D’Arcy Vicknair partner, Andrew Vicknair, and senior associate, Ashley Robinson, recently authored a blog for the New Orleans Bar Association, “Price Escalation – Protect Yourself from Material Escalation Costs“
It is no surprise that the price of construction materials has significantly increased over the past 12 months. Some of the price increases include steel, lumber, concrete, cement, paints, asphalt, fuel, and labor costs. The increased costs are due to many issues, but primarily due to the effects of the COVID-19 pandemic. For instance, many manufacturers were forced to either shut down entirely or vastly reduce production. At the time of shutdowns, there was not much concern as the demand declined due to other shutdowns and there was a surplus for many of these materials, such as steel. However, that is no longer the case. Unfortunately, the demand for construction materials is high and supply is low leading to an escalation in prices.
With the increased pricing, attorneys should advise contractors that they must take action to protect against the risk of price increases. A majority of construction contracts, such as lump-sum or fixed price contracts, are worded so that the contractor bears the risk of an increase in the cost of materials. The owner will be guaranteed the project at the agreed upon lump-sum price and the contractor ends up using anticipated profits to pay for the unexpected increase in the price of materials. To address this problem contractors should shift some or all of the risk to the owner through a cost escalation clause.
A cost escalation clause is a clause that will allow a contractor to shift the risk of price increases to an owner after the contract has been executed. It is a good idea to advise your contractor clients that before signing any contract be sure that the contract includes some type of cost escalation clause. Basically, language is added to the contract where the owner will agree to grant the contractor a change order to account for material price increases after the contract is signed. This is normally used when dealing with a lump-sum or guaranteed max price (GMP) contract and is especially important when dealing with multi-year complex projects. While owners will often resist a cost escalation clause, most owners understand that material prices have increased and are continuing to fluctuate due to the pandemic and may be willing to work with contractors on price increases. A common cost escalation clause is on where both the contractor and owner share the risk of cost increases. For example, the contractor may agree to take responsibility for price increases up to a certain price or percentage and the owner agrees to take responsibility for price increases beyond that point. While owners may be willing to work with a contractor, don’t be shocked if the owner is only willing to grant increases for certain materials as opposed to every material used for the project. It is good practice to identify the specific materials subject to any cost adjustments so that the parties are on the same page. If practical, it is also a good idea for the parties to agree to order certain materials earlier in the project to lock in pricing and avoid future price increases.
A sample cost escalation clause is illustrated below:
If the price of equipment or materials to be supplied for the Project increases by more than 5% after execution of this Contract and the time of purchase by Contractor or subcontractors, the Owner shall grant Contractor a change order increasing the contract sum to account for any such price increase greater than 5%. Price increases may be established by Contractor through invoices, quotes, or other evidence illustrating increase in price.
The clause above may also include additional limitations such as specifying the specific type of materials that qualify for a price increase and providing an owner with advance notice before any such materials are ordered so that the Owner is aware of the increase and can decide whether or not to approve the purchase.
Contractors should also address the issue of potential delays due to late delivery of materials. Delays are often associated with the increased pricing. Currently, contractors are dealing with unusual delivery delays due to material shortages. To address this issue, contracts should include language granting additional contract time for delays attributable to unusual delivery days beyond the contractor’s control. Such language may already be contained in the typical force majeure clause. If not, be sure to add language granting additional time due to delays incurred from late delivery of materials.
The construction industry is aware of the increased prices and its effects and cost escalation clauses are commonly used to deal with this issue. Contractors should protect themselves and address this issue head on before signing any contract. Parties should also discuss these issues early in the process so that both parties understand the market conditions and so that the owner understands that contractors have no control over the pricing of construction materials.
 Natalia Siniavskaia, Building Materials Prices Start 2022 with 8% Increase, National Association of Home Builders, Apr. 15, 2022, http://www.nahb.org/blog/2022/04/building-materials-prices-start-2022-with-8-percent-increase; David Logan, Building Materials Prices Up More Than 19% Year over Year, National Association of Home Builders, May 16, 2022, http://www.nahb.org/blog/2022/05/building-materials-up-more-than-19-percent-year-over-year#.