The construction industry in the United States has faced serious economic headwinds in the past several years. An exceptionally tight trade labor market and dramatic increases in the price of construction materials have strained owners' budgets and shrunken (or eviscerated) contractors' margins. The global COVID-19 pandemic not only supercharged these issues, it also combined them with inefficiencies, supply-chain interruptions, and inflation. Although donning masks is hopefully a thing of the past, these legacy economic disruptions are forecast to continue, especially in the wake of the war in Ukraine and its own impacts on the global economy.
Commercial construction professionals have increasingly responded to these economic challenges and their associated risks with a series of strategies that modify or re-cast some common contractual arrangements, including: (1) the inclusion or expansion of force majeure provisions; (2) the inclusion of materials price escalation provisions, (3) the adoption of early work release procurement arrangements; (4) the increasing use of cost-plus project delivery systems over fixed-price schemes; and (5) a reduction in the severity of liquidated damages provisions.
This Article addresses the trends and strategies for each of these clauses in the post-pandemic economic environment.
Strategy 1: expanded force majeure provisions
Although it took the world by storm, courts and owners alike found the pandemic to be something less than "force majeure," as many pre-pandemic contracts and cases defined that term. Surprisingly, many standard commercial contract templates neither defined nor specifically accounted for force majeure. For example, the American Institute of Architects' (AIA) A201-2017 General Conditions of the Contract template, the industry's most commonly-used set of commercial terms and conditions, lacked any force majeure provision. In the pandemic's aftermath, owners and contractors have insisted and (should insist) on the inclusion of a force majeure provision in their contracts. Contracting parties should draft that provision to account for pandemics and epidemics, other global health-crises, and their potential disruptions, including (among others) government-mandated shutdowns, materials and labor unavailability, supply chain disruptions, and drastic price increases. Because courts ordinarily interpret contractual provisions according to their plain meaning, adopting a more expansive definition of force majeure will lower the threshold of qualifying events and increase the possibility that contracting parties may take advantage of the benefits and protections in those terms.
And while traditional force majeure clauses usually assumed a force majeure event would terminate or suspend the contract indefinitely, post-pandemic force majeure provisions should be drafted on the assumption that the project will continue. In this regard, these provisions should clearly define the force majeure event's contractual effect on the project's schedule and contract price, including by addressing any associated material price escalations or extensions of time for the purposes of calculating liquidated damages, as discussed further below.
Strategy 2: material price escalation provisions
In the past three years, prices for steel doubled, they fluctuated wildly for lumber, and they have jumped 20 to 40 percent for concrete products. While significant, these price impacts are, ordinarily, not sufficient to constitute force majeure. They are also unlikely to render performance commercially impractical or impossible, as courts have historically understood those concepts. To mitigate the impacts of these price changes (especially since the pandemic), many sophisticated contractors are increasingly including materials price escalation provisions in their contracts. These provisions allocate the risks and costs associated with price changes between the contracting parties. There are number of potentially effective strategies for accomplishing this goal, and while parties often draft bespoke price escalation provisions, major industry groups have begun to address the issue through their contract templates. For example, the ConsensusDocs 200.1 Time and Price Impacted Materials Amendment employs a variety of risk mitigation tools, including: (a) time limits on quotes for materials; (b) project phasing; (c) allowances for alternate materials; (c) early materials procurement and storage; (d) materials prefabrication; and (e) higher contingency amounts. Parties may also wish to consider objective price-increase thresholds, beyond which the contract may entitle the contractor to an equitable adjustment to the contract price, subject to a negotiated cap. Whatever the particular mitigation strategy, effective price escalation provisions should equitably allocate the risks and costs associated with price increases among the parties and clearly establish objective, appropriate boundaries for their use.
Strategy 3: early work and procurement releases
Commercial construction projects often require sophisticated equipment or imported materials with long lead times. In the face of supply-chain disruptions and price escalation, strict adherence to the traditional design-bid-build project delivery system may render these materials and equipment either too late or too costly to fit within a project's schedule and budget. This system may also prolong the project's schedule, particularly if the project requires highly specialized work to occur earlier in the project schedule.
