What is the most influential part of any construction project: the designer? the contractor? the owner? the selected materials? No. Money is. Money either holds a project together or allows it to fall apart. Unanticipated or uncontrolled costs can ruin a project and those associated with it. Given the current market conditions for various building materials and the potential for trouble when the cost genie comes out of the bottle, a price escalation clause that allows for an equitable adjustment for the increased costs of certain materials may be advisable.

Escalation clauses should be tailored to the individual project and commodity. This is a sample escalation clause, being provided for context only:

The amount of this Contract is subject to increase if the cost of products increase by more than _____% over the amount quoted to us between the date of this Contract/ Proposal and delivery of such ________ products to the Project. In the event of such increases, and upon written documentation establishing the extent of the increase, the contract amount will be equitably adjusted.

Why should an owner provide one? It is unlikely that an owner will be unable to avoid the price escalation altogether. If an owner refuses to provide a reasonable equitable adjustment, the contractor will likely pursue a claim, declare a breach and attempt to terminate or go under. The owner will be faced with litigation or arbitration, and may have to hire a replacement contractor who will undoubtedly pass the price escalations on to the owner. There will be additional costs associated with the replacement contractor providing a warranty for the initial contractor’swork, if at all. There will be time delays associated with locating a replacement contractor and giving it time to mobilize. There may be a drop in the quality of the project as the contractor attempts to save costs to compensate for the increases in prices.

A price escalation clause allows the parties an opportunity to plan for the uncertainty and allocate how and to what extent the additional costs will be absorbed. Another issue that usually walks hand in hand with price escalations (i.e. supply and demand) are material shortages. The contract should also contain a companion provision allowing for time extensions for material shortages. While many contracts allow for time extensions for unforeseeable circumstances that cause delay, depending on the circumstances, material shortages may be foreseeable.

If an owner cannot or will not agree to a price escalation clause, consider arranging for the advance purchase of materials, the use of a bonded warehouse and payment by the owner for materials stored in the bonded warehouse. If an owner cannot agree to an unrestricted price escalation clause, consider including a contingency budget in the contract for price escalations.

Price escalation clauses are potentially important to every trade. In the recent past we have seen significant price escalations occurring with concrete, steel, lumber and fuel to name a few. With the hurricanes of last year, there have been regional shortages of certain building materials. The sources of these price escalations are not going to go away. Make sure you have explored the possibilities of a price escalation clause while your contract is in negotiations. Do not wait until the escalations begin affecting the project, your profitability or your company’s sustainability to try to convince the owner that it should absorb the cost increases.

For more information, contact bgaudet@coatsrose.com or 713-653-5761.