price escalation clauses in construction contracts
TRANSCRIPT
Price Escalation Clauses in Construction Contracts: Mitigating Risks for Owners, Contractors, and Subcontractors
Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 1.
WEDNESDAY, AUGUST 25, 2021
Presenting a live 90-minute webinar with interactive Q&A
V. James Dickson, Of Counsel, Adams and Reese LLP, St. Petersburg, FL
Jeffrey M. Reichard, Member, Nexsen Pruet LLC, Greensboro, NC
Tips for Optimal Quality
Sound QualityIf you are listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection.
If the sound quality is not satisfactory, you may listen via the phone: dial 1-877-447-0294 and enter your Conference ID and PIN when prompted. Otherwise, please send us a chat or e-mail [email protected] immediately so we can address the problem.
If you dialed in and have any difficulties during the call, press *0 for assistance.
Viewing QualityTo maximize your screen, press the ‘Full Screen’ symbol located on the bottom right of the slides. To exit full screen, press the Esc button.
FOR LIVE EVENT ONLY
Continuing Education Credits
In order for us to process your continuing education credit, you must confirm your participation in this webinar by completing and submitting the Attendance Affirmation/Evaluation after the webinar.
A link to the Attendance Affirmation/Evaluation will be in the thank you email that you will receive immediately following the program.
For additional information about continuing education, call us at 1-800-926-7926 ext. 2.
FOR LIVE EVENT ONLY
Program Materials
If you have not printed the conference materials for this program, please complete the following steps:
• Click on the link to the PDF of the slides for today’s program, which is located to the right of the slides, just above the Q&A box.
• The PDF will open a separate tab/window. Print the slides by clicking on the printer icon.
Recording our programs is not permitted. However, today's participants can order a recorded version of this event at a special attendee price. Please call Customer Service at 800-926-7926 ext.1 or visit Strafford’s website at www.straffordpub.com.
FOR LIVE EVENT ONLY
"Price Escalation Clauses in Construction Contracts: Mitigating Risks for Owners, Contractors, and Subcontractors
Wednesday, August 25, 1:00pm-2:30pm EDT.
Jeffrey M. ReichardNexsen Pruet LLC
Greensboro, NC
V. James DicksonAdams and Reese LLP
St. Petersburg, FL
Strafford Webinars
Over the past year, lumber and steel prices havetripled, PVC and copper prices have almostdoubled, and certain material suppliers haverefused to hold pricing for more than twenty-four hours.
Who bears the risk of these price escalations?
The Problem – Price Escalation
The answer to the Question should be based on the terms of the Contractbetween the parties.
It often depends on the type of contract:
• Fixed price contracts – The downstream entity usually bears the risk.• Cost-plus contracts – The upstream entity usually bears the risk.• Cost-plus with a Guaranteed Maximum Price.
If the Question is not addressed in the Contract, the Answer may become arole of the dice.
Contract Type
Project Price Structure Time and Material/Cost Plus Fee Price:
For Projects priced on Time and Material or Cost Plus Fee, the Ownerwould typically be responsible for material price escalation. Such pricingprovides Owners with limited price escalation protection while providingdownstream Contractors with significant flexibility.
Lump Sum/Fixed Price:A fixed price gives an Owner substantial protection while providing downstreamContractors with limited ability to pass price increases to Owner without an Extra PriceEscalation clause that that allows the Contractor to charge the Owner for unexpectedmaterial price increases or price impacts from delays in delivery.
Cost Plus Fee with Guaranteed Maximum Price (GMP):A Cost Plus Fee with GMP Price structure offers a modest protection for both Owners anddownstream Contractors. While a Contractor can reduce risks in price escalation by thisstructure especially with a material escalation contingency line item, it still providesOwner with an upside limit.
