Recent fluctuations in building material prices have threatened to wreak havoc on otherwise well-planned and well-managed construction projects. Economists and industry professionals have identified many factors causing or contributing to these fluctuations, including closures and restrictions related to COVID-19, persistent tariffs and quotas, increased construction activity among homeowners. single-family homes, and even cases of hoarding and profit. Whatever the underlying cause, large price fluctuations represent a deep and lasting risk for construction projects. These fluctuations not only cause unanticipated spikes in construction costs, but also threaten to delay project completion dates due to rationing or unavailability of materials. This article explores two fundamental ways of dealing with the impacts of large price fluctuations: (i) attribution of risk and liability through contractual arrangements; and (ii) take proactive measures to avoid or mitigate impacts on the project.
While extreme fluctuations in the prices of building materials are a relatively new phenomenon, managing contract fluctuations is not a new concept. For decades, parties doing business across borders have included provisions in their contracts dealing with exchange rate fluctuations. These provisions, which are broad, varied and supported by a well-developed body of law, are excellent examples of how contracting parties may consider spreading the risk of fluctuating prices for building materials. Based on these examples, below is a list of approaches parties to a construction contract can take to spread the risk of fluctuations in material costs. This allocation can be applied either to material costs in general or to specific types of materials that present a particularly high risk (eg steel, wood or copper).
- Entrepreneur at risk. No modification will be made to the Contract for any increase in material costs and / or any delay caused by unavailability of material.
- Homeowner at risk. The Contractor is entitled to a change order to account for any increase in material costs and / or any delay caused by the unavailability of the material.
- Risk allocation. The parties mutually agree to share the cost of any increase in material costs based on a predetermined allocation (eg, 50:50).
- Threshold approach. The owner or contractor agrees to bear the risk of increased material costs up to a predetermined threshold (eg 5% of deemed cost), beyond which the risk is transferred to the other party.
- Trigger provision (allocation). The contractor assumes the costs of the materials at a value assumed in the contract. If the actual costs are greater than the assumed value, the contractor has the right to increase the contract amount to reflect these costs. If the actual costs are less than the assumed value, the savings flow back to 100% to the owner. This is similar to an allowance in the construction industry.
- Indexing provision. The parties mutually agree to tie the cost of a particular material to an index, such as the NYSE American Steel Index, rather than the cost charged by an individual supplier.
- Freezing arrangement. The parties mutually agree on a predetermined cost for the material (s) in question, which is paid for and is not subject to change regardless of subsequent market fluctuations.
- Guardrail approach. The Parties mutually agree on a predetermined cost for the material (s) in question, as well as a maximum and minimum amount that the cost of the material may fluctuate. The contractor would bear the risk of increases beyond the maximum amount, while the owner would bear the risk of decreases below the minimum amount.
- Combination. Parties may combine different elements of the provisions listed above to suit their particular circumstances. For example, the Parties could agree to a threshold of 5%, beyond which they share the risk 50/50.
Beyond risk allocation, contracting parties should also take into account significant price fluctuations in the context of contract suspension and termination provisions. Specifically, owners would be well advised to include these fluctuations as an express basis for suspending the start or progress of construction. This option can be useful if the unavailability of materials impacts the planned progress of construction, causing prolonged delay and extended general condition costs. In extreme circumstances, the severity of the impact may justify the complete termination of the contract. In this case, the owner will likely have to rely on a termination for convenience provision, unless a reasonable argument can be made that the contractor is in serious breach due to significant cost overruns or resulting delays. .
Unfortunately, many homeowners and construction professionals entered into contracts before the extent of material price fluctuations became widely known. As a result, many parties to existing contracts have not included provisions dealing with how to deal with such fluctuations. To make matters worse, many contractors guaranteed their prices, whether through flat-rate contracts or GMP / GMAX, without anticipating the surge in prices to come. In these cases, contractors would be well advised to review their contracts for force majeure or hardship clauses. Even without such clauses in the contract, contractors can still assert common law defenses, such as goal frustration or the doctrine of impossibility, especially if the unavailability of materials makes performance impossible. or impractical for the contractor.
Whether or not the contract addresses significant price fluctuations, project owners and construction professionals should consider proactive steps they can take to reduce the impact of these fluctuations on their projects. The starting point for reducing these impacts is communication. It is essential that material suppliers promptly communicate price impacts and product unavailability to the general contractor, and equally essential that general contractors communicate this information promptly to the owner. If this information is not communicated in a timely manner, it will significantly reduce or eliminate the options available to resolve the issue.
Once the problem has been identified, project participants should consider all available options, including those that are unusual or creative. Equally important, project participants need to be flexible – and not too rigid – when it comes to implementing these solutions. For example, planned sequences may need to change, contingencies may need to be exploited, design features may need to be changed, and additional funds may need to be provided, each as needed to promote project success. Here are some specific solutions that parties may consider:
- Offer “sweeteners” to the supplier to ensure performance (eg, pay a substantial deposit, accept cancellation fees and / or promise additional work on other work);
- Identify alternative or additional suppliers, including those located in neighboring cities or states;
- Direct purchase between owner and supplier to reduce profit margin;
- Purchase all the materials needed at the start of the construction project;
- Secure space in warehouses or tank farms for the storage of excess materials until they are scheduled for installation; and
- Suggest substitutions or alternatives to the materials specified in the design.
Due to the uncertainty surrounding fluctuations in raw material prices in the construction industry, some developers may decide to suspend or postpone planned construction projects. Those moving forward with projects in the current economic environment bear the risk that further fluctuations will lead to increases in construction costs, delays in the construction schedule and / or disputes with contractors and suppliers. materials. However, these risks can be reduced or avoided by including provisions in the contract that distribute liability equitably in a manner mutually acceptable to the parties. Finally, for projects already underway, it is essential that the parties open a dialogue to explore ways to proactively mitigate the impact of fluctuations in commodity prices or material unavailability on the project.