Tag Archives: material price

MATERIAL PRICES CLIMB…AND CLIMB…ARE YOU CONSIDERING A MATERIAL ESCALATION PROVISION?

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As you may know, material prices have been climbing.  And they continue to climb based on the volatility of the material market.  On top of that, there are lead times in getting material due to supply chain and other related concerns.   The question is, how are you addressing these risks?  These are risks that need to be addressed in your contract.

As it relates to climbing material prices, one consideration is a material escalation provision.  The objective of this provision is to address the volatility of the material market in economic climates, such as today’s climate, where the price of material continues to climb.  Locking down a material price today will be different than locking down the same price months from today.  This volatility and risk impacts pricing and budgets.  Naturally, an owner and contractor would like to be in a position to lock down supplier prices as soon as possible—both to secure pricing and to account for items with long lead times or that recent data forecasts a long lead time due to supply chain concerns.  However, this is not always possible or practical and can depend on numerous issues such as when the owner contracts with the contractor, when the owner issues the notice to proceed (and permits are issued), final construction documents and revisions to the construction documents, the type of material, whether there is staging or storage available for the materials, and the current status including climitazation of the project.

With a material escalation provision, you are negotiating the risk of material escalations based on how this risk is addressed in your construction contract.  This allows parties to be on the same page when a material escalation claim or price adjustment is submitted. Please make sure you work with construction counsel to draft, negotiate, and explain the material escalation provision to you.

If you entered into a fixed sum contract, the reality is that within that fixed sum the contractor should be factoring in this risk into the fixed sum.  Under a fix sum contract, the sentiment is an owner is paying “X” for its project and whether the contractor can deliver the project for well under “X” or well over “X” is of no moment because the owner agreed to pay the fixed sum of “X” for the project.  As a result, the contractor should bear the risk in a traditional fixed sum contract.  However, contractors are trying to address this risk with allowance items by identifying in the contract certain items that constitute an allowance.  If a contractor does this, they need to understand that they need to demonstrate the costs for the allowance items because if the cost is less than the allowance item, that amount is credited to the owner.  If the cost is greater than the allowance item, than that overage would increase the fixed sum.

A cost-plus contract, on the other hand, is different because there is more transparency in costs than a traditional fixed sum contract.  In a cost-plus arrangement, an owner is paying the cost of the work (inclusive of a contractor’s overhead-related items) plus a mark-up for profit.  If the cost-plus contract does not contain a cap, known as the guaranteed maximum price, than the owner is going to pay the actual costs so that if there are demonstrated material escalations, that will be a cost passed on to the owner.  A prudent owner however shall still require the contractor to demonstrate actual escalation costs (from time of contract to time of procurement) because the escalations should impact the contractor’s control estimate that forms the basis of the cost-plus without a guaranteed maximum price contract.

If there is guaranteed maximum price, then a material escalation provision is a must.  (In my opinion, it is good to address this risk even without a guaranteed maximum price.)

There are numerous ways a material escalation clause can be addressed because it involves a negotiation on the frontend as to how the parties will address this risk.   Here are some considerations:

  • Do you want to address the specific materials / items subject to material escalations (e.g., lumber, PVC, steel, aluminum, copper, etc.)? This way the parties understand those materials / items where the provision can apply. In other words, how specific do you want to be in the material escalation provision?
  • Do you want to consider certain pricing for materials? For instance, this contract is based on the specific pricing set forth in Exhibit “A,” and pricing that increases “Y”%  from this pricing shall support the basis of a change order.  The specified pricing is the budgeted pricing that forms that basis of the contract but any increase over that pricing over a certain percentage will result in a change order.
  • Similar to the above bullet point, do you want to include an exhibit for certain material pricing and identify that this pricing is secured through a set date. Any material price increase beyond this date (or above a certain percentage) shall result in a change order.
  • Similar to the above bullet points, if you are identifying certain pricing for materials for which the contract is based, what if the material prices decrease? Is the owner entitled to a credit?
  • Is there a contingency in the contract and are buy-out savings rolled into the contingency? If so, does the contractor have full discretion to use the contingency to fund material escalations up to the balance of the contingency?  Or, is there a separate contingency solely for purposes of material escalations that reverts 100% to the owner if there are no escalations?
  • Does the contractor include allowances for certain materials such that there will be a decrease or increase in the contract amount based on the allowance items?
  • Is the material escalations provision tied to delay?

