The Price Isn’t Right: Don’t Get Escalated Out of Business
Brian Perlberg, Executive Director of ConsensusDocs and AGC’s Senior Counsel for Construction Law
Price escalation spikes and supply shortages threaten construction companies’ financial viability in an unprecedented way. It creates a conundrum for existing contracts with a firm fixed price, lump sum, and to a lesser extent a guaranteed maximum price (GMP). The best approach to address cost uncertainty going forward is to include a price escalation clause in your next contract. A price escalation clause adjusts the contract price based upon an agreed upon metric, usually an objective cost index. This approach is both equitable and effective for owner clients, suppliers, trade contractors and General Contractors’ financial solvency. Rather than guessing on prices, an agreed upon objective index provides a superior risk management strategy.
ConsensusDocs produces the only standard price escalation contract document. The ConsensusDocs 200.1 Material Price Escalation Amendment. At contract signing, you need to complete the 200.1 and establish the materials and the objective indexes that establish a baseline price in Schedule A. Because ConsensusDocs is an industry standard and written by a coalition of 40+ construction groups including AGC and owners groups like COAA, CURT and NASFA, you are more likely to get owner-buy-in. Proposing a fair standard contract document is particularly important when proposing something atypical to date.
There are several variations in price escalation approaches. ConsensusDocs takes a very fair approach that establishes a baseline price for covered materials. At least 30 days must pass, and notice must be given before any adjustment can be made. Adjustments are only given to those materials that are specifically identified; notice given of an increase; and the increase is documented. No overhead or profit is included in the adjustment. Significantly, the clause can act as a de-escalation clause if the price goes down, so an owner can actually save money. The industry has already seen lumber prices come tumbling down faster than the initial spike, although the price remains much higher than before the Covid-19 outbreak.
Choosing a reliably accurate material price index is one of the more difficult aspects of drafting a complete price escalation clause. ConsensusDocs has created a price escalation resources page at https://www.consensusdocs.org/price-escalation-clause/ examples. You can also download a sample of the ConsensusDocs 200.1 from a page link.
Existing contracts are more problematic to solve after the fact. Typically, price fluctuations are considered a foreseeable risk, even if they are nobody’s fault. However, total supply shortages or price increases that occur during an owner-caused delay potentially give rise to a legal cause of action. Look to your contract an analyze if your force majeure or change order provision may merit equitable relief. And if both parties agree, a price escalation clause like the ConsensusDocs 200.1 could be agreed upon after contract signing.
Other mitigation strategies for future contracts include using cost of the work agreements like the ConsensusDocs 230; breaking projects into phases; providing allowances or alternates for materials; early procurement and storage of materials; and prefabrication. Increasing contingency amounts is a common approach. In conclusion, while prices are uncertain, you certainly reduce risk with vigilant communications up and down the contractual chain.