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In this blog, presented by SunRay Construction Solutions and Saul C. Glazer, Partner, Axley Brynelson LLP, we’ll explore how construction professionals can prepare for the potential challenges of the next few years, particularly in dealing with price escalation and unavoidable delays. This guide will cover contract strategies, risk management, and the importance of a proactive approach in safeguarding your projects.
The Impact of COVID-19 on Material and Labor Shortages
During the COVID-19 pandemic, the construction industry experienced several disruptions that still linger today. Among the most notable were price increases on essential materials, such as lumber, steel, and windows. Supply chains were broken, and manufacturers struggled to keep up with demand. For example, one project faced challenges with window shortages, resulting in a complete re-sequencing of the work—something that added complexity and cost to the project.
As we move forward, we need to be prepared for the potential continuation of these challenges. The uncertainty of supply chain disruptions could impact availability and pricing of essential materials, as well as labor shortages due to ongoing changes in immigration policies and workforce dynamics.
How to Prepare for Price Escalation and Material Shortages
Price escalation and material shortages have become common concerns for contractors and subcontractors. With inflation, global trade dynamics, and tariff regulations, materials can become unexpectedly expensive, causing budget issues for developers and contractors alike.
When it comes to price increases, it’s essential to address these concerns proactively within your contracts. For example, if you’re a general contractor, you need to have a clear understanding of what your subcontractors will charge. For subcontractors, being clear about the materials and labor needed to fulfill the scope of work is equally important. If any unforeseen circumstances arise, you should have mechanisms in place to protect your margins.
Protecting Yourself Through Contract Clauses
One of the most effective ways to safeguard against price escalation and labor shortages is by including protective clauses in your contracts. Two important mechanisms that can help mitigate risk are the Force Majeure Clauses and Price Escalation Clauses.
Force Majeure Clauses: What They Are and How They Work
A Force Majeure Clause is a provision in your contract that addresses unanticipated events or situations beyond your control, such as pandemics, natural disasters, or strikes. This clause protects both contractors and subcontractors in case of unexpected disruptions, offering either an extension of time or additional compensation—or both.
For example, if a shortage in materials arises or labor becomes unavailable due to a global event, a force majeure clause could provide you with more time to complete the project and/or more money to cover the costs associated with delays or procurement challenges. However, it's important to note that force majeure clauses typically don’t cover price increases or labor shortages unless specifically detailed.
In the case of the COVID-19 pandemic, for example, a force majeure clause might not be invoked because the pandemic had already been recognized as a global event. When drafting a force majeure clause for your contracts, make sure to include terms like "including but not limited to pandemics" to avoid ambiguity.
Price Escalation Clauses: How to Address Rising Costs
Price escalation clauses are crucial when dealing with unpredictable cost increases for materials or labor. The goal of a price escalation clause is to protect contractors by ensuring that they won’t be left absorbing the costs of material price increases that exceed a certain threshold.
For instance, if your contract is based on a baseline price for materials, and unexpected tariffs or shortages lead to a 23% increase in the cost of those materials, a price escalation clause would allow you to adjust the contract price accordingly. The key here is to outline potential items in your contract (such as lumber, steel, windows, or electrical components) and specify a baseline price. If the price of these materials increases above a specified percentage, you can negotiate for a price adjustment based on the escalation.
It’s important to note that the price escalation clause doesn’t cover every type of potential cost increase. Items that aren’t pre-listed or agreed upon in the contract may not be eligible for price adjustments. That’s why it’s important to thoroughly discuss and document any materials or labor that could see potential price fluctuations.
Checklist to Address Rising Costs
- Incorporate a Price Escalation Clause: Include clauses in contracts that allow adjustments for cost increases in materials or labor beyond a specific threshold.
- Set a Baseline Price: Define baseline prices for key materials (e.g., lumber, steel, windows) in your contract to serve as a reference for escalation calculations.
- Specify Thresholds for Adjustments: Establish a percentage increase (e.g., 15–20%) that triggers a price adjustment to protect your budget.
- List Key Materials Explicitly: Pre-identify materials or labor prone to price volatility and include them in the escalation clause to ensure eligibility for adjustments.
- Negotiate Adjustments Transparently: Agree in advance on how cost increases will be calculated and approved to avoid disputes.
