The COVID-19 pandemic has had implications that no one ever expected (toilet paper shortage anyone?). Added to the ever growing list of unanticipated consequences: price escalation in construction projects.
In April 2021, supply chain disruptions started leading to increased costs associated with construction projects, and those increased costs have remained in place with very little light at the end of the tunnel. Between April 2020 and April 2021, input costs (e.g. materials, labor, etc.) for construction projects increased 26.1%.[1] In that same time period, bid prices (i.e. how much a contractor charges for the project) increased only 5.2%.[2] In other words, prices are going up for both contractors and buyers, but contractors are bearing the burden of approximately 21% of the price increases.
So, what can contractors and owners do to protect themselves in a time when price escalation is so unpredictable? In the past, force majeure clauses seemed to be the only option. However, these clauses generally provide only additional time for contractors to complete a construction project if an event which is out of its control occurs. This, on its own, is an impractical solution for the problems faced by contractors and owners in 2021 and that will likely continue into 2022. While supply chain disruptions may result in delays, the biggest issue facing both contractors and owners at this point is increased costs, which force majeure clauses do not address.
If a force majeure clause isn’t the solution, what is? For both contractors and owners, the answer is the same: when negotiating over a new construction contract, request that a price escalation clause be included. To be effective, a price escalation clause should set a baseline price, the bid price of the contract, a ceiling price, and a floor price. It should also be reciprocal and include language that protects both contractors, increasing the baseline price in the event of cost increases, and owners, decreasing the baseline price in the event of cost decreases. Moreover, the price escalation clause should state that any changes, increases or decreases, to the baseline price are based on an objective index, such as a consumer or producer price index, which the parties agree to during the contract formation stage. Both contractors and owners should work with their legal team to ensure that the price escalation clause is enforceable and [fair] to all parties.
If drafted well, a price escalation clause will protect both the contractor’s interest and the owner’s interest during this unprecedented time of supply chain issues and construction cost increases. If you have questions about adding a price escalation clause to your construction contract, please feel free to reach out to the Winthrop team.
[1] Paul Emrath, Nat. Assoc. of Home Builders, Record Numbers of Buildings Report Material Shortages (May 27, 2021), https://www.bls.gov/news.release/ppi.nr0.htm.
[2] Associated Gen. Contractors of Am., Prices for Constr. Materials Continue to Outstrip Bid Prices Over 12 Months, Despite Dip in Sept., Amid Increasing Supply-Chain Problems (Oct. 14, 2021), https://www.agc.org/news/2021/10/14/prices-construction-materials-continue-outstrip-bid-prices-over-12-months-despite