Legal ArgumentsIn the absence of clear contract terms related to priceincreases, the parties may assert legal doctrines such as:
• Impracticability / impossibility / frustration of purpose
• Force majeure
• Mistake of fact
• Cardinal change
Impossibility / Impracticability / Frustration of Purpose
• Impossibility is a concept recognized in unforeseen events that make performances of a contractobligation impossible. It has been defined as circumstances:• Where, after a contract is made, a party's performance is made impracticable without his fault by
the occurrence of an event the non-occurrence of which was a basic assumption on which thecontract was made, his duty to render that performance is discharged, unless the language or thecircumstances indicate the contrary. See Restatements of Contracts 2d Section 261.
• Was it impossible or just more expensive?
• Many courts have held that price escalations do not justify rescission of the contract under the doctrinesof frustration or purpose or impracticability. See, e.g., D.S. Simmons, Inc. v. Steel Group, LLC, 2008 WL488845 (E.D.N.C. 2008) (relying on UCC § 2-615).
• However, UCC § 2-615 Comment #4 says “Increased cost alone does not excuse performanceunless the rise in cost is due to some unforeseen contingency which alters the essential nature ofthe performance. Neither is a rise or a collapse in the market in itself a justification, for that isexactly the type of business risk which business contracts made at fixed prices are intended tocover. But a severe shortage of raw materials or of supplies due to a contingency such as war,embargo, local crop failure, unforeseen shutdown of major sources of supply or the like, whicheither causes a marked increase in cost or altogether prevents the seller from securing suppliesnecessary to his performance, is within the contemplation of this section.”
• Was price escalation due to COVID-19 foreseeable at the time of contracting?
Force MajeureMany contracts contain a clause that extends the time to perform obligations or excuses a partyfrom contractual obligations due to unforeseen circumstances and events outside the control ofthe contracting parties. Usually results in an extension of time, but not more money. An exampleof such a clause follows.
Force Majeure. If either party hereto shall be delayed or hindered in or prevented from theperformance of any act required hereunder by reason of strikes, lockouts, labor troubles,inability to procure material, failure of power, restrictive governmental laws or regulations,riots, insurrection, war, environmental remediation work whether ordered by anygovernmental body or other reason of a like nature not the fault of the party delayed inperforming work or doing acts required under this agreement, the period for theperformance of any such act shall be extended for a period equivalent to the period of suchdelay.
See also Section 8.3.1 of the AIA A201-2017
Force Majeure clauses are enforceable in most states. Force majeure clauses, however, aresubject to the express terms of the document. Courts have seldom utilized such clauses forprice increases or a loss of profitability. See Seaboard Lumber Co. v. United States, 308 F.3d1283, 1288 (Fed. Cir. 2002)
Mistake of Fact
Mutual MistakeThe mutual mistake of fact doctrine does not apply where the mistake pertains to afuture contingency or probability regarding the certainty of a future performancerather than a fact that existed at the time when the parties entered the agreement.
Unilateral Mistake“A unilateral mistake, unaccompanied by fraud, imposition, undue influence, or likeoppressive circumstances, is not sufficient to avoid a contract or conveyance.”Financial Services v. Capitol Funds, 217 S.E.2d 551, 560 (N.C. 1975).
Cardinal ChangeUnexpected events, conditions or changes in work that so changes the scope of performance“that fundamentally alters the contractually undertaking of the contractor” might be considereda cardinal change in the contract obligations. Atlantic Dry Dock Corp. v. United States, 773F.Supp. 335 (M.D.Fla.1991). In circumstances of a cardinal change, the contract terms areessentially rescinded and subject to new obligations created by the cardinal change inconditions of the Work. By definition then, a cardinal change is so profound that it is notsubject to redress under the contract. Air-A—Plane Corp. v. United States, 408 F.2d 1030(Ct.Cl.1969); Atlantic Dry Dock Corp. v. United States, 773 F.Supp. 335 (M.D. Fla.1991).
A cardinal change is not contemplated by the normal changes. See Saddler v. United States,287 F.2d 411, 152 Ct.C1. 557 (1961); and Magoba Constr. Co. v. United States, 99 Ct.Cl. 662(1943). If the actual work and schedule required of a contractor is so different from the workand schedule it could have reasonably anticipated from the contract documents, it may be ableto assert the existence of a cardinal change and seek total compensation based on the value ofthe work performed as changed.
