Like almost every other aspect of life, global supply chains have been upset by the pandemic. It has increased the costs of construction materials and disrupted construction schedules due to late deliveries. Impacts to the costs of materials and time of delivery obviously can have a financial impact on contractors. If the contract does not provide for contractor claims for material cost escalations, or prohibits such claims, the contractor may be liable for the escalation. Further, if material delivery delays in turn delay the project, a contractor could face the assessment of liquidated damages.
In previous articles, I discussed ways to potentially mitigate the risk of the assessment of liquidated damages due to pandemic-related delays through the invocation of contractual force majeure provisions and/or the common law doctrines of frustration of purpose and impracticability of performance. Given the unprecedented increases in material costs and delays in delivery of materials, contractors facing the assessment of liquidated damages should review their contracts for a force majeure provision or, in the absence of one, consider the common law defenses mentioned above and discussed in my previous articles.
However, contractors faced with astronomical material cost increases may also wonder whether they are locked into their bid price and whether they can get some financial relief from the owner. Some contracts contain – and likely most future contracts will contain – provisions that address this question. On the less equitable end of the spectrum of those contract provisions, owners may try to place all of the liability for material cost escalations on the contractor.
For example, a contract may provide that material escalation costs are to be included in the bid and that no cost escalation charges are allowed. Whether such a provision would be effective to bar claims by contractors for material cost escalations is evidently not an issue that has been addressed by an Oregon appellate court. However, considering such a provision in light of the unprecedented escalation in material costs due to pandemic-related supply chain issues, a contractor could argue that such price escalations were unforeseeable at the time the parties entered into the contract. In other words, the contractor could not have foreseen the astronomical cost increase and therefore could not have reasonably been charged with including that contingency in its bid. Whether this argument would prevail against an unambiguous prohibition against material cost escalation claims is unknown.
On the kinder, more certain end of the spectrum, some contracts contain provisions that attempt to more fairly allocate the risk of material cost escalations. Such provisions typically provide that the contract price will be equitably adjusted through the change order process when there is a “significant” materials price increase. A “significant” price increase is usually defined as an increase of 20 percent or more from the contract date to the date of installation of the materials.
Some provisions cap the allowable cost increases to a percentage of the originally anticipated cost of the material. The presence of such a provision can provide clarity and assurance to both the owner and the contractor by allocating the risk more equitably, with the contractor knowing that it will not have to completely absorb the cost increase, while providing the owner assurance that its liability for any escalation has a limit.
That said, most contracts entered into prior to the recent supply chain issues fall in the middle of the spectrum; that is, they do not address material cost escalations. The reason for that absence is likely because, prior to the pandemic, prices have generally not risen so sharply in such a short period of time. While material cost escalations did occur prior to the recent supply chain issues, in general those escalations could be anticipated and addressed in the contractor’s bid. Contracts that do not reasonably or clearly allocate the risk of material cost increases (i.e., the majority of contracts entered into prior to the supply chain issues) have left contractors and owners in uncharted territory, with the contractor’s expectation of profitability competing with the owner’s expectation of staying within budget. Which interest will prevail will be left to negotiation and, inevitably, litigation.
Regardless of where the contract falls on the spectrum of its treatment of material cost escalations, to preserve its claim, a contractor should immediately put the owner (or general contractor in the case of a subcontractor or material supplier claim) on notice of the price escalation and follow the contract’s change order and/or request for equitable adjustment procedure. Additionally, contractors should attempt to negotiate informally with owners to obtain an equitable adjustment. Reasonable owners should recognize that even if the contract does not address material cost escalations, or even if it prohibits such claims, the present pandemic-caused material cost escalation was unforeseeable if the contract was entered into prior to the supply chain issues.
Going forward, contractors should attempt to negotiate the inclusion of price escalation provisions in their contracts to avoid potentially being liable for the full amount of the material cost escalation. These provisions can and should be as specific as possible. That is, if contractors are aware that the cost of certain materials may increase dramatically between the date the contract is signed to the date of performance, they should specifically provide for that possibility in the material cost escalation provision. Some consideration and risk allocation at the contract negotiation phase is vastly preferable to litigation when the project is complete.
Brent Carpenter is a Jordan Ramis PC shareholder. He focuses his practice on construction law. Contact him at 503-598-5524 or firstname.lastname@example.org.