THE IMPACT OF MATERIAL PRICE ESCALATION ON CONTRACTORS & HOW TO MITIGATE THE FINANCIAL RISK
We’ve been hearing it and we still are, but what does it mean? It means that fixed price contracts with guaranteed maximum prices expose the contractor to bearing the risk of a volatile market.
How do contractors mitigate this risk?
The only certain way for contractors to mitigate this financial risk is through negotiation of a material price escalation clause.
Such clauses help clarify who bears the risk of significant price increases in material because of events beyond the contractor’s control.
There are different types of price escalation clauses that may be appropriate depending on the situation.
How a Price Escalation Cause can help Contractors during Material Price Inflation
There are various types of price escalation clauses that may be appropriate for contractors when it comes to mitigating inflated material prices.
For example, percent-change price escalation clauses allow a contractor to recover costs once their budged costs have increased by a certain percentage.
Some are limited to certain materials. In most cases, large jobs are bid on by contractors several months in advance and take years to complete. Price escalation clauses can help cap the risk of unpredictable material costs over the life of the project.
Force Majeure Clause to protect Contractors
Another provision Contractors should consider is the excusable delay provision. The AIA A201 standard form General Conditions has the following excusable delay provision, sometimes referred to as the Force Majeure clause.
The Force Majeure clause states:
“If the Contractor is delayed at any time in the commencement or progress of the Work by (1) an act or neglect of the Owner or Architect, or of an employee of either, or of a separate contractor employed by the Owner; or Separate Contractor; (2) by changes ordered in the Work; or (3) by labor disputes, fire, unusual delay in deliveries, unavoidable casualties or, adverse weather conditions documented in accordance with Section 188.8.131.52, or other causes beyond the Contractor’s control; or (4) by delay authorized by the Owner pending mediation and arbitration; or binding dispute resolution; or (5) by other causes that the Contractor asserts, and the Architect determines may, justify delay, then the Contract Time shall be extended by Change Order for such reasonable time as the Architect may determine.”
Under this provision, certain disruptions from the virus, including material delay may be deemed beyond the contractor’s control. But these provisions are frequently modified and are separate and distinct from price escalation clauses.
Therefore, it is essential to understand what your contract says and, when entering new agreements, ensure that the negotiated language fits the realities of the current and ever-changing landscape.
Will material prices go down this year?
This is the question many contractors and home builders want to know as they plan for the future. While there are is no clear answer, we can say that the escalated material prices are largely due to the insufficient domestic production and supply chain curtailments.
While there is hope of relief to the increased material prices, there is no definite answer as to if, when and how much material costs will decrease.
Impact on Contractors & What They Can Do
With that said, the best option for contractors when navigating these uncertain times is to implement contractual clauses that protect from potential financial burden caused by inflated material prices.
When evaluating price escalation clauses, it is important that you seek legal counsel. The Construction Attorneys at Garcia & Milas Law Firm are ready and available to help contractors navigate contractual provisions related to increased lumber and material prices.
By Jaime Paoletti, Garcia & Milas, P.C.
Jaime Paoletti is an attorney at Garcia & Milas, P.C. who represents contractors, owners, developers, subcontractors, and design professionals. She routinely drafts and negotiates construction contracts to meet the needs of each project and helps her clients navigate key contractual provisions such as insurance, price escalation, excusable delay, and force majeure.
This publication is for general information purposes only and is not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.