Turn the tables on tariffs and other market disruptions
The recent announcement of aluminum and steel tariffs is the latest wild card in the high-stakes game of pricing construction work.
Over the last decade, we have experienced significant spikes in costs of diesel, asphalt, cement, gypsum, lumber, PVC, and steel. Shifting international demand, production anomalies, and other market forces can sometimes predict the occurrence, but not necessarily the magnitude or timing, of these market shifts.
With the yet-to-be-determined impact of tariffs on the immediate horizon, both owners and contractors should consider the benefits of price escalation clauses.
How Does “Price Escalation” Work?
Price escalation clauses allow periodic adjustments to a contract price when we expect a market disruption but cannot predict when or by how much.
Price escalation clauses can be tailored for a particular current event (e.g., tariffs or conflicts in the Middle East) that converge with a particular project’s needs (e.g., large quantities of steel, fuel, or asphalt). To address each situation, these clauses can dictate:
- The types of commodities that are covered
- How to calculate a baseline price
- How to calculate price adjustments
- Bid items to be adjusted
- A minimum threshold to trigger an adjustment
- A maximum cap allowed for an adjustment
- Mark-ups for overhead and profit (typically not allowed)
- Notice requirements
- Whether and how to adjust prices downward
- Intervals between adjustments
- Owner’s audit rights
- Documentation requirements
- Expiration (e.g., reinstating original bid prices if original or extended completion date not met)
- Time extensions for impacted delivery schedules
Nothing is Free
No owner is excited to pay higher prices and accept time extensions. Why not simply force contractors to bear all the risks?
The simple answer is that nothing is free.
As long as construction remains a for-profit industry, owners should expect to pay for what they get. Owners can either have a plan to do this in a controlled, fair, and stabilizing way, or roll the dice and likely pay a premium for the extra risk.
On private contracts, the choices for the owner are ripe for negotiation. And even on public contracts, some owners have realized the benefit of including price escalation clauses. For several years, the Minnesota Department of Transportation has included a fuel escalation clause in its standard template for all state-let projects. Contracting officers on federal projects can include a standardized clause to cover price escalation.
Playing the Hand You’re Dealt
Nearly 40 years ago, the Federal Highway Administration encouraged public owners to consider the benefits of using price escalation clauses. Nevertheless, these clauses are underutilized in public works specifications.
So, what if adding price escalation to your contract is no longer an option? Options on immediate projects are limited, but a few short- and long-term options may be considered:
- Raise the issue in pre-bid question and answer forums
- Look down the supply chain for exposure to escalating prices
- Seek early material purchases and alternative sources
- Propose value engineering
- Examine contracts for change-of-law change orders
- Price any risk that cannot be passed along either up or down the supply chain
- Offer early services of specialty contractors and suppliers to support design and budgeting of future projects
- Pursue better contracts for future projects through trade associations
The biggest barrier to using more price escalation clauses is persuading owners that these are good for their budgets. But once owners are enrolled, the tools are readily available. AGC of America provides a sample price escalation clause that can be customized for individual projects. AGC also publishes a monthly summary of producer price indexes, which is one of many tools available to calculate price adjustments.
All bets are off as to when or how the repercussions of the current tariff situation will play out. However, when a major disruption is expected, and the odds of varying outcomes are difficult to measure, having a price escalation clause may be an ace in the hole for owners and contractors alike.
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© 2018 Welle Law P.C. No unauthorized use or reproduction.
This blog is for informational purposes only and should not be interpreted as legal advice. You should contact your attorney regarding any particular issue or problem. Nothing on this website creates an attorney-client relationship between Welle Law P.C. (or any of its attorneys) and the reader.