much to consider:
- What are the more prevalent materials that must be procured for the project and how stable are their prices leading up to the negotiation of construction contracts? Identifying these materials during the bidding process and discussing them candidly with the owner can go a long way towards avoiding disputes over price escalation during and after the project.
- Are there opportunities to purchase certain materials earlier and store them on-site? Procuring materials early can give the owner and its construction team more certainty about the cost of construction and lessen the effect that supply chain uncertainty could have on the time and cost of construction.
- Could a “material price escalation clause” be beneficial? A material price escalation clause allows contracting parties to adjust the price based on an agreed-upon metric or conditions. Contractors can benefit from such a clause because it provides a mechanism to pay for unforeseen cost increases. In addition to incentivizing contractors to provide market pricing, an escalation clause could also benefit owners if the provision is drafted to function as a savings clause (i.e., where material prices decrease during the project). If the prices for materials do not fluctuate during the project, then the provision will not come into play.
The contractual mechanisms and considerations for allocating the risk of material price fluctuation in construction contracts have been around for a long time. The surge in material prices that has accompanied the COVID-19 pandemic is the latest reminder that, while project stakeholders cannot be expected to foresee the unforeseeable, there are ways to mitigate potential risks and disputes early in the process. Parties who discuss potential price increases early on—and use the tools at their disposal to balance the additional expenses—are more likely to keep projects going and avoid costly disputes.
Daniel E. Fierstein is a construction partner at Cohen Seglias Pallas Greenhall & Furman, representing industry members throughout the country, including owners/developers, general contractors/construction managers, and trade subcontractors. Fierstein helps his clients navigate day-to-day issues with sensitivity to cost, resources, and the reality that suing a long-time customer is a last resort; not a first one. Contact him at email@example.com and 267-238-4765.
Reprinted with permission from the August 11, 2021 edition of “The Legal Intelligencer” © 2021 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, firstname.lastname@example.org or visit www.almreprints.com.