Construction Material Price Increases: Options for Contractual Risk Shifting

Brian R. Zimmerman

Recent surges in material prices have caused many construction industry participants to question their rights and remedies under their contracts as well as change their future contracts to address substantial price increases. Brian Zimmerman discusses the recent price increases and the contract clauses implicated thereby.

During the COVID-19 pandemic, construction material prices rose substantially and, in some cases, skyrocketed to record high levels.1

Lumber prices reached historic highs in May 2021, with futures prices rising from $423 per thousand board feet as of Jan. 8, 2020, to a $1,607 per thousand board feet on May 10, 2021.2

Although lumber prices have started to fall, prices are still nearly double January 2020 prices. The rise in lumber prices has largely been attributed to increased demand for new homes and renovations resulting from lifestyle changes brought on by COVID-19, while at the same time lumber mills’ output shrunk due to worker shortages and work limitations due to COVID-19.3

Although lumber prices have garnered the most media attention, prices for numerous construction materials have increased dramatically. Producer price indexes for construction inputs, rose 19.7% between April 2020 and April 2021.4 These price increases include raw materials such as lumber, steel, aluminum, and plastic/PVC materials, as well as manufactured products including appliances, HVAC equipment, and flooring materials.

The cause of the price increases include direct impacts from the COVID-19 pandemic due to manufacturing plant shutdowns, along with more indirect impacts such as supply chain disruptions, increased demand, and labor shortages. Other events have also increased prices or reduced availability of materials, including the global microchip shortage, import/export tariffs, and the Texas blackouts experienced earlier this year.

With such dramatic price increases, many have questioned whether common law principles provide relief.

Frustration of Purpose, Impossibility, Impracticability, and Acts of God

Common law principles of “frustration of purpose or impossibility, impracticability, and acts of God” may excuse a party’s obligation to perform a contract due to unforeseen events beyond the parties’ control.

For example, in McMillan v. Fox,5 the court excused the failure of delivery of specific piles of lumber that were burned in a fire. The court found that the continued existence of the lumber was an implied condition of performance and the fire rendered performance impossible.

The UCC § 2-615 (codified by the Wisconsin UCC at Wis. Stat. section 402.615) also excuses delays in delivery or nondelivery in whole or in part where performance is impracticable by the occurrence of a contingency, the nonoccurrence of which was a basic assumption on which the contract was made or by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid.

Some courts have applied these doctrines to substantial material price increases. For example, the Supreme Court of the State of New York in Moyer v. City of Little Falls6 excused a contractor’s performance of a municipal waste disposal contract, where one of two local landfills closed and dumping charges rose by more than 666% times the price at the time of the original contract.

Wisconsin, however, lacks precedent holding that material price escalations alone are outside the contemplation of the parties and that substantial price increases are sufficient to excuse performance.

As a result, although circumstances related to the current material shortages or future government actions may create fact-specific circumstances excusing performance, material price increases alone are unlikely to excuse a contractor from performance under common law principles.

Contract Clauses Impacting Transfer of Material Price Escalations

The following are four contract clauses that can impact the transfer of material price escalations.

Price Locks, Deposits, and Early Procurement

Generally, the longer the duration of a project, the higher the risk that material prices change during the term of the project. Nonetheless, as the recent lumber price surge has shown, even short-term projects may be impacted by rapid price changes. Accordingly, the timing of bidding, ordering, contracting, and delivery of materials are all critical considerations in the evaluation of material price escalation on a construction project.

Price quotes for commodity type materials, as well as certain other manufactured materials, often include limited price lock periods during which the prices are held. With the major price fluctuations some suppliers and subcontractors have revised their provisions, from periods allowing acceptance up to 90 days, down to limited windows of five days or fewer, or in some instances no holds at all on pricing.

The timing of acceptance of prices, along with the common requirements of deposits or payment in full in order to hold such prices, creates complications when upstream contracts may not be signed yet or standard contract language may limit the contractor’s ability to bill the owner for deposits or payments for materials that have not been delivered to the project.

These early procurement complications may be alleviated by anticipation of these issues with the contract and negotiating conditions for payment of amounts expended to lock pricing. Another means to alleviate early pressure to lock prices prior to the full project contract is for owners to place deposits where necessary for price locks.

