The cost of building materials has risen significantly this year. Who should bear this risk and how can the various parties to construction contracts mitigate this risk?
Owners, contractors, subcontractors, and suppliers have historically taken divergent perspectives in the control of risk of material price increases on construction projects.
An Owner’s position is that prices are fixed once a contract is signed and that increases must be limited to signed change orders. Downstream contractors, subcontractors, and suppliers will contend that any unplanned event or condition that causes results in an increased cost is a basis for an extra. Until recently, the risk of such unexpected material price increases have been relatively infrequent, so construction contracts have often not directly addressed such risk. Volatile material price increases of building materials in 2021 has again highlighted the importance of addressing potential price increases when negotiating construction contracts.
Many downstream contractors, subcontractors, and suppliers faced with unexpected material supply costs attempt to pass them on to the Owner or upstream parties by asserting a force majeure or a cardinal change event. An Owner faced with such unplanned costs will, however, generally reject such claims unless directly addressed in the contract. Neither legal theory would typically apply to a product price increase. The result is that litigation will likely arise to resolve such unexpected conditions.
A better approach is for all parties to recognize potential volatility in material price increases and negotiate a mutually acceptable price escalation clause. Factors in such approach should include an analysis of the following:
- Can specific materials be identified that will likely have short term volatile pricing?
- Can a common understanding be reached as to what constitutes volatile pricing (i.e., 5% over 30 days or 30% over 180 days)?
- Can contractors or owners identify any suppliers for that will provide fixed pricing for specific materials for a period of time?
- Can materials be ordered at commencement of project and stored on-site or at approved off-site location until needed?
- What is the overall potential impact on the contract pricing?
- Can use of a contingency line item be used for unexpected volatile pricing?
- Can the parties agree to give benefits to an Owner if material prices go down?
Owners, contractors, subcontractors, and suppliers should consider these issues when negotiating agreements. Price escalation is not likely to disappear soon. As with many issues, open and honest communication often is vital to a good working relationship and addressing this issue before a project begins may help avoid litigation on the back-end of a project.