"A cardinal change can occur even when there is no change in the final product because it isthe entire undertaking of the contractor, rather than the product to which we look.“ J.A. JonesConst. Co. v. Lehrer McGovern Bovis, Inc., 120 Nev. 277, 295, 89 P.3d 1009, 1021 (2004).
Pre-Contracting Mitigation
• Should start in the bidding or proposal process.
• Contractors should identify which materials are most susceptible to price
volatility.
• Be aware of bid documents that contain terms that limit change orders related to
price escalation.
• Proposal could include price escalation language.
• Proposal could be available for acceptable for a limited period of time.
• Could include allowances or large contingencies.
• Owners may will want deductions in the event of price decreases.
• Consider payment/performance bonds or subcontractor default insurance
Pre-Contracting Mitigation
To develop a mutually acceptable price escalation clause all parties need torecognize potential volatility in material price increases. Factors should includean analysis of the following:
Can specific materials be identified that will likely have short term volatilepricing?
Can a common understanding be reached as to what constitutes volatilepricing (i.e., 5% over 30 days or 30% over 180 days)?
Can contractors or owners identify any suppliers that will provide fixedpricing for specific materials for a period of time?
Can materials be ordered at commencement of project and stored on-site or atapproved off-site location until needed?
Price Escalation Provisions
There are many different types of price escalation provisions that can be included in a construction contract, but the three most common types are:
(1) any-increase escalation clauses;
(2) threshold escalation clauses; and
(3) delay escalation clauses.
Any-Increase Escalation Clauses
ExampleAn increase in the price of any construction materials used in the Work between the date of Contractor's bid and the date of installation shall warrant an equitable adjustment of the Contract Sum.
While such general language alerts the parties to potential adjustments, it doesnot provide standards as to the extent of such adjustments, and thus remainssusceptible to disputes.
Threshold Escalation Clauses
ExampleAn increase in the price of any construction materials used in the Work of more than 5% between the date of Contractor's bid and the date of installation shall warrant an equitable adjustment of the Contract Sum.
Upstream entities may want to include a cap on the price escalations as well. For example, FAR §§ 52.216-2 and 52.216-3 include a 10% cap.
Establishing a range of when a price escalation is considered a materialchange may offer a better framework to achieve a mutual understanding andoperational price escalation clause. Such clauses will require documentationand may provide for adjustments of full or partial increased costs.
Delay Escalation Clauses
ExampleThe Contract Sum assumes that the Project will reach Substantial Completion on or before _______. If the Project is delayed through no fault of Contractor or its Subcontractors more ___ days beyond the aforementioned date, the Contract Sum shall be equitably adjusted to account for any price escalations incurred as a result.
The prior comments regarding materiality of cost increases are equally applicable to impacts due to delays in delivery .
Annual Price Adjustment Clauses
Some ongoing material supply contracts contain an annual price adjustment clause similar to the following.
The Price may be adjusted upward or downward on each anniversary of the Commencement Date by an amount that is mutually agreed upon by Supplier and Customer and that is reflective of then current market condition.
Such a clause is vague and requires mutual agreement. As noted previously, agreements to agree are inherently unenforceable. Parties can not be forced to reach an agreement.
Establishing Baseline Prices
A dispute may arise regarding whether a material price escalation has occurred.
A solution is the include baseline pricing in the contract.
ExampleThe Contract Sum has been calculated based on the prices for construction materials identified in the following chart (collectively, the “Baseline Prices”). In the event of an increase or decrease between a Baseline Price and the actual cost incurred by Contractor in procuring the construction materials identified below, the Contract Sum shall be equitably adjusted to account for such increase or decrease upon written notice from Contractor to Owner identifying the actual cost incurred for such materials.
Remember that an Owner perspective is that its funding is limited and pricing should not change unless scope of work changes. Downstream Contractors and supplier perspective is that any unexpected event is justification for an Extra.
