Pricing labor and materials in the wake of the pandemic has become a roll of the dice for owners and contractors. Early manufacturing lockdowns and a downturn in the economy caused labor pools to shrink and material production to slow. As construction recovered from the initial shock, demand began to outstrip lagging supply, causing prices in certain sectors to soar. Since this time last year, for example, the composite price of lumber is up more than 70% and certain iron and steel products are up 50% or more.
Although market volatility has been particularly intense since the pandemic began, the basic concept of price escalation is not new to construction. Contractors are accustomed to betting on the stability of pricing when they enter into contracts, but this uncertainty is much harder to accept when prices are unstable at the time the contract is bid. The contractor is faced with the choice of building price escalation risks into its proposal, and potentially overbidding, or using current pricing and footing the bill for post-contract increases.
There is another option. Pricing risks can be well-managed, and more fairly apportioned between the owner and the contractor, by negotiating a “price escalation clause.” A typical escalation clause authorizes additional compensation to the contractor when certain predetermined market conditions arise and significantly impact the cost of labor, equipment or materials. The contractor can be compensated for every dollar of the escalation, resulting in a lower bid value, or only for escalations over a set percentage, allowing the risk to be shared among the contracting parties.
Owners often conclude that escalation clauses benefit only the contractor. Consider, however, that escalation clauses discourage bid padding and encourage more accurate “apples-to-apples” pricing on bid day. If the escalation never occurs, the owner does not overpay for the work. If escalation does occur, the owner and the contractor have a predetermined payment formula to determine compensation. This reduces the number of disputes and cuts down on project interruptions.
Our Construction Practice Group is here to help if you need assistance drafting a price escalation clause or navigating any other issues in construction.