In this era of trade wars and tariffs, the likelihood that fluctuating building material costs will derail present and future construction projects is greater than ever. This is because over the past year the volatile world economy has made the price and availability of essential building materials such as steel, aluminum, lumber, asphalt, copper, and quartz increasingly uncertain. Without predictable access to standard construction materials, owners and contractors now face critical hurdles in building and completing construction projects on time and within budget.
In particular, the costs associated with changes in material pricing and accessibility are wreaking havoc on the construction industry by forcing owners to reduce project scopes, making them scramble to find increased funding, and even putting construction projects at risk of complete cancellation. Contractors are similarly at risk: the impact of price escalation puts contractors and suppliers on the hook for delays or increased costs caused by unexpected surges in material prices, particularly when they are asked to guarantee the prices submitted during the bidding process.
Fortunately, both contractors and owners can effectively mitigate their risk—and plan for the possibility of significant changes in material prices—by incorporating price-escalation clauses into their construction contracts.
The Contractor’s Perspective
The contractor absorbs increased material prices under most construction contracts, unless a price-escalation clause has been negotiated. Anticipating material cost fluctuations is essential for preventing or limiting potential contractor disputes with owners. Contractors walk a precarious tightrope of having to estimate material costs low enough to stay competitive but high enough to keep profit margins safe. If a contractor underestimates material costs, it risks losing money if the materials become more expensive and the contractor is forced to make up the difference. Conversely, if the contractor overestimates material costs, the contractor risks losing the project to a lower-bidding competitor. Consequently, contracts without price-escalation provisions are particularly dangerous for contractors, especially given the likelihood that material prices will change between the time of bidding and actual construction—a time lapse that can span months and even years.
Because standard form contracts such as AIA do not typically contain model price-escalation language, contractors should consider negotiating price-escalation clauses into their contracts. These negotiations should include specific discussions about (1) which materials are subject to the price-escalation clause (e.g., steel, fuel, oil-based products); (2) what percentage in increased material cost will trigger the contractor’s right to an adjustment in price; and (3) when the contractor will be entitled to an adjustment of contract time or schedule if materials become unexpectedly unavailable or shipping is delayed.
The Owner’s Perspective
An owner’s anticipation of material costs and allocation of risk in construction contracts are essential for three primary reasons: first, to ensure that the construction project stays within budget and funding limits; second, to prevent delays caused by contractors’ or suppliers’ inability to procure building materials—for example because of trade embargoes or tariffs; and third, to avoid having to make last-minute changes to the project design in order to replace unavailable or prohibitively expensive materials. As with contractors, owners will benefit from the inclusion of a price-escalation clause to clearly set parameters on their potential risks.
Specifically, owners can benefit from price escalation clauses by negotiating limits on which materials qualify under the contract price-escalation provisions and narrowing those provisions’ applicability to circumstances in which material price fluctuations are unanticipated. For example, if, at the time of contracting, there is a tariff on lumber, the owner can negotiate to exclude lumber from the types of materials eligible for the contract’s price-escalation clause because the parties can foresee that timber may experience dramatic price changes. Additionally, owners should consider negotiating price caps on designated materials—in other words, establishing material cost ceilings, so that any amount beyond the ceiling becomes the contractor’s burden. Setting cost limits in this way can provide owners with greater ability to keep control over expenditures and ensure that their projects stay within budget.
Changes in material prices can affect all phases of construction. Owners and contractors must be forward-thinking in their contract negotiations to address the realities of market fluctuations and to avoid dealing with building material cost hikes reactively. While financial and scheduling hurdles are inevitable in the construction business, the impact of material price escalation can be minimized if it is addressed and negotiated up front.