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November 13, 2018 at 8:30 am

Are you in for a (price) shock?

Strategic considerations in allocating risks of Tariffs, price escalation and supply chain disruptions in construction contracting

By:  Robert Ruesch, Esq., Verrill Dana, LLP

Compared to where we were ten years ago, the real estate and construction segments of our economy are booming.  The uptick in development in hotels, condominiums, apartments and commercial facilities, particularly in southern Maine, has been well documented.  Beyond Maine, metropolitan Boston, southern New Hampshire and indeed many parts of the United States are enjoying record growth.  This positive news is tempered somewhat by the reality that increased demand for construction materials, equipment and skilled labor has pushed up prices and increased building costs in Maine and across the U.S.  Added to this price dynamic is the U.S. government’s recent threatened and actual tariffs which have further disrupted markets resulting in increased prices for lumber, steel, aluminum and other key construction materials.

In response to these price fluctuations, private developers, owners, public procurement officials, design professionals, contractors and construction managers (CMs) are having frank conversations about how to handle the risks of price increases.  All project participants agree that limiting and allocating exposure to price escalation is paramount.  One of the common steps that the parties opt for is to accelerate delivery of the entire project or procurement of those items that might be subject to price escalation due to tariffs or other factors, particularly structural steel.  Efforts to fast track purchases of steel or other items earlier than anticipated may make sense, but creates potential for risks down the road that may flow from expedited design, hasty review of submittals, changes in the owner’s program or handling and storage costs.  Often these considerations are not given a second thought in the contract process.  That is probably a mistake.

Project owners, designers and contractors should pay closer attention to how price escalation and risks of fast track procurement are handled in their contracts.  In addition to the risks of accelerated procurement, owners often assume that once the contractor commits to a lump sum price or a guaranteed maximum price (GMP), there is no further need to worry about price increases regardless of what happens in the marketplace. That is not always the case and will depend on the nature of the price escalation and the specific contract terms. Like it or not, contracts may allow for the possibility of price adjustment relief in the face of cost escalation under certain circumstances.   In addition, in the current marketplace contractors faced with price instability will likely hedge against the risk of price escalation by increasing lump sum and GMP quotes to the owner’s detriment.

Here are some of the contract provisions that may allow for price adjustments:

Unit Prices:  Some contracts, including those that incorporate state or federal procurement provisions may allow for unit price adjustments due to cost escalation outside of certain pre-defined parameters (say, beyond 10%).

Force Majeure:  More common place are contracts containing force majeure provisions which allow for relief from contract obligations for a range of events that are generally considered to be outside the contractor’s control.  Are tariffs and supply chain disruptions covered by that clause?

Taxes/Fees:  Some contracts provide that the owner is responsible for taxes or government fees that take effect after the contract is signed.  Do tariffs fall within the scope of that type of clause?

Allowances:  Still more common in GMP and lump sum contracts are allowance provisions that cap contractor costs to budgeted line items.  Costs beyond the budgeted allowances flow to the owner.

Contingency:  Depending on who controls the contract contingency, what, if any, latitude does the contract provide to use the contingency for price increases?

Regardless of the type of contract, owners and contractors should review even the most familiar contract forms to evaluate price escalation risks.  Most of the time there are ways to deal with the risk of price escalation in a transparent fashion in which the true cost of the risk is identified, quantified and allocated up front.  This provides some predictability for the contractor that it will not suffer losses outside its control due to commodity price changes.  In addition, the owner will have the benefit of knowing that the bid prices are not being irrationally adjusted to hedge against the risk of price escalation that may not actually occur.  As always, open communication and a fair allocation of risk produces a preferred result.  The alternative is to just sign the contract and hope for the best.

Categories: Maine Real Estate Insider