Here it is 2023, and the construction industry is still grappling with the supply chain crisis and material price escalation. According to the AGC’s 2023 Construction Outlook National Survey, 36% of contractors canceled projects in 2022 without rescheduling those projects and cited “rising costs” as the primary reason for cancelations. In the same survey, contractors highlighted “economic slowdown” and “building material prices” as their top two concerns in 2023. Costs were continuing to rise across major US markets in Q4 of 2022 according to the construction cost index.
How are firms mitigating these material costs and supply chain concerns? Ultimately, construction companies are making earlier and smarter material purchasing decisions in the bid and contract phases to avoid supply chain turbulence during construction. Neither owners nor general contractors nor their suppliers want to carry the risk of escalating material prices. Luckily, we’re seeing construction contracts negotiated to benefit all parties and keep construction going. However, contractors are not necessarily taking as much precaution as one would think, given how prevalent this issue has become.
For reference, a review of an anonymized, random sampling of construction contracts uploaded into Document Crunch in 2023 showed only 34% of construction contract agreements had clauses addressing price escalations, 66% did not. Document Crunch’s proprietary AI was able to scan all such contracts for language related to this issue.
While it is safe to assume that this issue has become more prevalent than pre-pandemic, when it was not common that this was addressed, the above data emphasizes that the industry still has work to do in order to protect itself.
How construction contracts can cover rising material costs
Material cost negotiation starts way before the contract is drafted. In a volatile market, bids and quotes expire and change. The invitation to bid phase is the first step for general contractors in managing rising material costs. Even pre-construction teams should be coached on ideal purchasing and contract terms to get the ball rolling.
Contractors can place language in their bid proposals that establish a period of time in which their proposal must be accepted to be valid. This approach would allow the contractor bidding on the job to update their pricing and proposal to reflect any increases or decreases after the allowed time has passed. Conversely, contractors need to watch out for any bid instructions or RFP documents that preemptively exclude any price increases or require bids to remain valid for a specified period.
In the contract negotiation phase, crafting a material escalation clause becomes even more critical but is too often neglected as the above data suggests.
When it comes to contracts, the material price escalation clause (and therefore the burden of risk) will depend on the pricing structure of the construction project.
- Fixed price contracts – The contractor bears the burden of any increased costs over the agreed-upon price, subject to agreed to change events.
- Cost plus contracts – The owner bears the burden of any increased costs over the agreed-upon price, but contractors have a responsibility to control and manage rising costs to the extent possible.
- Cost plus fee with guaranteed maximum price (GMP) contract – Contractors and owners share the burden, as owners cover additional costs but only up to the agreed GMP, subject to agreed to change events.
In an ideal world, contractors would lock in material pricing (or “buy out”) as quickly as possible, but this means owners must be willing to write checks immediately. A compromise may be identifying materials with the most price volatility and buying out those materials in advance and storing them, though this adds storage costs. After the chaos of the pandemic, we’re seeing an increased willingness of owners to share in price escalation risk as the above data suggests.
Other ways contracts can mitigate rising material costs
There are certainly other common clauses in construction contracts such as Section 8.3 — titled, “Delays and Extensions of Time” — that lists the types of delays which would entitle a contractor to relief from certain delays or Section 3.4 (titled, “Labor and Materials”) of the AIA A201, however, these are more general in nature and not specific to supply chain disruptions or material price escalations. In these types of provisions, it’s not uncommon for them to generally state that a contractor gets relief for events “beyond its control.” However, this vague catch-all leaves a lot to interpretation and chance.
When it comes to contracts, courts and the law tend to favor specific provisions over general provisions. It makes the job of interpretation much easier and less susceptible to argument. Adding specific categories that may entitle you to relief, such as “material price escalation” or “supply chain disruptions due to a pandemic” versus leaving clauses vague for all issues “beyond contractor’s reasonable control” is more likely to be interpreted favorably and help grant relief for events such as rising costs of materials. Without clarifying such language, you may be leaving it to chance or argument by parties seeking to use the clause in their own favor. Given how prevalent of an issue material price escalation has become, (just like COVID-19 over the past several years), it is common sense that you ensure this is adequately covered by your contract. And it would certainly be prudent to address this issue head-on rather than leaving it to chance interpretation.
Finally, AI contract review software, like Document Crunch, scans contractor agreements for issues and risks, including spotting a “Material Price Escalation” provision (or the absence of) and flagging it for your team’s Comprehensive Review. This helps users identify 1) if your contract includes proper language and 2) how any escalations in costs to materials are to be handled between the contracting parties. Before, contractors had to rely on their contract professionals to spot these issues or they would review the contract (particularly prebid) prior to executing. Now they can quickly assess contract terms and confidently lead the discussion themselves. They can advise their project teams to save overhead costs and material costs down the road and, most importantly, protect fees on the job. Learn how Document Crunch can help your construction company against material price escalation.
The original article can be found at: Construction Dive