Contractual Protection: Sharing the Risk of Escalating Prices for Material

/
Facebooktwitterlinkedinmail

By RICHARD A. STOCKENBERG

Dick Stockenberg

Lump sum construction contracts are designed to provide for the comfort of certainty, or at least relative predictability. But in times of uncertain and volatile economic conditions when prices for materials are neither certain nor predictable, an enhanced level of risk is introduced into the equation, resulting in a need to head to shore to seek the comfort of a safe harbor.

During periods of escalating prices, not even an owner with an ironclad lump sum contract can be assured it has the best deal it can get. For example, when contractors are unsure that they can procure materials for the duration of the project at the same price as contained in their bids, it will not come as a surprise that savvy contractors have built into their bids a “material escalation factor” that is perhaps more than is needed. In that case, the owners may be paying more than necessary.

To avoid such a dilemma, an option that may work for some owners, but not others, is to pre-purchase materials, especially if there is storage space available and insurance coverage.

Another source of possible relief is to provide for a line-item contractual contingency fund to be drawn upon when material prices exceed a defined level.

Contractors and subcontractors sometimes qualify their bids to allow for adjustments when there are unusual price increases in materials, equipment and energy. In such case the bidder, in order to receive an adjustment, will have to reveal how it priced these commodities, and most importantly it needs to assure that the price escalation qualification language found in the bid finds its way into the contract. This is particularly important for subcontractors who often have subcontract language saying that their bid does not become a binding contract document.

However, in reality there is no perfect solution that will eliminate all risk for all parties. As a matter of principle, risk should be borne by the party who can best control the risk. But when it comes to price escalation for materials, it can be generally said that parties who sign construction contracts have little, if any, control over such escalation. Fortunately, stakeholders in the construction industry are not totally averse to risk; if they were, they would find employment elsewhere.

ConsensusDocs’ Response

ConsensusDOCS is a consortium of 40-plus trade associations formed for the purpose of agreeing on fair and equitable – but not perfect – contract terms, especially as those terms deal with how risks are shared, not shifted. These documents do not contain one-sided clauses designed to purposefully shift risks downstream. Instead, they are drafted to find a balance that is equitably apportioned.

ConsensusDOCS is believed to be the first, if not only, publisher of a standard material price escalation clause (ConsensusDocs 200.1). This material escalation clause allows users to list specific materials affected for their project, and it may adjust the contract price by referencing an agreed-upon objective market index. In fact, only commodities specifically identified can potentially be adjusted up or down, and the parties may limit the extent of the adjustment.

The new language is intended to be completed and executed contemporaneously with the construction contract. Because it is intended to be flexible and to cover many different kinds of materials, calculation methods are suggested, e.g., established market or catalog prices; actual material costs; material cost indices. 

The document can also be incorporated into subcontract agreements and others, such as design/build and construction management at risk.

Safeguards are built into the language. For example, documentation for adjustments is required. The number of increases/decreases can be limited; however, the Associated General Contractors has noted that using a cap eliminates some of the benefit of a contractor eliminating contingency in submitted bid amounts.

The new form also addresses time extensions in the event of project delay caused by scarcity or delivery delay. Adjustments to time and money are not allowed for impacts caused by the contractor or its subcontractors or suppliers.

Also, the clause can function as a de-escalation clause when prices go down, thus allowing for mutuality to the owner’s financial benefit.

In addition to the duty of both the contractor and the owner to mitigate damages due to price escalation, the contractor is not allowed to include overhead and profit in any price adjustment.

Like the entire family of contract documents published by ConsensusDOCS, the new price escalation clause represents a consensus of a broad spectrum of construction industry stakeholders. Whether the ConsensusDOCS form is used, parties at all levels should consider some form of contractual protection extending the entire length of the contractual food chain, starting with the owner and extending down to the lower tier subcontractors and suppliers.

Richard A. Stockenberg, founder of The Stockenberg Law Firm LLC, limits his law practice to construction law. He can be reached at richard@stockenberglawfirm.com.

Facebooktwitterlinkedinmail

Leave a Reply

Your email address will not be published.

This site uses Akismet to reduce spam. Learn how your comment data is processed.