Legal Blog

Drafting Contract Terms That Protect Owners and Contractors From Unforeseen Increases In Construction Costs

Construction material costs are up 17.5 percent year-over-year from 2020 to 2021—the largest increase since 1970. In these uncertain times, even the most skilled contractors find it difficult to prepare accurate cost estimates (sometimes submitted up to a year before the start of construction) without placing themselves at undue risk of underbidding the project. As a result, contractors use price escalation clauses to protect them against having to absorb unforeseen increases in material costs.

A well-drafted escalation clause will protect a contractor from unforeseen increases in material costs by establishing an agreed-upon metric that entitles the contractor to additional compensation in the event the costs of materials increase after the contract is signed. Project owners are generally reluctant to agree to blanket contract terms that require them to absorb increases in costs of materials without an explanation. However, the current market conditions have caused many owners to become willing to accommodate the impact the pandemic, inflation, and supply shortages are having on the construction industry. As is the case in any contract negotiation, the contractor that takes the time to educate the owner about the impact the unstable economy is having on construction costs and proposes an escalation clause that is fair to both parties will have the greatest chance of having it included in the contract.

 

There are many ways to draft an escalation clause that is fair to both parties. A few examples include:

  • Guaranteeing the cost for materials provided in the bid for a certain period of time and requiring the owner to absorb any increase in costs after the guaranty period lapses.
  • Requiring the contractor and owner to share the risk of any increased costs. Under this model, the escalation clause will require the contractor to absorb any increase in material costs up to a certain percentage above the current price of material. Once the costs of materials exceed this “trigger point,” the owner is required to pay the contractor for any increase in the costs of materials.
  • Relying upon pricing indexes to determine any increases in contract price caused by a change in material costs.

 

Some important questions to consider when negotiating an escalation clause include:

  • What is the method and time for notifying the owner of the change in the material costs?
  • Is there a maximum limit for price increases?
  • Will the contractor be granted an extension for delays in the delivery of materials?
  • Will the contractor be permitted to include mark-ups for overhead and profits?
  • What supporting documentation must be provided to justify the price increase?

 

There are many other factors that owners and contractors must consider in order to mitigate the risks of significant impact on the project and costs. Consider retaining an experienced construction lawyer to address these issues by negotiating and drafting provisions that can help to avoid disputes when it’s too little too late. By drafting contract provisions that fairly allocate the risk of unforeseen costs between the contractor and owner, the parties can avoid disputes that can delay the completion of the project and may lead to litigation.

 

For questions about construction contracts, claims, or related issues, contact Mark Shaffer at mark.shaffer@offitkurman.com.

ABOUT MARK SHAFFER

Mark Shaffer is a first-chair trial attorney with significant courtroom experience. He has litigated throughout the United States with substantial experience in the state and federal courts of Virginia, Maryland, and the District of Columbia. Mr. Shaffer concentrates his litigation practice in construction litigation, eminent domain, contract disputes, land use litigation, and leasing disputes. He represents owners, developers, contractors, project engineers and design professionals at all levels of the state and federal courts, and includes litigating a wide variety of design defects, differing site conditions, delay claims, and change orders. He also represents owners and developers in zoning appeals, development agreements, easement rights and restrictive covenant disputes.

 

 

 

 

ABOUT OFFIT KURMAN

Offit Kurman, one of the fastest-growing, full-service law firms in the United States, serves dynamic businesses, individuals and families. With 17 offices and nearly 250 lawyers who counsel clients across more than 30 areas of practice, Offit Kurman helps maximize and protect business value and personal wealth by providing innovative and entrepreneurial counsel that focuses on clients’ business objectives, interests and goals. The firm is distinguished by the quality, breadth and global reach of its legal services and a unique operational structure that encourages a culture of collaboration. For more information, visit www.offitkurman.com.

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