In the past two years, the costs of lumber, steel, and other building materials have risen substantially and quickly. So what should a contractor do when writing jobs today that may cost much more to build if prices jump unexpectedly tomorrow?
Many contractors mistakenly believe that a “force majeure” clause in their contracts will protect them from cost overruns. A force majeure clause limits a contractor's responsibilities for delays caused by certain events, such as labor strikes, acts of God, terrorism, and the like, that the parties agree are beyond the contractor's control. Most courts in the United States and Canada, however, won't let a contractor out of a fixed-price contract simply because the raw material costs of a job have unexpectedly increased. In the eyes of our legal system, price fluctuations may make a job more difficult to complete, but not impossible.
Going Up? Instead, contractors may want to consider using an “escalation” clause in their contracts. (Sometimes these clauses are also referred to as “changed circumstances,” “equitable adjustment,” or “cost plus” clauses.) An escalation clause is designed to protect the contractor from volatile job costs by passing the price changes along to the consumer. Obviously, this can be a touchy issue when it arises on a job in progress, so an escalation clause has to be very carefully drafted.
The clause should identify the specific building materials the contractor feels are at risk for price fluctuation, and should then explain that if those costs increase, the total job price will increase by the same amount.
The clause should also explain how the contractor is going to notify the consumer of the price increases, what price guide will be used to measure the changes in prices, and when and how often during the job the escalation clause can be triggered.
Trigger Points There are three common types of escalation-clause triggers, with many variations. The most basic is the “invoice method,” which generally uses an invoice or letter from the supplier to substantiate the changes in price of the goods from the time the contract was signed to the time of actual purchase.
The second type of trigger, the “index method,” activates the escalation clause based on changes reflected in a designated price index guide, such as are regularly published for lumber, asphalt, cement, and steel. This may work best in those instances in which the supplier is unwilling to provide a fixed-price quote until the time of actual purchase. Price index guides are usually published regionally, so this method may still leave the contractor open to local price fluctuations.
The third type of escalation-clause trigger is a combination of the first two. Here, the parties agree to a “certified bid cost,” in which the contractor discloses his estimate of the raw material costs based on then-current supplier prices or an index price listing. When the contractor actually goes to purchase the materials, if the “supplier's actual price” has increased by more than, say, 5% from the certified bid cost, the increase gets added to the contract price.
D.S. Berenson is the Washington, D.C., managing partner of Johanson Berenson LLP ( www.homeimprovementlaw.com), a national law firm specializing in the representation of contractors and the home improvement industry. He may be contacted at email@example.com. This article is for informational purposes only and should not be construed as legal advice.