Material Price Per (Unit of Measurement) Date Supplier
ConsensusDocs 200.1 Amendment No. 1 Potentially Time and Price-Impacted Materials
1. POTENTIALLY TIME AND PRICE-IMPACTED MATERIAL As of the date of this Amendment, certain markets providing essential materials to the Project are experiencing or are expected to experience significant, industry-wide economic fluctuation during the performance of this Agreement that may impact price, availability and deliver time frames (“Potentially Time and Price-Impacted Material”). This Amendment provides for a fair allocation of the risk of such market conditions between the Owner and the Contractor and shall only apply to the Potentially Time and Price-Impacted Material(s) listed in Schedule A to this Amendment.
2. BASELINE PRICE AND TIME Owner and Contractor shall agree upon method for establishing the market price as of the date of this Amendment (“Baseline Price”) and the method for calculating an adjustment in the pricing for a Potentially Time and Price-Impacted Material listed in Schedule A to this Amendment.
2.1 Compensation for any Potentially Time and Price-Impacted Material shall not be duplicated in any contingency amounts established under the terms of the Agreement.
3. ADJUSTMENT IN BASELINE PRICE If during the course of the Project a Potentially Time and Price-Impacted Material item experiences an increase or decrease in its Baseline Price, either Party may notify the other in writing within thirty (30) Days from the dat the basis for equitable adjustment to the Contract Price, pursuant to Article 8 of the Agreement arises and shall provide appropriate documentations Material shall not include any amount overhead and profit.
3.1 In the event of a decrease in a Baseline Price, the Contract Price shall be equitably adjusted to reflect such decrease, subject to Paragraph 3.3 of this Amendment, but only for those Potentially Time and Price-Impacted Materials delivered on or after the date on which written notice of the adjustment in Baseline Price is given.
3.2 In the event of an increase in a Baseline Price, the Contract Price shall be equitably adjusted to reflect such decrease, subject to Paragraph 3.3 of this Amendment, but only for those Potentially Time and Price-Impacted Materials delivered on or after the date on which written notice of the adjustment in Baseline Price is given.
3.3 The Contract Price shall not be adjusted by more than __________________________ (______%) percent of the original Contract Price for the aggregate of the increases or decreases in Baseline Prices for Potentially Time and Price-Impacted Materials.
3.4 No adjustment shall be made for any quantities of Potentially Time and Price-Impacted Materials scheduled for delivery under the terms of this Agreement prior to the date on which written notice of the adjustment in Baseline Price is given, unless the failure to deliver such quantities before that date is beyond the control of and without the fault of the Contractor, its Subcontractors and Material Suppliers.
3.5 Payment, if any, for an adjustment shall be made in accordance with the terms of the Agreement.
4. TIME-IMPACT AND AVAILABILITY If the Contract is delayed at any time in the commencement or progress of the Work due to a delay in the delivery of, or unavailability of, a Potentially Time and Price-Impacted Material, beyond the control of and without the fault of the Contractor, its Subcontractors and Material Suppliers, the Contractor shall be entitled to an equitable extension of the Contract Time and an equitable adjustment of the Contract Price in accordance with Paragraph 6.3 of the Agreement. The Owner and Contractor shall undertake reasonable steps to mitigate the effect of such delays. Notwithstanding any other provision to the contrary, the Contractor shall not be liable to the Owner for any expenses, losses or damages arising from a delay in the delivery of a Potentially Time and Price-Impacted Material item not the fault of the Contractor, its Subcontractors and Material Suppliers.
Commonly used AIA documents do not directly address material price escalation.AIA Document A503-2017; Guide for Supplementary Conditions, includingAmendments to AIA Documents A201 and Owner Contractor Agreements provide incomments A201, Section 3.8 Allowances the following comment.
Unanticipated price escalations in construction materials after the contract isexecuted have caused concern to owners and contractors. If the Owner andArchitect are concerned about facing such price escalations in certainmaterials, they should identify those materials prior to the bid and provide forthem in the bidding requirements as allowances.
