Legal and Regulatory

Deescalating Hyper Escalation

Legislation at the federal and state levels would address record materials price increases in public procurement.
By Paul F. Williamson
June 7, 2023
Topics
Legal and Regulatory

Recent years have seen the construction industry get hit by a perfect storm of rising costs, workforce shortages, delivery delays, supply-chain issues, inflation, interest-rate hikes and materials price escalation. The cost of construction has become more expensive, leaving all parties to grapple with the sufficiency of their risk-management strategies and the ramifications of contracts that are ill-equipped to deal with unprecedented cost increases. Of particular concern to industry participants are the volatile price fluctuations that construction materials have undergone and how to appropriately mitigate the risks they present.

Although owners, general contractors and subcontractors may seek to mitigate future risks, many who are party to an existing contract all too often must scramble to divine how to absorb significantly more financial risk than they expected pre-pandemic. Contracts that were bid and entered into prior to the pandemic may have seen, in some instances, double- and triple-digit percent increases in prices due to hyper escalation, with little recourse to address such situations. While parties to private contracts are free to mitigate their risk through contract negotiations, parties to federal or state public procurements are somewhat more constrained.

That being said, there are growing efforts at the state and federal levels to address materials escalation in public procurements that should give contractors cause for optimism.

FEDERAL: NATIONAL DEFENSE AUTHORIZATION ACT

At the federal level, earlier this year, President Joe Biden signed into law the 2023 National Defense Authorization Act (NDAA), which has brought welcome relief to U.S. Department of Defense (DoD) contractors that are subject to firm-fixed price (FFP) contracts. Prior to the NDAA being signed into law, DoD contractors that failed to negotiate an economic price adjustment clause into their contracts were left with little recourse to seek contractual relief from the unanticipated inflation or materials price increases that much of the industry has experienced. Indeed, the DoD went as far as to issue guidance stating that contracting officers (COs) had “no authority for providing contractual relief for unanticipated inflation under an FFP contract” and “should not agree to contractor REAs [requests for equitable adjustment] submitted in response to changed economic conditions” because they did not constitute contracting-officer-directed changes.

The NDAA appears, in part, to be the federal government’s recognition of the plight of DoD contractors experiencing record increases in their costs of performance. Specifically, section 822 of the NDAA, titled “Modification of Contracts to Provide Extraordinary Relief Due to Inflation Impacts,” provides temporary authority to DoD COs to provide equitable adjustments to prime contractors when, due solely to economic inflation, the cost of performing the prime contract is greater than the price of the prime contract. The NDAA similarly authorizes a prime contractor to seek an equitable adjustment on behalf of its subcontractor(s) where the cost for the subcontractor to perform under their subcontract is more than the subcontract price. Interestingly, and unlike traditional pass-through claims, which must be brought by a prime contractor on behalf of a subcontractor, the NDAA expressly provides for a subcontractor to make an REA directly to the DoD in the event the prime contractor fails to make a request on the subcontractor’s behalf. Regardless of which contracting party an equitable adjustment is granted to, all equitable adjustments granted under the NDAA are contingent on a contractor’s continued performance under the contract. Furthermore, a contractor’s equitable adjustment will be limited to the actual cost of performance and, if it’s determined to be appropriate by the DoD, a contractor’s indirect costs.

Although the temporary relief that the NDAA will provide is certainly welcome to those presently engaged—or contemplating engagement—under a DoD FFP contract, it may be fleeting. The authority granted in the NDAA is set to expire on Dec. 31, 2023. Whether this authority is extended remains to be seen. As such, DoD contractors would do well to pursue alternative risk-mitigation strategies, so they are well positioned to address increased materials prices and inflation costs, such as by paying close attention to the language of new procurements. If a contractor is actively performing, they should endeavor to leverage their contract to its fullest extent.

MARYLAND: SENATE BILL 358

Relief also appears to be on the horizon at the state level. In particular, on Jan. 30, 2023, Senate Bill 358 was given its first reading before the House in the Maryland General Assembly. Senate Bill 358 states that it has been proposed for the “purpose of requiring a procurement contract for construction to include a clause providing for contract modification when there is a substantial increase or decrease in the price of materials required to complete the contract, according to prevailing average market prices and as determined by the unit, due to certain factors; and generally relating to contract modification for construction contracts.”

In other words, the legislation aims to provide COs with a powerful and equitable tool to adjust Maryland procurements. Indeed, Bill 358 would allow a CO to give contractors much-needed relief in times of hyper escalation. Conversely, it would also allow a CO to take advantage of significant decreases in materials costs by issuing a commensurate downward adjustment to the contract price.

The applicability of Bill 358, if it’s signed into law in its current form, would be widespread in Maryland construction procurements insofar as it seeks to require all procurement contracts for construction to include a clause providing for contract modification when there is a substantial increase or decrease in the price of materials caused by certain events. It would provide COs with a measure of discretion in determining what constitutes a substantial increase, insofar as the legislation broadly defines “substantial” to mean “large in amount, size or number” without providing further specificity.

Bill 358 otherwise provides that a modification to a procurement contract for construction may be granted only to capture costs arising from:

1. Notice of commencement by the government for any reason;

2. Acts or omissions by the government;

3. Changes in the work or the work sequencing by the government that impact the contractor’s time of performance;

4. The contractor encountering hazardous materials or concealed or unknown conditions;

5. Delay in authorization by the government; or

6. Force majeure events, including an epidemic or pandemic.

The clause does not, however, provide a contractor—or the government, depending on the situation—an unlimited right to adjustment in these circumstances. The proposed maximum increase or decrease is limited to 10%.

Furthermore, Bill 358 seeks to prohibit any contract modification or change order that would increase the cost of a contract beyond the amount budgeted and available money. Thus, if a procurement contract for construction that is issued under a particularly tight budget is subjected to significant materials price increases, the practical result may be that the contractor finds itself without recourse under the proposed legislation, despite being entitled to it.

Bill 358 continues to make its way through the legislative process, and it remains to be seen whether it will be signed into law in its current form, or at all. In 2022, New York tried without success to pass similar legislation providing relief to contractors from the adverse impacts of materials escalation. The proposed legislation made it through the State Senate and Assembly, only to be vetoed by Gov. Kathy Hochul on Dec. 30, 2022.

BEFORE SIGNING ON THE DOTTED LINE

The main take away for contractors performing on public contracts is that, although the extent of legislative relief they can expect to address materials price escalation is uncertain, what is certain is that the ramifications of materials price escalation and general inflation will reverberate through the construction industry for a while longer. Prime contractors and subcontractors alike would do well to closely scrutinize any future procurements before signing their name to the proverbial dotted line.

Specifically, they should verify the presence of those clauses necessary to mitigate any materials price risks are included and, in the absence of such protections, decide whether it makes good business sense to take on the work anyway. Seeking professional legal advice is always recommended if you are uncertain of your rights, risks and obligations under a contract.

by Paul F. Williamson

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