A material escalation provision is grounded in fairness and allocating risk in an equitable manner. Do not neglect this discussion and including a material escalation provision in the construction contract.

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

 

NOW IS THE TIME TO REVISIT CONTRACT LANGUAGE IN LIGHT OF COVID-19 TO ADDRESS FUTURE CONTRACTS

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Now is the time!  Today!  If you are currently in the process of negotiating or executing contracts, now is the time to ensure the contract protects your interest in light of this new world we enter into.   The impacts associated with COVID-19 may have been realized by some parties, but not others.  Regardless, the full extent of the COVID-19 impacts has likely been realized by no one — we are dealing with an unknown, prospective impact.

Will projects get suspended?  Will they stop and start back up due to disinfecting?  Will they slow down due to health concerns and preventative measures?  Will there be unanticipated material lead times?  Will current material lead times or material orders  be delayed?  Will material prices increase?  Will there be a labor shortage and/or inefficiencies with the labor force?  Will labor costs increase in order to address the preventative measures and anticipated inefficiencies?

These are some questions you may be asking, plus more.   You are asking these questions because of the unknown factor associated with COVID-19 and any future health crisis.  This is the reason now is the time — the time to ensure your contract best captures the risk of the unknown.

Here are considerations:

1.  Force majeure wording. –   This needs to be beefed up and tweaked to address COVID-19 and, potentially, other pandemics / health crisis.   You need to have an understanding who is bearing the cost risk for a project being shut down (by the government or otherwise), suspended, or slowed-down due to this issue.    Leaving it alone is a mistake.  All contracts until this pandemic hit left it alone meaning no contract truly addressed the global pandemic we are all facing.

2.  Additional safety and preventative health measures. – This needs to be factored in as the additional measures will add a cost to the project.  The measures may also add a cost in that they will add certain inefficiencies into the project that need to be factored into the schedule and general conditions.

3.  Material price escalations.- Could the cost of materials increase due to supply chain issues?  It is certainly a possibility and should be considered.  Further, it is likely that to avoid this issue, a party wants to accelerate the ordering of materials at today’s price, and there may be additional storage costs associated with doing this.   Conversely, what if the price of materials skyrocket post-contract?  This issue could break a party’s performance, profitability, and financial wherewithal to perform.  A party may want to address protection from any uncertainty with material price escalations.

4.  Material lead times and material delays.- If there are delays tied to COVID-19, how this being allocated?  There could be a realistic delay in material deliveries that impacts the project’s schedule.  The delay is not the ordering party’s fault but the result of impacts associated with the pandemic.  Based on this concern, this may result in the discussion of material accelerations and the additional storage costs associated with doing this (also discussed above).

5.  No-damage-for-delay.-  A no-damage-for-delay provision is common.  However, a party may want to deliberately carve-out from this issue delays associated with or tied to COVID-19 or any pandemic / health crisis.  The carve-out language should be broad and include language “arising out of or relating to” COVID-19 or any pandemic / health crisis based on the uncertainty as to how impacts may be realized.

6.  Contingencies.- Certain contracts, such as GMP contracts, contain a contingency.  Parties may want to add a contingency in the contract for COVID-19 and pandemics / health crisis.  A certain sum is built into the contract sum to address the unknown costs that could be incurred.

7.  Dispute resolution.- Knowing that the onslaught of COVID-19 cases will start affecting the judicial system, parties may want to revisit their dispute resolution provisions to see how disputes can be more efficiently resolved.  Parties may consider turning towards more specific arbitration provisions that modify standard contractual language.  Since arbitration is a creature of contract, parties can essentially start negotiating the rules of arbitration within the parameters of the contract.  Parties may demand pre-suit mediation provisions, executive settlement meetings, or partnering agreements as vehicles to efficiently resolve disputes and avoid delays or inefficiencies with the judicial system.

These are some talking points.  There will be others based on the scope.  I remain available to assist any party that wants to revisit their standard form contracts or needs help in drafting or negotiating contracts.   A party should not rely on their same-ole contract forms.  Also, a party should not rely on the same-ole negotiation as COVID-19 brought new issues to the table and highlighted the significance of other issues and contractual provisions.

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.