- Document Discussions Thoroughly: Ensure all agreements regarding materials, labor, and potential cost fluctuations are clearly outlined and documented in writing.
- Understand Limitations: Recognize that only pre-listed materials or labor categories are covered by escalation clauses; unlisted items are not eligible.
- Stay Proactive: Regularly review market conditions and update contracts to reflect current risks and ensure continued protection.
- Consult Legal and Industry Experts: Work with construction attorneys or consultants to craft clauses that comply with local regulations and industry standards.
Dealing with Labor Shortages: Managing Workforce Issues in a Changing Market
Labor shortages are another significant risk for the construction industry. Factors such as shifting immigration policies, changing demographics, and the overall availability of skilled labor can create delays and disruptions in your project timelines.
To safeguard against labor shortages, you should include equitable adjustment clauses in your contracts. These clauses allow for the adjustment of the contract sum and time frame if labor becomes unavailable or if there are substantial workforce disruptions.
Additionally, allowance items can be used for labor if you're uncertain about the future labor market. By setting aside a certain amount of money for labor, you can adjust your costs based on real-time labor availability, without having to renegotiate the contract entirely.
The Importance of Understanding Your Contracts
One of the most crucial steps in protecting yourself from material price increases and labor shortages is ensuring that you thoroughly understand your contracts. Too many contractors, whether general contractors or subcontractors, sign contracts without fully understanding the language and implications of the terms.
Before you sign any contract, it’s essential to understand the clauses within it, especially those related to price escalation, force majeure, and equitable adjustments. If there’s something you don’t understand, reach out to a construction attorney who can help clarify terms and make sure that the contract aligns with your best interests.
Additionally, always make sure that any change orders, adjustments, or negotiations are documented in writing. Oral agreements or change orders may be harder to enforce later on. Having everything documented ensures that you have a solid legal standing if disputes arise.
Summary
As we move into an uncertain future in the construction industry, it’s important to be proactive. Understand that price escalation, labor shortages, and supply chain disruptions are very real risks that could impact your projects in the next year or two. The best way to handle these risks is by making sure your contracts protect your interests.
By including force majeure clauses, price escalation clauses, and equitable adjustment clauses in your contracts, you can ensure that you’re prepared for whatever comes your way. And remember, always read your contracts carefully and never sign something you don’t fully understand.
Ultimately, the future may hold challenges, but with the right protections in place, you can navigate the complexities of construction projects and ensure that your business remains resilient, even in tough times.
Key Takeaways
- Price escalation and labor shortages are growing risks in the construction industry due to global disruptions.
- Include Force Majeure Clauses to protect your projects from unforeseen events and disruptions.
- Price Escalation Clauses allow for cost adjustments in the event of unexpected material price increases.
- Equitable Adjustment Clauses help protect against labor shortages and workforce disruptions.
- Understand your contracts thoroughly before signing, ensuring they include protective clauses.
- Keep all changes, adjustments, and negotiations documented in writing to avoid disputes.
Common Questions Contractors Ask
1. What is a Force Majeure Clause, and why is it important?
A Force Majeure Clause is a provision in a contract that releases parties from liability or obligation when an extraordinary event beyond their control occurs, such as a pandemic or natural disaster. It's crucial because it allows for project delays or extensions without penalties.
2. What types of materials are commonly affected by price escalation?
Common materials impacted by price escalation include lumber, steel, concrete, and certain electrical components. Prices for these materials can fluctuate due to tariffs, shortages, or global supply chain issues.
3. How do price escalation clauses help protect contractors?
Price escalation clauses ensure that contractors can adjust project costs if the price of materials or labor increases unexpectedly during the project, allowing them to maintain profitability and cover any unforeseen price hikes.
4. What should I do if I don’t understand my contract’s clauses?
If you’re unsure about any terms or clauses in your contract, it’s important to consult a construction attorney. They can clarify the terms and help you ensure your contract adequately protects your interests.
5. Can labor shortages be addressed in my contract?
Yes, labor shortages can be addressed using equitable adjustment clauses, which allow for adjustments to both the project timeline and budget if labor availability becomes an issue.
6. How can I ensure my contract protects my business from future disruptions?
Ensure your contract includes clauses like Force Majeure, Price Escalation, and Equitable Adjustment. These clauses can provide you with legal protection in case of material price increases, labor shortages, or other unforeseen events.