Force Majeure Clauses

Force majeure, French for “greater force,” are the most common clauses utilized to excuse a parties’ performance for unforeseeable circumstances beyond a parties’ control that prevent performance. Force majeure clauses are “interpreted in accordance with their language and context.”7 As a result, performance will only be excused if the specific circumstances are excused by the force majeure clause. Further, force majeure clauses only excuse nonperformance if caused by circumstances beyond the control of the party charged with performance.8 As a result, the specific language of the force majeure clause is critical to determination whether performance is excused in the specific circumstances presented.

Force majeure clauses most often excuse time related performance and do not specifically provide relief to a contractor for material price increases. For example, the American Institute of Architects’ AIA Document A201-2017 General Conditions of the Contract for Construction (perhaps the most commonly used contracting document in the construction industry), includes the following clause:

Section 8.3.1. If the Contractor is delayed at any time in the commencement or progress of the Work by (1) an act or neglect of the Owner or Architect, of an employee of either, or of a Separate Contractor; (2) by changes ordered in the Work; (3) by labor disputes, fire, unusual delay in deliveries, unavoidable casualties, adverse weather conditions documented in accordance with Section 15.1.6.2, or other causes beyond the Contractor’s control; (4) by delay authorized by the Owner pending mediation and binding dispute resolution; or (5) by other causes that the Contractor asserts, and the Architect determines, justify delay, then the Contract Time shall be extended for such reasonable time as the Architect may determine.

The AIA version of force majeure deals only with causes of delays or extension of time for the project, but provides no direct remedy for additional costs resulting from the delay. In particular it does not address events of material price increases.

Other types of force majeure clauses may permit price increases due to events of force majeure, although those cost increases will often be tied to the additional costs resulting from project time extension. These time extension costs most often include increased costs for supervision and general conditions costs such as jobsite trailer rentals, temporary facilities, site utilities, and other similar costs. Although clauses differ, the most common clauses require the delay to be a result of causes beyond the contractor’s control, nonconcurrent with noncompensable causes, and be delays to a critical path of the project. Some clauses also require the delay be “nonconcurrent” with other causes that are not excused under the contract.

Where delays are compensable under a force majeure clause, such delays may provide an opening for a contractor to make a claim for material price increases to the extent such price escalation occurs during, and as a result of, the period of compensable delay. Such claims would likely require the contractor to establish that the price escalation is a result of the project delay. For example, delays in the owner’s selection of materials may prevent a contractor from ordering materials until a later date resulting in increased costs, both those associated with the selection itself and those that are ancillary for such installation. Other types of delays might provide an opening for such a claim as well, for example where weather events cause extended delays and prevent ordering of materials resulting in price increases.

Given the potential for cascading consequences of delays, both contractors and owners should be aware of the scope and remedies available under force majeure clauses and take care to avoid causing delays that may provide exposure to industry wide price increases.

Allowance Clauses

Within Lump Sum and Cost Plus Fee with GMP contract structures, allowance clauses are often used to budget costs for specified categories of work where pricing is undetermined at the time the contract is executed.

Allowances will usually identify a budget amount within the contract price, with the contractor entitled to bill the actual cost of the work or materials. Where costs exceed the set allowance, the contractor is permitted to increase the Lump Sum or GMP amount by the amount of the increase. Where costs are less, the Lump Sum or GMP is adjusted down by the difference. As a result, the allowance clause creates a partial Cost Plus Fee pricing structure for only a portion of the work.

Allowances are often used for categories of work that may not be fully known at the time of contracting where information is incomplete, such as preliminary plans, unknown soil conditions, or pending owner selections.

Depending on the clause, allowance clauses may apply to materials prices or the costs of both materials and labor. Where the allowance clause includes materials, the risk of price increases for those materials will be effectively transferred to the owner. Allowances are employed on the vast majority of large construction projects. As a result, these ubiquitous clauses may be used as a relatively subtle method for contractors to pass along price increase risk for specific categories or materials without changing the overall price structure or risk allocations for the project.

