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Avoid Being Dragged Down by Supply Chain Disruptions
Every day we hear about supply chain disruptions in the marketplace. Everything from computer chips to food products. Indeed, concern is starting to rise as to whether consumers will be able to get the gifts they want for the coming Holiday Season. Of course, the construction industry is not immune to these supply chain disruptions. In a recent article, Fitch Ratings observed that the disruptions are causing production delays, which have been exacerbated by ongoing port congestion, pressuring sales volumes and leading to higher raw materials and transportation costs. It was further noted that the supply chain disruptions in the US building products and materials sector are taking longer than expected to normalize. With the passage of the new Infrastructure bill, even more pressure will soon be asserted on the construction supply chains with anticipated increasing demand. Because of these disruptions, the cost of processed inputs for US firms is rising at its fastest rate in 40 years. Building products and materials companies are employing actions, including price increases, surcharges, and capacity expansion to navigate the production and inflationary pressures caused by supply chain disruption. Materials and components for construction costs increased at a double-digit year-over-year rate since March and rose 19% in August 2021. Transportation costs, particularly for shipping, are also increasing. In-bound freight container costs nearly tripled during Q2 – 2021.
Given the market uncertainty and the potential for huge price swings, it is time to revisit price escalation clauses in your contracts. Traditionally, the contractor bears the risk that costs will increase during the performance of the contract in a fixed price contract. A price escalation clause is a provision in a contract that addresses whether a party will be able to recover price increases for materials that have occurred since bid submission or the time the contract was made and when the materials were ordered. For example, the ConsensusDocs Standard Agreement and General Conditions Between Owner and Constructor provides “[t]he Contract Price . . . shall be equitably adjusted by Change Order for additional costs . . . resulting from any change in Law, including increased taxes, enacted after the date of this Agreement.” ¶ 3.21.1 ConsensusDocs 200 – 2016.
In today’s market, when the parties are negotiating a contract a discussion must be had regarding the risk of increasing material costs. Owners will want to eliminate the risk of increasing prices by barring any price escalation. General Contractors will want to flow that limitation down to its subcontractors and suppliers. Subcontractors and suppliers will want to shift all of the price increase upstream to the general contractor and owner. Of course, excessive risk shifting in either direction can lead to unintended consequences. For example, if an owner and general contractor bar any price increases in the bid documents or contract, such risk shifting will lead to price increases in the bids overall as the subcontractors and suppliers are forced to estimate the potential impact of increasing material costs in the future. Such “estimating” can lead to unnecessarily high bids. If the estimates are bad and the material cost increases are large enough subcontractors and suppliers can fail which adds even more costs to the general contractor and/or owner. More reasonable price escalation clauses can be negotiated with material price increases being shared on a percentage basis that changes depending on the amount of the increase. Sharing the burden may prevent a larger problem. Regardless of your position in the construction tiers, everyone in the process must start considering how to address the impacts of these supply chain disruptions and what to do with the material price increase risks.
More than just price escalation is at issue. Contractors and owners need to prepare for the potential of unavailable materials at any price. Force Majeure clauses need to be drafted to specifically address supply chain disruptions. Scheduled completion dates need to be qualified or conditioned on the ready availability of supplies and materials. If you have questions about how to address uncertainty caused by supply chain disruptions please contact any member of Wright, Constable & Skeen’s Construction Law Practice Group or Government Contracts Practice Group.