Careful wording of contracts can combat price escalations

Oct 1 10AM



What You Need To Know

As supply chain disruptions and material pricing volatility continue to rattle the construction industry, the timeline for when contractors might see a return to normalcy has only grown murkier.

For example, 73 ships were waiting to unload cargo off the coast of Southern California last week, according to the Wall Street Journal, while on the other side of the country, 20 vessels were anchored off the Port of Savannah. All of them were delayed due to cascading logistics snarls from earlier in the pandemic that have yet to work their way through the supply chain.

At the same time, material prices continued to escalate, with the Associated General Contractors of America issuing the fifth update to its Construction Inflation Alert report this year on Friday. It highlighted that overall construction input costs — the price to build a job — have risen 27.8% since April 2020, while steel mill products have skyrocketed 111%.

For contractors, the combination of supply chain quagmires and rising prices on materials are playing out on jobsites, where costs have increased for both physical goods and labor. This makes it more important than ever for contractors to consider strategies and language in their agreements with owners to limit risk, while still trying to get the job done during less-than-optimal conditions.

How contracts can protect contractors

In this uncertain time, comprehensive and carefully worded contracts are more important than ever, said Trent Cotney, CEO of Cotney Attorneys & Consultants.

“Specific provisions can help builders and contractors anticipate material shortages and price increases, while providing them with options,” Cotney said.

Here are key clauses to consider, according to Cotney.

  • Force Majeure—This clause allocates the risk of performance if progress is stopped or delayed indefinitely due to unexpected circumstances outside of a party’s control. These events include floods, tornadoes, hurricanes, earthquakes, landslides, wildfires and other “acts of God,” as well as human-caused emergencies such as terrorism, war, riots, strikes and explosions. Many contractors have argued that the pandemic was a force majeure event.
  • Material Delay—Force majeure events are seen as excusable, and contractors are not responsible for delays that result. Usually, material delays are not considered excusable; however, a material delay clause can be added to a contract, which prevents contractors from the risk associated with late receipt of stipulated materials, Cotney said.
  • Material Substitution—If a specified material is unavailable, a material substitution clause allows the contractor to make a reasonable substitution for the material in question. Contractors can benefit from working with their suppliers to determine what materials will be available and best suited for the task at hand.
  • Price Acceleration—When prices increase after a contract is signed, this provision generally allows the contractor to revise the price to reflect the adjusted actual cost of labor and materials. If the contractor uses its own labor force, labor costs may not actually be affected. However, this provision could permit a contractor to increase its price in line with the price increase for materials, but without the need for a change order. The language likely will state the contractor must provide the customer with evidence of the material price increase.
  • Termination—A price acceleration clause may also contain a termination-for-convenience provision, which allows the contractor to escape a contract if material prices have increased dramatically or if the materials have become difficult or impossible to secure.

Look at the specific language in your contract

While these types of clauses have helped shift risk and get more time on projects, contractors still need to be careful with the language in boilerplate contracts, especially those supplied by the owner.

“Contractors must carefully read the form contracts provided by owner, because most such forms state that the contractor is solely responsible for material cost increases,” said Mark Himmelstein, partner at law firm Newmeyer Dillion in Newport Beach, California.

The more specific the contract language, especially if it’s in favor of the contractor, the better.

“It is common to find general contract language relating to delays outside of the contractor’s control or force majeure,” said Jordan Nadel, a partner at Mark Migdal & Hayden.

“However, it is better practice to specifically address supply chain disruptions in the agreement,” Nadel said. “Failure to do so could lead to claims or litigation concerning whether supply chain-related delay is excusable or compensable. Such a provision will, at a minimum, allow the contractor an extension of time relating to the delay.”

To the extent practical, Himmelstein advises contractors to purchase materials as soon as possible in order to protect both owner and contractor from price increases, and keep apprised of market conditions so bids accurately reflect potential price increases. They should also make sure their contracts with subcontractors are consistent with the contractor’s contractual obligations to the owner. “If the contractor must take on such risks, it needs to pass that risk onto its subs, too,” Himmelstein said.

Cost increases and time delays may not just be related to materials alone. In today’s tight labor market, finding the workers to put materials in place can be just as much of a challenge.

“I’m putting escalation clauses in contracts for labor as well,” said Carol A. Sigmond, partner at Greenspoon Marder. To figure how much a contract amount should be increased, she recommends using audit clauses in the contract, too. “That allows the owner to verify the amount of the increase,” Sigmond said. “Basically, fixed price contracts are being modified to be cost plus to deal with supply chain issues.”

Given the unreliability of the supply chain currently, it’s also possible that the materials needed to get the job done simply aren’t available in the time frame that needs to be met.

“That’s basically the perfect storm for claims and legal disputes unless the project participants can reach an agreement to amicably part ways,” said Adam Richards, a partner at Berger Singerman in Miami who’s a board- certified specialist in construction law. “Other players such as lenders, carriers and of equal, if not greater import, sureties, may also become involved, further escalating the stakes.”

To avoid that, the possibility of not being able to get the job done in the first place needs to be addressed up front. “No one should first learn what the contract provides for, in terms of bearing the risk for cost increases or product unavailability, after the event that gives rise to the potential claim happens,” Richards said.  

Further advice for contractors

Some experts predict that the supply chain will not fully meet demand until late 2021 or early 2022. Until then, construction companies and contractors should use caution and common sense when bidding on contracts for projects that may not start for several months after proposals are submitted. 

In addition, contractors are advised to keep meticulous records of their change orders, price increases, material delays and other correspondence with their suppliers and customers. Solid documentation can go a long way if projects go wrong and firms need to defend themselves against legal claims.

While owners could push back in these instances, the reality of current market conditions can give contractors leverage in those situations, said Lisa M. Wampler, managing partner of Cohen Seglias’ Pittsburgh office.

“Even though there may be a contractual right to refuse an escalation change order, the customer has to recognize that major material price increases can bankrupt a contractor, and that finding a replacement who can procure the same material at lower prices is unlikely,” Wampler said. “The customer and the contractor need to work together like they did with COVID-19 related delays and expenses. If the parties are most interested in getting the project done on time and at a reasonable price given the circumstances, there are ways to do so as long as the parties communicate and work together.”

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