While allowances may be a method of addressing price escalation of products, itplaces the risk of such costs almost exclusively on the Owner. Owners wouldtypically reject that approach.
Other Potentially-Relevant Provisions
Even with express price escalation clauses, other common contract provisions could impact the ability to obtain payment for price escalations, including:
1. Price Structure.
2. Rights and Limitations to Extras.
3. Exculpatory Clauses.Contingent Payment TermsPay-When-Paid ClausesFlow Down ClausesWaiver of Consequential Damages
1. Price Structure
The impact of the Price Structure was discussed in Slide 4. As noted in that slide:
Fixed prices place primary risk on downstream parties in the absence of a price escalationclause.
Cost Plus Fee or Time and Material put primary risk on the Owner similar to the use of anAllowance.
A Cost Plus Fee with GMP Price structure offers a modest protection for both Owners anddownstream Contractors. A Contractor can reduce risks in price escalation with a materialescalation contingency line item but still provides Owner with an upside limit that it canaccept. Use of “Savings Fee” to spit final cost below GMP provides an incentive to reducecosts but there remains the potential conflict over claims that Cap should be increased toreasonably allow a right to obtain the savings fee.
2. Right to Extras
Any increase in Price on a Construction Project may be consideredan “Extra”.
Many contracts contain express limitations on Extras. Examples include:
Notice Provisions – No right to an Extra unless notice given with limited time periodafter discovery of event;
Notice Provisions – No right to an Extra unless notice given prior to performance ofwork or delivery of material;
No Damages for Delay – No right to an Extra for costs associated with delays even iftime extensions possible.
Acceptance of Payment (progress or final) shall constitute a waiver of any preexistingclaim for an Extra known by Contractor but not noticed to Owner prior to the Payment.
Change Order Clauses – No change order except for Owner caused increase in Work; Change Order Clauses -- No right to Extra unless in accordance with Contract provision
for additional costs;
Such provisions can serve as an additional limitation even if a clause provides a basis toseek a price increase due to material price escalation.
3. Exculpatory Clauses – Pay-If-Paid, Pay-When-Paid and Flow-Down
Upstream Owners/ Contractors typically want conditions to be met before a Price is paid or aPayment is due. These are known as contingent payment or condition precedent provisionsthat can limit right of payment.
An example of such clauses is a “pay when/if paid” clause. An Owner may condition itsobligation to make payment upon receipt of funds from the Construction Lender. More oftena General Contractor often conditions payment to Subcontractors on receipt of paymentfrom the Owner. (“Pay When Paid clause”). If the Contractor is not entitled to payment for aprice escalation, the Subcontractor may similarly be barred from such Extra by such aclause.
Another example in a Subcontract is a requirement to comply with an Owner’s Flow DownClause. In a subcontract with a flow-down clause, the Subcontractor assumes the samelegal obligations and limitations exist in the Contractor’s agreement with the Owner. If thereis a limit on Extra claims in the primary contract such terms may limit Extras by theSubcontractor.
Some of these provisions are unenforceable under some states law.
3. Exculpatory Clauses – Waiver of Consequential Damages
Indirect or consequential damages are often subject to a waiver of such claims.
To the extent the payment of price escalation costs could be a contract duty, the scopeof recoverable unpaid costs that are indirect or consequential costs could be impactedby such a waiver of consequential damages.
A common example of such a clause:
All consequential damages except liquidated damages for delay are waivedregardless of the cause. This waiver includes:
Damages incurred for rental expenses, for losses of use, income, profit, financing,business and reputation for loss of management or employee productivity or of theservices of such persons; or damages incurred for principal office expensesincluding the compensation of personnel stationed there.
Also see AIA A201-2017 Section 15.1.7
Mitigation After Contracting
• Closely monitor costs and pricing changes
• Provide immediate notice to the upstream party
• Consider purchasing materials early
• Can the contractor bill for stored materials?
• Communication is the key
