July 7, 2021
De-escalating The Impact of Price Escalation
What happens when construction material prices abruptly rise by 15%, 35%, 50%? Moreover, what happens to a construction project when such volatility occurs? While there is no definite answer, delays in procuring such materials and associated cost overruns will likely impact the construction project. The last 15 months contractors have had to work through extraordinary construction material price increases, such as a 90% price increase for lumber from April 2020 to April 2021. While there is no statistic quantifying the impact these increases have had on the construction industry, the increases surely have had an influence, whether it has been through lost profits, delays, or damage to contractors’ otherwise strong reputation for timely performance.
Considerations Prior To Contract Execution
The first way to mitigate price escalation is identifying materials most susceptible to price volatility during the bidding process and then having an open discussion with upstream parties regarding the potential price volatility. Additionally, the bid may also include either (1) an allowance for the materials providing additional funds, if necessary, should the material price increase, or (2) a shortened timeframe in which the bid is open, which would lessen the time in which a price shift may occur.
Once the bidding is completed, parties may also utilize material price escalation provisions within the contract itself. These provisions are common and frequently incorporated in contracts on both private and public projects. For example, Federal Acquisition Regulation (“FAR”) §16.203-3 permits price escalation provisions in certain agreements. Similarly, ConsensusDocs includes a price escalation provision amendment designed to establish “baseline prices” for materials identified by the parties as potentially “time and price-impacted” and provide a method for adjusting the contract price due to the fluctuation in those baseline prices. See ConsensusDocs 200.1 Amendment No. 1 Potentially Time and Price-Impacted Materials. The ConsensusDocs provision calls for price increases or decreases to specified materials, a “baseline price” for each material designation, and notice requirements for subsequent contract adjustments. The provision also allows for the possibility of a time extension if there is delayed delivery due to material unavailability outside the contractor’s control.
Overall, price escalation provisions have similar characteristics to consider and recognize. First, the provisions require specific identification of the materials to which the clause will apply, or in other words, the parties must identify the materials which are anticipated to have price fluctuations. After identification, parties will agree to the “baseline price” for the materials, which will generally be premised on anticipated or current market conditions and are oftentimes linked to published material cost indexes such as the U.S. Bureau of Labor Statistics’ monthly publication providing national price information on various products, including construction materials (e.g., lumber). Tying the baseline price to a published cost index will provide the parties with an objectively verifiable method of determining the extent of any material price fluctuation. From there, the provisions can sometimes include a minimum fluctuation triggering threshold which will allow for an adjustment only if there is a change over a minimum amount (e.g., there must be an increase over 3% of the market price for there to be a contract adjustment). There also may be limits as to the maximum adjustment amount, such as in FAR § 52.216-2, which sets a standard 10% increase limit. Finally, price escalation provisions will generally require adherence to specified notice procedures to qualify for an adjustment.
While a price escalation clause may initially seem entirely in favor of contractors, the truth of the matter is that they benefit all parties. For contractors or suppliers, the benefits are rather obvious – there is “protection” when facing market conditions similar to those parties are dealing with today (where the costs of certain materials has rapidly increased 50% or more over a year). On the other hand, including a price escalation clause can also benefit owners and other upstream parties as its inclusion may result in limiting delay claims related to material price escalation, avoiding potential costly defaults and terminations, and ensuring that parties are paying relatively close to market prices for the materials used on the project. Accordingly, utilizing price escalation clauses can prove to be the key factor in mitigating the impacts of future material price volatility.
After Executing The Contract – Can I Still Mitigate Price Volatility?
Unfortunately, sometimes it is impossible to foresee which materials will go through abrupt price fluctuations. Thus, what happens when an extraordinary price escalation occurs that the parties did not account for when contracting?
The answer: go to the contract to determine whether a price escalation clause is included or if there are any other provisions that may assist in determining responsibility for unanticipated changes and the steps parties must follow to address such changes. As referenced above, many price escalation provisions include steps parties must follow to adjust a contract when fluctuation occurs. Other contract provisions should also be reviewed for guidance and potential alternative relief. For instance, parties should check whether the contract includes a force majeure provision addressing delays caused by events outside the contractor’s control. While these provisions will, if certain criteria are met, typically allow for additional time to perform the contract work, they often will not allow additional compensation. Similarly, change order provisions should be carefully reviewed to determine the extent the contract price may be adjusted on account of either a change in the scope of work or price relating to material price fluctuation. The change order provisions will likely specify the documentation needed and requirements contractors must follow to obtain and request a price adjustment. Finally, it is also prudent for parties to be aware of any contract acceleration clauses. By way of example, where price escalation coincides with a delay in the delivery of materials, the owner may have a right to require acceleration and the contractor may have additional rights and remedies when such acceleration is required.
While the above considerations may assist parties facing unforeseen material price escalation, the below action items may promote the mitigation of such escalation:
- Review and Research – Before negotiating your contract, do your research on the price volatility of materials required for the project by using experienced contractors or suppliers and examining U.S. Deptartment of Labor national price index statistics.
- Price Escalation Clauses – Negotiate a price escalation clause that works for you. There is no uniform clause that fits every contract but consider using a clause allowing for a triggering price that can adjust both upward and downward.
- Document – Make sure to continue your review of material prices throughout the course of the project and keep detailed documentation of price changes along with potential supply chain disruptions that may impact work.
- Early Purchasing – If possible, allow parties to pre-purchase, and be paid for, materials which can be ordered early and which may be particularly susceptible to volatility.
- Communicate – Be sure there is open communication between the parties. Open and comprehensive communication can lead to mitigation efforts by all parties. If a contractor is faced with unanticipated price escalation, promptly advise the upstream party to work together to come up with alternative materials or revised plans for the project.
Overall, there is always one common goal – timely and acceptable project completion. If parties execute these steps, they can work together towards that common goal through de-escalating the impact of price escalation.
Watt Tieder is one of the largest construction boutique law firms in the United States, with a diverse and experienced team of attorneys representing many of the world’s leading corporations, developers and contractors on both domestic and international projects. We represent more than half of the Top 30 Engineering News Record contractors and most of the nation’s top sureties. With offices in six cities in the United States, the firm is a dynamic, mid-size boutique that provides knowledgeable and practical legal representation to the construction, surety, government contracts and bankruptcy industries world-wide.
The views expressed in this article are not necessarily those of ConsensusDocs. Readers should not take or refrain from taking any action based on any information without first seeking legal advice