Price Escalation Clauses

Although used less frequently than force majeure and allowance clauses, price escalation clauses are becoming increasingly common. These clauses allow a contractor to increase its contract price due to market price increases. They take a variety of different forms with a myriad different provisions, but with three general categories:

(1) Any Increase/Day-One. Any increase or day-one clauses allow a contract price increase for any increase in material pricing during the project on or after a set date, often the date of bidding or contract date. As these clauses are open ended and expose the upstream party to the complete risk of price increases, they often designate the specific categories of materials to which the price increase is allowable. As a result, these clauses function much in the same way as allowances, although potentially not permitting the upstream party the benefit of price decreases. Given the broad exposure presented to the upstream party, these clauses are used less frequently.

(2) Threshold. A threshold price escalation clause sets a specified threshold over which the contractor is entitled to a price increase. As a result, the parties take on a share of risk for material price increases dependent on the threshold set. With this structure the contractor will share the risk up to the set percentage increase and the owner (or other upstream party) is protected from market changes up to that threshold, but will bear the high-end market changes. The contractor’s risk is effectively capped, with the owner’s risk being open ended, although the parties could contract to cap the owner’s high-end risk at a higher threshold. The ConsensusDocs 200.1 Time and Price Impacted Material Amendment provides a form of a threshold price escalation clause.

(3) Delay. A delay price escalation clause provides for the contractor to increase its price if the project or portion thereof is delayed beyond a milestone date. Generally, these clauses set the triggering milestone at a date within which the contractor has locked prices and delays in ordering would result in suppliers being able to adjust prices. For example, the Wisconsin Department of Transportations’ standard specifications allow for increased material costs due to delay.9

Escalation clauses may include an amalgamation of the three types whereby a contractor may be entitled to a price increase beyond a certain threshold, provided the project is subject to delay beyond a set milestone date when prices may be readjusted. As a result, there can be further risk sharing between the parties with the contractor being able to obtain price increases provided there is an event outside the contractor’s control, but with the contractor still assuming some risk of price increases.

Within the price escalation clauses, the amount of increase to the contract price may be adjusted for the actual costs incurred or mirror changes in industry material price indexes such as the producer price index.

Given the current market conditions, price escalation clauses are becoming increasingly common. Such clauses present both parties an opportunity to contemplate the circumstances of material price increases before they become a substantial burden on either side. Although parties are generally incentivized to transfer such risks to the other, failing to manage and apportion the risks may be counterproductive for a construction project and render one party in a position of being unable to perform creating a precarious position for both sides.

Conclusion: Worth the Attention

Whatever the cause, changes in material prices pose a significant risk to the parties on any construction project.

This article was originally published on the State Bar of Wisconsin’s Construction and Public Contract Law Section Blog. Visit the State Bar sections or the Construction and Public Contract Law Section web pages to learn more about the benefits of section membership.

Endnotes

1 Joe Hernandez, Lumber Prices Are Finally Dropping After They Soared During The Pandemic, NPR.org, June 21, 2021.

2 Commodity Price Graph for Lumber from July 6, 2020, to July 6, 2021, NASDAQ.com.

3 Hernandez, supra note 1.

4 Proliferating Materials Price Increases and Supply Chain Disruptions Squeeze Contractors and Threaten to Undermine Economic Recovery, AGC.org, May 13, 2021.

5 McMillan v. Fox, 90 Wis. 173, 62 N.W. 1052 (1895).

6 Moyer v. City of Little Falls, 510 N.Y.S.2d 813 (N.Y. Sup. Ct. 1986).

7 Wisconsin Elec. Power Co. v. Union P.R. Co.,557 F.3d 504, 507 (7th Cir. 2009).

8 Goldstein v. Lindner, 2002 WI App 122, ¶ 31, 254 Wis. 2d 673, 687, 648 N.W.2d 892, 899.

9 See Wisconsin Department of Transportation 2021 Standard Specifications, 109 Measurement and Payment, §109.4.7.2.5.

109.4.7.2.5 Materials Escalation or Material Storage
(1) The department will pay the contractor for increased material costs or material storage costs due to the delay. Obtain the engineer’s approval before storing material due to a delay.