More than two years removed from the first reported case of COVID-19 in the United States, the construction industry continues to cope with the pandemic’s lasting effect on the costs of new construction projects. These impacts include soaring construction material costs, a diminishing supply of construction labor, and lingering disruptions to supply chain channels. Together, these forces resulted in skyrocketing construction costs across both the commercial and residential construction landscape.
As a consequence, project owners and construction contractors have exercised a new degree of vigilance, closely monitoring and documenting claims for increased project costs. This new landscape has often fostered an adversarial dynamic on projects, with both owners and contractors facing unprecedented pressures to track construction spending and cut costs where possible. More than ever, cost concerns have become an issue of contention before, during, and after project completion.
This dynamic between owner and contractor will face new challenges ahead as costs become less predictable, potentially returning to near pre-pandemic levels. Recent trends concerning construction material costs demonstrate extraordinary volatility, with the cost of lumber dropping from $1,400 per 1,000 board feet in March 2022 to $640 per 1,000 in board feet in May 2022. This decrease comes on the heels of lumber prices reaching an all-time high, topping $1,500 per 1,000 board feet in May 2021.
Although unpredictable material costs have the potential to create animosity between an owner and contractor, they can also be an opportunity for the parties to pursue mutually beneficial cost savings on projects where the contractor is paid for the cost of the work plus the contractor’s fee. This can be accomplished through the addition of a shared savings clause to the parties’ contract.
A shared savings clause is an agreement between the owner and contractor providing that the contractor will be paid a percentage of the difference between the actual construction costs incurred, plus the contractor’s fee, and the guaranteed maximum price. These clauses can be either simple or detailed, depending on the parties’ needs. While the language of a shared savings clause should be specifically tailored to the needs of both the parties and the project, an example of a basic clause is as follows:
Upon final completion of the Work, if the total Contract Sum is less than the final Guaranteed Maximum Price (GMP), then the difference between the GMP and Contract Sum (the “Savings”) will be divided among Owner and Contractor as follows: (a) 50% of the Savings will be retained by Owner, and (b) 50% of the Savings will be paid to Contractor.
Shared savings clauses have many benefits. First, they incentivize the contractor to monitor and control construction costs, as the contractor has the opportunity to recognize a direct financial benefit from any cost savings realized on the project. The greater the percentage of the cost savings that the contractor will receive, the more likely that the contractor will be motivated to pursue cost savings. This demonstrates another key benefit of a shared savings clause: it provides flexibility by allowing the parties to negotiate the percentage of the cost savings that will flow to the contractor. During contract negotiations, a contractor may be willing to concede its position on other contested contractual provisions in exchange for an increase in its share of the cost savings, and the same is true for the owner.
Lastly, and perhaps most importantly, a shared savings clause ensures that both the owner and contractor are working towards the same goal: the delivery of a completed project that is within, if not below, budget. This not only increases the likelihood of cost savings on the project, but it can also help reduce claims between the owner and the contractor and ensure that they maintain a cooperative, amicable working relationship. Given the constantly evolving pressures in today’s construction industry, this is an invaluable benefit.
Project owners and construction contractors should therefore have legal counsel review their construction contracts and evaluate whether a shared savings clause would be appropriate under the circumstances. While such a clause may not be necessary on every project, it can be highly beneficial if utilized correctly.