Central to any construction project is the issue of money – how to control unexpected costs, and who is responsible for it. In the construction industry, the fluctuation of material prices is a constant. This year, in particular, has experienced intense material cost escalations in the aftermath of the COVID-19 pandemic. The price of lumber, in particular, has tripled within the past year. It is anticipated that other materials such as petroleum, steel, cement, and copper will also increase as economies recover from pandemic related shutdowns.
These soaring costs are causing serious financial consequences for parties to construction contracts, which typically dictate whether the contractor, supplier or owner is responsible for the increased bill. Contracts written without escalation clauses that are susceptible to dramatic price increases are more likely to be open to litigation. The proper contract language can provide a basis for relief. And while escalation clauses are not new, they are more important than ever.
Escalation clauses are typically used on larger sized construction projects or projects that span several years. As the name implies, an escalation clause is a provision in a contract that calls for adjustments in fees, wages, or other payments to account for fluctuations in the costs of raw materials or labor. This clause shifts the burdens for increasing materials and labor costs from the contractor to the client. For instance, the clause can specify that if a certain building material, i.e., lumber, increases by a certain percentage, then the client would be responsible for paying the higher cost. Including such a clause allows all parties to be on notice that the contract costs could change if labor or materials prices rise due to supply constraints outside the builder’s control.
Material escalation clauses vary. Some contracts include a material price escalation clause that allows the parties to adjust the price based on an agreed-upon metric. For example, the measure could be the difference between the price quoted at bid time and the price of the material when delivered if the price change exceeds an agreed-upon threshold. This provision can also work as a savings clause if material prices decrease beyond a certain threshold, which can be a useful incentive to facilitate the inclusion of an escalation clause in your contracts.
Threshold escalation clauses allow compensation to the contractor when price increases exceed a certain percentage or dollar amount tied to a published material price index. The index must be identified in the contract and generally available for reference.
Delay escalation clauses hold a fixed price for a limited period of time and allow the contractor additional compensation if the project is delayed beyond a given number of days or a specified date. It is intended to reimburse the contractor for increased costs that occur during the delay.
Escalation clauses, while not new, are more important than ever in this current volatile economic climate. Given this environment, contractors should not be shy about proposing escalation clauses in their contracts with owners and developers. It is advisable that escalation clauses not be solely limited to long-term construction contracts either. When properly implemented, they can benefit all parties inasmuch as it can go a long way to protect the relationship of the interested parties to a construction contract, which ultimately saves the project and avoids costly litigation.
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