The construction sector has been in a bull market for an unprecedented period of time. With the novel impacts from the coronavirus—and all the associated side effects, such as government moratoria, shipping delays and materials availability—we are now in a market of extreme volatility in pricing, inflation and increasing capital finance rates. And yet the construction sector continues to plow forward despite uncertainty, producing critical infrastructure, and much necessary housing, among other projects. The signs are that this trend will continue at least through Q1 of 2023, and likely beyond that, especially when you factor into the equation the many billions of dollars being placed into the market through the Bipartisan Infrastructure Law. It is not surprising, therefore, that the number one issue in construction contracts in 2022 is how parties handle inflation and materials cost escalations in existing contracts and in the negotiations for new contracts. There is no other issue more heavily negotiated, often disputed and hotly debated in the construction sector today. While this may sound provocative, the private market reality is this: Hard lump sum and guaranteed maximum price contracts are a thing of the past, at least for the near-term future. It’s not common to see a hard GMP or lump sum that does not provide some form of relief for unavoidable materials cost escalations. Some projects are proceeding on a cost-plus basis, which, historically, was a contracting model reserved for unique projects with a challenging number of unknown conditions or incomplete designs. The data is admittedly a bit more unique in the public sector, at least on hard-bid jobs where contractors can bid with a contingency to cover this risk, but it is a line item that is generally not seen in any breakdown. The current reality is that qualified contractors, subcontractors and suppliers are not likely to provide firm or hard quotes without some form of relief to fairly allocate the risk of inflation. The intent of this column is to identify the current market realities and risk and outline the various contract mechanisms that parties can use to allocate risk and cost in an equitable manner.
There is no one-size-fits-all solution to handling cost escalation on a construction project. The most common contractual approaches to address the risk allocation for materials cost escalations include the following:
Regardless of what approach is used to address the risk of materials price escalations, contracting parties should also address some of the following additional considerations.
Tremendous change has occurred in construction contracts over the last two and a half years, especially in the force majeure and contract price relief context, and it does not appear that 2023 will revert to prior practices. If anything, the market continues to reveal a certain degree of volatility that justifies the parties continuing to apply a more conscientious and customized approach to how they handle the allocation of risk and liability. Hopefully the thoughts expressed in this column will assist parties in negotiating more fair, balanced construction contracts in this ever-increasingly complicated market.
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