HANDLING MATERIAL COST VOLATILITY AND SUPPLY CHAIN DISRUPTIONS IN A POST-PANDEMIC MARKET

Those in the construction industry waiting for a return to normalcy from the COVID-19 pandemic still have no end in sight. In the months following the onset of the pandemic, for seemingly the first time ever, the general public began to follow the price of lumber, for example. Although that spike in lumber prices has fallen out of the news cycle, the construction industry continues to experience extreme volatility in both the price and availability of all materials.

According to recent information published by the Associated General Contractors of America, the price of construction materials in general increased approximately 20% in 2021. Certain materials are impacted more than others. For example, the producer price index for asphalt rose nearly 70% and steel mill products rose over 125%. Supply chain disruptions are no different. In fact, the New York Times published an article earlier this week predicting that a normal supply chain is “unlikely” in 2022, perhaps longer. In short, contractors must proceed under the expectation that the current volatility in both material prices and supply chain will continue and, more specifically, ask how to protect themselves against that volatility.

Including a price escalation clause in your contracts can shift the financial risk of material price volatility from the contractor to the owner or developer. In our experience, including a material escalation clause can also help avoid disputes in the future. However, owners and developers typically object to these clauses because they want to know the total fixed costs of the build. The Owner’s objections can be managed in multiple ways. First, remind the owner that it is securing the fixed bids for another reason – to compare the prices offered by multiple contractors and see who provides the most value. Second, advise the owner that not addressing this at the time of contract will likely lead to owner-contractor disputes during the project, which can be avoided by clearly delineating the risk each party is taking up-front. Finally, agree to take on some of the risk of material volatility. Faced with these realities, owners and developers are often willing to discuss and negotiate an appropriate material escalation clause.

Our office has used the below form material escalation clause successfully:

The Contract Price has been calculated based upon the prices for materials as of the execution of this Agreement [or at time of bid].  Contractor agrees to use its best efforts to obtain the lowest possible prices from available material suppliers. But, if a significant price increase occurs during the period of time between contract execution and substantial completion of the Project [or at the time of purchase of the materials], the Contract Price shall be adjusted by an amount reasonably necessary to cover any increase.  A significant price increase shall mean any increase in price exceeding three percent (3%).

This suggested language can also be modified to fit your needs and negotiations with the owner or developer. For instance: “Contractor shall absorb the initial three percent (3%) increase under the Contract Price, but is entitled to a change order for all increased costs in excess of three percent (3%).” Lastly, you can change the applicable timeframes in the paragraph to from “between contract execution” to “the time of contractor’s bid” or “substantial completion of the contract” to “the date Contractor purchases materials for the Project.”

Whatever modifications you make to the material escalation clause, our you must ensure that you will be able to substantiate the increased costs. This is often done by establishing a baseline of what the costs of the material was at the time of your bid or at the time of the agreement through supplier estimates, and comparing that to actual costs paid for materials on the project.

As for the supply chain delays, we recommend looking in both the clause of your contract permitting extensions of time as well as your force majeure clause addressing this issue. In both you should have a listing of items that either entitle the contractor to an extension or constitute a force majeure event. Simply adding an item for : “unforeseen travel or supply chain delays” could go a long way in avoiding a dispute over the contract time. For example, see the below extension clause:

Contractor shall be entitled to an equitable extension of the Contract Time if it is obstructed or delayed in the commencement or prosecution of the Work as a result of causes beyond the control of Contractor, including but not limited to: (i) acts or omissions of the Owner, its agents or third parties; (ii) changes in the Work, or delays in decisions required to prosecute the Work; (iii) acts of nature or of the public enemy; (iv) acts of government; (v) unforeseen travel or supply chain delays; (vi) fires; (vii) floods; (viii) epidemics; (ix) concealed or unknown conditions; (x) quarantine regulation; (xi) strikes; (xii) lockouts; or (xiv) unforeseen weather.

While we remain optimistic that the material delays and price volatility being experienced by the construction industry will return to normal, there is no way to know when that will happen. Unfortunately, it is more likely than not that projects being bid and awarded today will experience some level of price volatility and supply chain delays. Although you may not be able to eliminate the risk to your project, we are hopeful that this article will help you mitigate the risk to your business.

Bruce E. Loren and Kyle W. Ohlenschlaeger of the Loren & Kean Law Firm are based in Palm Beach Gardens and Fort Lauderdale. Loren & Kean Law is a boutique law firm concentrating in construction law, employment law, and complex commercial litigation. Mr. Ohlenschlaeger focuses his practice on construction law and a wide range of commercial litigation disputes. Mr. Loren has achieved the title of “Certified in Construction Law” by the Florida Bar, exemplifying the Bar’s recognition of this expertise. The firm’s construction clients include owners/developers, general contractors, specialty contractors in every trade, suppliers and professional architects and engineers. Mr. Loren and Mr. Ohlenschlaeger can be reached at [email protected]or [email protected] or 561-615-5701.

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