MATERIAL PRICE ESCALATION
Updated: Jun 8, 2021
Most jobs contractors bid on are based on a “fixed price”. These prices are determined by the material prices which are estimated prior to the beginning of the project, even though the project may take a year or more to complete. It is not uncommon for material prices to fluctuate, sometimes dramatically, from the time of bid to the time of completion. This leads to difficulty in anticipating and managing the expenses of material for a project. When you hear steel, copper, aluminum, cement, petroleum, natural gas or lumber to name a few, what words come to mind? Crazy? Volatile? Unpredictable? All those words not only describe the material but the cost fluctuations of these commodities. Any contractor or supplier involved in construction will be familiar with a number of those items as well as their constantly changing prices and how that can pose a concern in terms of estimating a bid price. How can you best plan for a material price increase? Do you include that contingency in your bid price and risk you not being awarded the job? Do you include the price escalation clause in your contract to cover the unforeseen price variations? Do you just ignore it entirely? Every company will approach this issue uniquely and it is best to consult your attorney regarding any contact language relating to this potential concern.
Trying to Avoid the Pitfalls
There are several things a contractor can do to manage price escalations. One way to manage this is by being proactive in the pre-construction phase will allow a contractor to add a material cost escalation clause into the contract. This approach would be based on individual cost indexes, for specific products that reach a certain price point escalation and will avoid large contingencies that the contractor would need to build into their bid price. A contractor should always monitor his costs versus the estimate. Strong pre-construction service is essential for setting costs, scheduling, determining alternative methods and solutions, providing early identification of issues and risk management.
Contracts with Material Escalation Clauses
A material escalation clause shifts the risk from the supplier of goods and services back to the owner. If properly handled as previously discusses, this can prevent many projects from entering legal battles and claims. Material escalation clauses can be “cost-based” or “index-based”. A cost-based clause compares actual incurred cost with the bid cost. An index-based clause tracks and adjust prices based on numerous existing material price indexes such as the producer price index “PPI” published by the Bureau of Labor Statistics. Contracts written without material escalation clauses that experience exceptional price increases in commodity costs will undoubtedly be subject to claims. The outcome of these claims will be based on factual circumstances and whether the contract language and applicable legal doctrines provide a basis for relief. Providing relief will benefit both parties as it will result in avoiding claims, avoiding a breach or avoiding a contract termination. A replacement contractor would most likely pass the price escalations onto the owner, will not guarantee the previous contractor's work and most likely cause time delays on the project due to remobilization, causing the owner more stress than necessary. The contract binds parties to absolute liability for the unconditional contractual promise. Contractors attempt to use the “force majeure” language in a contract, which pertains to when an event occurs that is beyond a party’s control that invariably led to the non-performance of a contract, for example, a disastrous weather event. A contractor would not be able to use the force majeure clause for escalation material cost as it usually only allows a contractor additional time to perform, rather than additional money to perform.
Other Legal Considerations
“Impossibility” occurs when defects in the plans and specifications arise for which the contractor is not responsible. However, courts will not apply the doctrine of impossibility just because the performance of the contract has become more expensive than previously anticipated.
“Mutual mistake” deals with situations where the mistake was a fact that caused a severe imbalance in the risk of a project.
“Frustration of purpose” must be a substantial claim, requiring a demonstration of certain facts to satisfy legal criteria. This is very difficult and rarely successful. A party’s purpose of the contract must be completely, or almost completely, frustrated by a supervening event. Without it, the transaction would make little sense.
These are just a few of the legal considerations. Regardless of a contractor’s situation, the “burden of proof” lies with the contractor. Either they must make the owner/developer understand it and compensate them for it through a change order or they will have to fight for it in court. Either way, it’s on them.
Sample Material Escalation Clause
“If, during the performance of the contract, the price of the material significantly increases, through no fault of the contractor, the price shall be equitably adjusted by an amount reasonably necessary to cover any such significant price increases. As used herein, a significant price increase shall mean any increase in price exceeding ____% experienced by contractor from the date of the contract signing. Such price increases shall be documented through quotes, invoices, or receipts. Where the delivery of material is delayed, through no fault of the contractor, as a result of the shortage or unavailability of _______, contractor shall not be liable for any additional costs or damages associated with such delay(s).”
Managing Escalation During the Project
Monitoring costs versus the original estimate is crucial in managing a potential price escalation. Money can keep a project going or cause it to stop. Monitoring your progress on a job will bring to light potential issues early, hopefully avoiding job loss or stoppage.
Strong pre-construction service is essential for setting costs, scheduling, determining alternative methods and solutions, providing early identification of issues and risk management. The importance is to try to manage costs since you cannot control the costs of commodities. Sometimes an owner will not agree to a material escalation clause. The contractor’s other options are purchasing materials in advance or increasing your buying power by buying the material for several projects at once. Perhaps the owner will pay you for materials for his job that will be procured and stored in a bonded warehouse, eliminating possible price escalations. You can also include a contingency budget, or an adder to your bid, for price escalations.
You should always discuss the concern of material price escalation while in the negotiation stage with the owner. We recommend being proactive in revising contract language to reflect this as soon as possible. We always say, “communication is key”. If you can get out ahead of any price escalation appearing, this can save you a lot of headaches, and possibly several jobs.