How to Prevent Material Increases from Hurting Your Bottom Line by Trent Cotney
Material price increases. You probably cannot go a day without thinking about them. Everywhere you look, everything costs more, and those increases can impact your construction projects and your profit margin.
As you may have heard, some contractors are suffering huge losses due to material shortages and price increases. Some have even closed up shop. So how can you protect yourself and your company during these challenging times?
If you find yourself unable to complete a project because prices have spiked, two legal doctrines may protect you.
• Force Majeure: You have likely heard of this doctrine, but usually it is tied to uncontrollable issues such as the weather, labor strikes, and fire. However, since it can excuse you from contractual performance due to unforeseen events, it may apply to price increases. It will not apply to normal changes in market prices, but if your ability to perform is not possible, this doctrine may cover you.
• Commercial Impracticability: This doctrine is similar to force majeure in that it also contends that you cannot fulfill your contractual obligations due to issues outside your control. In this case, you may need materials stipulated in your contract, but your seller cannot deliver them on time because of shortages or significant price increases.
If you rely on either of these doctrines to protect you, however, you must show evidence that the impact on material prices was caused by an unforeseen event—such as factory shutdowns, war, or raw material shortages—not just a normal variation in price. You will also need to show that you explored alternatives to your material issues prior to seeking protection from these doctrines.
Before you begin a project, the best way to protect yourself is to ensure that specific language is included in your contract. As you know, a contract addresses different types of risk, and in construction, they often fall into these categories: scheduling, performance, and financial. When material shortages and prices increase, all those risks are in play. For example, materials may take longer to get, which will impact your timeline and performance, and as prices rise, your costs will impact your finances. So it is imperative that you understand the risks you are taking when you sign a contract.
There are a number of contractual clauses you can include to mitigate that risk.
• Force Majeure: In keeping with the doctrine already discussed, a force majeure clause can be modified in your contract to include material shortages and price increases.
• Price Escalation: This clause can set a base price for materials and provide the contractor with the right to an adjustment if the price rises over a given limit.
• Contract Price: Similar to the price escalation, this clause states that if material prices exceed a specific level, the contract price can increase.
If you are already involved in a project that is experiencing an extreme material price increase, there could be ways for you to recover those costs. For example, if your project was delayed due to actions by another party and prices increased during that time, you are likely entitled to recover those costs. But keep in mind that you will need to show evidence. You must prove that you did not cause the delay and the costs are compensable based on your contract.
Advice for Contractors
Staying ahead of today’s material price increases can be challenging. But the market is expected to be volatile for some time to come. So before you get frustrated and cancel a contract or suffer the financial hit, be sure to consult legal counsel. An experienced construction attorney can review your contract and help you understand your options.
The information contained in this article is for general educational information only. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice for your specific factual pattern or situation.
Trent Cotney is a partner and Construction Practice Group Leader at the law firm of Adams and Reese LLP. For more information on this subject, please contact the author at [email protected]