“Always plan ahead. It wasn’t raining when Noah built the Ark.”
Cost Increase Issues
The pandemic continues to trouble the construction industry in many ways. One of the most significant is the erosion to the contractor’s bottom line. The lack of materials due to supply chain impacts, as well as increased production costs, have caused prices for building materials to soar to unparalleled heights. The usual suspects for price escalation – steel, copper, lumber, engineered wood products and plastic-based materials – have seen unpredictable price fluctuations over the past year to a degree not seen in decades.
Material Shortage/Labor Pinch
The Wall Street Journal reported recently that 73 ships were waiting to unload cargo off the coast of Southern California and 20 vessels were anchored off the Port of Savannah. These have added to the disruption in the supply chains for construction materials and are increasing the cost of construction.
Cost increases and time delays are not just related to materials. The difficult labor market (finding the workers to put materials in place) can also be a major challenge.
During the bidding phase of a project, contractors, subcontractors, and suppliers should identify which materials are most susceptible to price volatility and discuss them with the upstream contracting party. Downstream contractors and suppliers also should be wary of bidding requirements which require them to bear the sole risk of any price escalations and should modify their standard bidding forms and proposals to include general price escalation clauses.
Mitigating the Risk
Generally speaking, a contractor bears the risk of price increases in materials that occur between the time of contracting and the time of purchase. However, there are ways to mitigate your risks, some practical and some contractual.
One way to insulate against price escalation is through negotiation of a material escalation clause. A typical escalation provision acknowledges that the contract price is based on current pricing for building materials, but that certain building materials are considered subject to sudden price increases. For instance, an escalation provision may provide for an equitable adjustment if the price increases exceed a certain threshold percentage of the as-bid price.
Owners want price certainty, and usually balk about negotiating price escalation clauses. One idea to make an escalation provision more acceptable to an owner is to limit the provision to specific types of materials (for example, copper, engineered lumber products, etc.) based upon a threshold percentage of increase from the as-bid price. Another way is to include a corresponding savings provision that account for any decrease in pricing for materials to the owner’s benefit. Any dealings require transparency by all parties both in the negotiations and conduct of the contract.
Be aware that the delay provision in a typical construction contract providing for an equitable adjustment for material cost increases to you caused by project delays beyond your control may not be enough to protect you. No damages for delay provisions (also common in construction agreements) can legally weaken your request for equitable adjustment for price increases incurred due to project delay.
Another possible idea is a financial contingency for material escalation provision in your agreement. The contingency can identify specific types of construction material, such as copper or engineered wood products that are traditionally unstable and set a threshold percentage of increase in pricing that allows you the right to access this contingency. The contingency is for the benefit of the contractor but offers some cost certainty and dispute avoidance for the owner. It can be a “win/win” for both parties.
An alternative to these contract provisions is for the contractor to procure and store its materials at the beginning of the project. A contract clause of this type allows the contractor to procure materials at the very beginning of the job to ensure the procurement occurs while the material supplier’s quoted price at the time of bid remains viable. The contractor gets partial payment up-front for stored materials, and the owner obtains assurance that no claim for material escalation will arise later on in the job.
Because of the likelihood of labor shortages will be a problem in the construction industry for some time to come, your escalation clauses should be for labor, also.
Although addressing the problem of escalating prices/ costs for both materials and labor are best handled when negotiating the terms to your contract, this is not always possible for a variety of reasons. The standard form AIA contracts do not contain escalation clauses and most contractors and owners are unwilling to change the terms of those agreements. The pressure may well be on your estimating team to account for those likely cost increases within your bids.
Now, more than ever, you must carefully read the form contracts provided by owner, because they usually provide that the contractor is solely responsible for material and labor cost increases.
Whatever approach you are best able to use, the goal is to have your projects run as smoothly as possible and to avoid unnecessary litigation. Avoiding litigation is in the best interest of both the owner and the contractors. An open and honest negotiating process is one of the best ways to achieve this goal.
Before signing on the “dotted line”, talk to an attorney who knows the construction industry and your profession. Abraham Lincoln’s advice has never been more appropriate than now: “Give me six hours to chop down a tree and I will spend the first four sharpening the axe.”