Does Your Contract Protect You Against Material Price Increases?

While the economy continues to struggle, prices for many construction materials have been on the rise. SteelontheNet.com reports a 25% – 30% increase in steel prices just since January 1, 2011. Ken Simonson, Chief Economist for the Associated General Contractors of America, reports that copper, diesel, plastics, asphalt, and gypsum have also experienced dramatic price increases so far this year.

The combination of economic downturn and increased material prices create a very dangerous situation for construction companies. Decreased construction demand keeps bid margins at a minimum while increasing the risks contractors undertake due to increased material costs. Bids must be low enough to be awarded the job but also must be high enough to take into account the possibility of an increase in material prices during the course of the project.

Now more than ever contractors are asking the following questions: (1) If a rapid price increase occurs, can I increase my contract price to reflect the increased cost of the material? (2) Can I terminate the contract without liability because I cannot afford to perform the work at the increased price? As always, the answers to these questions depend upon the terms of your contract; specifically, whether or not it contains a properly drafted price escalation or “force majeure” clause.

A force majeure clause is a contractual provision found within a variety of standard commercial contracts including construction contracts. It essentially allows you to seek price adjustments or to terminate your contract if a specified event beyond your control occurs. Standard force majeure clauses typically include protections against strikes or acts of a labor union, floods, earthquakes, acts of God, and acts of war.

Unfortunately, these provisions typically fail to cover other significant events such as material price increases. Because most courts narrowly interpret the events covered by force majeure clauses, it is important that you have a well-drafted clause in order to protect yourself against the risks of material price escalation. For example, a properly drafted clause should identify the construction material you are going to supply, the value of said material at the time the contract is executed, and explain that material price increases beyond a certain threshold amount, say 20% for example, constitute an event for which you are entitled to additional compensation or to terminate the contract without liability.

While a price escalation provision should be included in your contract to protect you against the risks of increases in material prices, these provisions can also be beneficial to the owner. Owners can expect contractors to submit lower bids if the contractors do not have to accept responsibility for increased costs resulting from material price escalation. Even if a construction contract contains a properly drafted force majeure clause, the contractor can still be responsible for increased material costs if the event or events resulting in the price increases were within its control. There are two important aspects of this rule.

First, you cannot invoke the clause if you could have taken reasonable steps to avoid incurring the increased material costs. For example, a contractor may still be responsible for increased material costs if the price increase occurs after the materials were reviewed and approved by the owner but before the contractor reasonably should have purchased the materials from its supplier.

Second, you cannot cause the materials to increase in price. For example, a contractor cannot utilize the provision to seek additional compensation for in-stock materials that were purchased prior to the execution of the contract when material prices increase after the contract is executed.

Now more than ever it is important to review your contract to ensure it properly protects you against the risks of material price escalation. If it does not, I encourage you to contact an experienced construction attorney to draft one for you. Because these provisions are narrowly construed by the courts, you want to be certain it will be enforceable if it is ever challenged.