The construction industry continues to face ongoing challenges related to supply chain delays and product availability due to COVID-19. Dodge Data & Analytics, a leading provider of commercial construction project data, recently reported that the construction materials cost index increased by 6% in the month of April alone, more than the average annual increase. Dodge also reported the anticipated timeline for return to normal stockpiled inventory could be as long as another 18-24 months.
Historically, skyrocketing material costs and product shortages were addressed through contract contingency; in current market conditions, this method is proving inadequate to address the monthly cost increases of construction materials. The inability to obtain materials may result in significant delays, making it difficult, if not impossible, to carry out work negotiated or hard bid under contract. Contractors and their subcontractors facing steep contractual obligations are beginning to find that these risks are uninsurable, either because insurance carriers have no interest, or contract language precludes coverage.
Fortunately, there are still ways you can transfer, mitigate, or reduce supply chain risk through careful contract review and management. Here we discuss several key considerations:
Force majeure clauses are designed to excuse a breach of contract (i.e., the inability to perform agreed upon work) caused by an unforeseen and catastrophic event. However, like all contract clauses, the details matter, which is why it’s important to make sure your force majeure clauses address the risks you realistically might face.
If a specific reason for failure to perform is not captured by the language of your force majeure clause, you could be on the hook for breach of contract. And while some courts have held that extraordinary shipping delays may constitute force majeure, you do not want that to be left to chance.
Drafting considerations: Instead of a laundry list of all the possible things that could go wrong, focus instead on what type of breach an unforeseen and catastrophic event might cause your organization to commit – and then make sure it is covered. The provision should cover natural disasters like hurricanes, floods, earthquakes, and weather disturbance, as well as human-caused events such as war, terrorism or threats of terrorism, civil disorder, labor strikes or disruptions, fire, disease, epidemic or pandemic, and specifically transportation and supply chain disruption.
Take note if the contract places any obligations on your organization from the delays of others, such as the contractor, an owner, or a third party. Consider modifying those to reduce your risk.
An escalation clause is a provision in a contract that calls for adjustments in the original contracted price or scope of work to account for fluctuations in the costs of raw materials or labor. This clause shifts the burden of the increase cost of materials and labor from the contractor or subcontractor to the project owner. Thus, the clause is used to escalate or increase a price or payment based on triggering events.
Including such a clause allows all parties to be on notice that the contract costs could change if material prices change due to supply constraints outside the contractor’s control – and also identify who is responsible for that escalation in price.
Non-performance clauses can be used to excuse the contractor from performing when availability or pricing make compliance unfeasible, impractical, or impossible. The following is a common example of non-performance language:
Performance will be excused, and the parties will not be liable for any failure to perform under this Agreement, when Contractor is unable, despite diligent efforts to do so, to obtain raw materials and supplies on terms Contractor deems commercially acceptable.
Non-performance clauses can be used in conjunction with or in lieu of escalation clauses.
Drafting considerations: Escalation clauses should state that the cost estimates for the construction project are calculated based on current materials or supply prices, but that the market for the materials is currently considered to be volatile, and sudden price increases could occur. Such clauses can include a specific method for determining market volatility, and can address delays and unavailability, as well.
Escalation clauses can also shift cost increases onto the owner/customer by stating if the costs associated with a project increase by a certain percentage over the negotiated amount, the customer is responsible for paying the higher cost. In addition, the contract can give the contractor the right to raise prices because of the increased price of raw materials due to rise in the market price or other “contingencies beyond” the contractor’s “reasonable control.”
Bidding considerations: Prior to entering into an agreement on a project, some contractors notify project owners that the bid provided has a short window of acceptance or the owner will have to "float" the risk for any additional costs and time delays. Another emerging term is offering a “buy down” option where the project owner shares the risk of the increased costs by paying a fee to lock in the contractual price for 60 days.
Many construction contracts include completion clauses that impose obligations to perform according to specific timelines or deadlines, and may also state that “time is of the essence.” Such time-related terms require strict compliance to avoid breaching the contract, since penalties can include payment reductions, non-payment, contract termination, and additional penalties, such as liquidated damages (see next consideration below for more information on liquidated damages). Time and delay terms are often found in standalone contract clauses, but may also be contained in other provisions, which is why it is important to carefully review every provision in a contract you’re being asked to sign.
In a volatile supply chain market, the risk of a missed deadline or delay increases significantly. As a result, it is important to understand what events might interfere with your ability to perform on a contract in a timely manner so that you can draft appropriate language to protect yourself from interruptions and delays beyond your control.
Drafting Considerations: Contractors should consider adding excusable time delays in their contracts, as well as a provision that reduces their exposure for certain missed deadlines or other timing delays due to supply chain and other unpredictable circumstances. For example, language such as the following can be used to permit partial shipments or delayed shipments due to supply chain delays or manufacturing shortages or even unavailability:
Where there is a delay outside the control of the parties due to unavailability of goods, delay in delivery, or other unforeseen or remote contingences, the parties agree such a delay is not considered a breach under this section. The parties agree to use commercially reasonable efforts to perform the contract under the deadlines allowable by the market.
If a specified event occurs, then the course of performance or terms would not require strict compliance with deadlines, thus eliminating a breach of contract. Note that such delays may increase the cost of the project, which the contractor and subcontractor will want to mitigate with a cost/escalation clause.
Parties to a contract can preemptively limit their risk and exposure through terms limiting the amount paid if a breach occurs, or alternatively, penalize a party with a specific dollar amount if an identified breach occurs.
Limitation of liability clauses typically cap damages payable under the contract to a specified amount, such as the amount of fees paid under the contract, available insurance proceeds, etc. Such clauses will also usually contain a waiver of incidental, special, punitive, and consequential damages.
Liquidated damages provisions establish a specific dollar amount for damages in the event of a breach. They are often used when the actual measure of damages may be difficult to establish, or when the determination of damages would likely require court intervention. In construction contracts, they are often used in connection with project delays and other problems that arise in connection with supply chain disruptions and unavailability.
Owner/Customer contracts – Liquidated damages provisions typically benefit owners/customers and are commonly included in construction contracts. Contractors will want to try to negotiate specific carve-outs in liquidated damage provisions, especially if the amounts seem disproportionate to the actual damages the owner/customer might realistically face.
Ideally, the contract should limit liability to an amount that is beneficial to the contractor, such as fees paid under the contract or the available insurance proceeds.
It is critical that you understand every clause in every contract you send out or receive to make sure the terms are favorable to you, or, in the alternative, that you understand and can come to terms with the risk you may be taking on. Strategic contract language includes planning for things like supply chain issues that might impact your ability to perform. Building in contract terms that reduce your exposure for circumstances over which you have no control should be a key component in your contract negotiations. Contact us to learn more.
Disclaimer: The above considerations contemplate general common law principles. State and federal laws vary in how these clauses have been interpreted and enforced. Companies should not assume that it is easy to defend or excuse non-performance or late performance due to COVID-19 and subsequent supply chain crises. As a result, it is always wise to consult legal counsel in connection with contracts you will be signing.
Heather offers practical guidance and helps employers find solutions to employment law and compliance matters.
Heather educates and advises employers on all aspects of employment law, including compliance with state and federal laws, leaves of absence, discrimination, harassment, accommodations, discipline and discharge, wage and hour obligations, unfair competition, and other issues that arise in the workplace. In addition to Heather’s employment counseling, her background includes nearly a decade of litigation experience. Her prior experience includes litigating for a regional insurance company, business disputes, and employment.
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