Ways to address fluctuating material prices in construction contracts.

When a subcontractor signs a fixed price contract, the subcontractor typically bears the risk of increased prices for materials.  Under normal circumstances the subcontractor will have to absorb increases in the price of lumber, paint, PVC, metals, glass, concrete, etc.  A construction attorney, however, can draft contract provisions that change how the costs of the work and material price fluctuations will be handled to mitigate impacts on the subcontractor.

Material Price Escalation Provisions

One direct way to account for increases in the price of materials is to add a material price escalation provision to the subcontract.  These provisions can be inserted into an otherwise fixed price contract.  The material price escalation provision will then entitle the subcontractor to a change order that increases the contract price if the material prices increase between the time of signing the contract (or of submitting its bid) and when the subcontractor purchases the materials to perform the work.

Material price escalation clauses can be drafted custom for the project and scope of work at issue or be more generic.  Below are two examples of what such clauses might look like.

Example 1 – Material Escalation Clause

“In the event of significant delay or significant price increase of material, equipment, energy, or labor occurring during the performance of the contract through no fault of the subcontractor, the contract sum, time of completion, and contract requirements shall be adjusted by change order.  A change in price of an item of material, equipment, energy, or labor will be considered significant when the price of an item increases 10% between the date of this contract and the date of material purchase.  The amount of the increase shall be capped at 20% of the original budgeted price for the item.”

Example 2 – Material Escalation Clause

“This agreement is conditioned upon the ability of the subcontractor to complete the project at the present prices for material and at the existing scale of wages for labor.  If the subcontractor is at any time or for any reason unable to complete the project at the present prices or scale, or unable to procure promptly as and when needed labor and material, then the contract sum and time shall be adjusted by change order.  A change in price will be considered significant if the price increases 10% between the date of this agreement and the date of the applicable work.”

Project-specific tailoring for these provisions could be to limit them to only apply to certain types of materials or a certain subset of the work.  The trigger points for when increased material costs result in increased compensation can of course be negotiated and set however the parties agree.  The parties can also negotiate whether the potential upward adjustment has a ceiling or not and, if so, what that ceiling amount should be.

Cost-Plus Contracts

A second direct way a construction attorney can deal with fluctuating material prices in the contract is to use a cost-plus contract instead of a fixed price contract.  In a cost-plus contract the contractor is paid what the cost of the work ends up being plus a fee for overhead and profit.  As the cost of materials increases that cost is passed on to the owner.  This removes the risk of unpredictable materials costs from the contractor.  It also can benefit the owner depending on the direction of price swings because if the material prices swing back down during the project then the cost of the work goes down and the owner ultimately gets the benefit of the decreased materials prices by paying less.

A cost-plus contract is commonly structured by defining the contract price as the cost of the work plus the contractor’s fee.  The cost of the work is then defined to include things like labor, materials, equipment, temporary facilities, payment and performance bonds, insurance, etc.  The contract may also define what is not included in the cost of the work such as salaries of home office employees and home office overhead.  The contractor’s fee will also be defined in the contract.  The contractors fee could be a fixed sum, percentage based on the cost of the work, combination of the two, or some other method.

Using Increased Prices in the Bid

A third way to address future material price increases is to factor the potential higher prices into the bid.  In this method, the subcontractor estimates what the future increased prices might be and bids off those higher prices.  The significant downsides to this are obvious.  It makes the subcontractor’s bid less competitive.  It also results in an owner receiving bids with higher costs factored in that might not actually come to fruition.  Avoiding this scenario is a compelling reason for using material price escalation clauses and cost-plus contracts during times of high volatility.

Less Direct Ways to Address the Problem

There are also arguably less direct ways to address the potential for increasing prices of materials.  A force majeure clause is a contract provision that relieves the parties from performing their contractual obligations if certain events occur.  A force majeure clause could be drafted or revised to address material pricing risk.

The parties could also build extended durations into the project schedule.  The longer durations could provide additional procurement time to protect against delays from shortages or give the contractor more time to procure materials under more favorable conditions.

From a bidding contractor’s perspective, the contractor could place time limits on how long its bid is good for.  This in theory could lessen the risk that a bid calculated at yesterday’s prices is accepted farther down the road than was expected.

To the extent even possible or practical, stockpiling key materials may be an option.  This will be subject to real world limitations though and is not necessarily feasible.

Finally, proposing use of substantial equivalent materials and systems can be attempted.  When fluctuations and procurement problems are widespread, owners may become more lenient under the circumstances.

Nick Schwandner

Nick Schwandner is a construction attorney in Cincinnati, Ohio and the founder of Schwandner Law Firm LLC.  He advises construction companies on their contract rights and options before, during, and after projects.