Even before the COVID-19 pandemic, sophisticated owners and contractors increasingly adopted the Construction Manager At-Risk (CMAR) project delivery system to maximize savings and reduce the project's duration. This project delivery system breaks the project into two phases – (1) a pre-construction and procurement phase and (2) a construction phase – and gives the owner's construction manager (CM) a central role in each. In the pre-construction phase, the CM works with the owner and design professional to refine the project design criteria, engage in value engineering, and begin the procurement and trade contractor bidding processes. In the construction phase, the CM acts as the project's general contractor or is otherwise responsible for the project's management.
This delivery system permits the CM to identify and procure long-lead materials and equipment before the design and procurement process is complete. In the current era of price instability and supply chain disruptions, well-advised construction professionals have increasingly utilized this pre-construction phase to lock-in prices for materials and ensure favorable delivery times for long-lead equipment. This delivery system yields similar benefits for early work that requires the engagement of specialized subcontractors.
Initially, owners and contractors relied on bespoke terms or agreements for the release of early work, such as limited notices to proceed. More recently, and in response to market demand, industry groups have developed form agreements that provide standard language for early procurement and early work releases, such as ConsensusDocs' 500 series of templates and the AIA's G735-2021 "Authorization to Proceed with Early Work," both of which were created for use with contracts employing a CMAR delivery system. The default AIA G735 template, in particular, authorizes the CM to proceed with early work or procurement even before the parties have negotiated and agreed to a guaranteed maximum price (GMP) for the project. This permits the CM to obtain materials and equipment pricing and delivery schedules as early as possible, maximizing savings and minimizing the schedule impact of these materials and equipment.
Strategy 4: increasing use of cost-plus and guaranteed maximum price contracts with contingency provisions
The traditional design-bid-build project system, often accompanied by fixed price payment terms, was the product of relatively stable pricing for construction materials and labor in previous decades. But the post pandemic environment has accelerated the demand for more flexible payment arrangements. Here, too, sophisticated parties have resorted to the CMAR delivery system, which they ordinarily pair with cost-plus and GMP payment terms. Under these terms, the owner pays the CM for the cost of the work plus a fixed fee, both of which are subject to a not-to-exceed GMP "cap." Two features typical of this arrangement make it particularly advantageous in the current environment. First, this type of contract often includes a shared savings incentive, under which the owner pays the CM a percentage of any "savings" if the final cost of the work is below the GMP, thereby incentivizing cost-effective construction. Second, the parties typically include contingency allowances in the project budget, which cover costs attributable to unforeseen price increases or other conditions that might render performance of the work more expensive, thereby accounting for risk before construction begins.
The typical negotiation items for parties contemplating this type of arrangement include: (a) the amount of any contingency allowances in relation to the GMP; (b) whether those allowances are subsumed within the GMP, such that unused amounts then have the potential to be shared savings; (c) whether the owner may (instead) wish to maintain an off-budget "project contingency" fund; (d) the circumstances under which the contractor may use any contingency allowance, which is often tied to the contract's definitions for force majeure or excusable delays; (e) the percentage of shared savings that the owner may split with the contractor; and (e) the timing and application of any shared savings agreement to materials procurement and subcontractor buyout.
Strategy 5: judicious use of liquidated damages clauses
Liquidated damages clauses are almost as ubiquitous in the commercial construction world as they are disliked by contractors. The increased risk of delays attributable to pandemic-related supply chain interruptions during the past few year has made these clauses all the more unpalatable to contractors, and contractors have increasingly resisted their inclusion in their contracts. Where the inclusion of liquidated damages provisions cannot be avoided, contractors have accounted for this increased risk in their price proposals or have attempted to pass this risk to their subcontractors and suppliers through flow-down provisions and other risk-shifting provisions. In this manner, the increased risk of liquidated damages may increase the costs of doing business in the industry, generally.
As an alternative, contracting parties are increasingly excluding circumstances attributable to excusable delays – including the pandemic and its numerous disruptions – from their assessment of liquidated damages. These exclusions take many forms, including more expansive force majeure and excusable delay clauses, as discussed above, and agreements to cap liquidated damages, often at an amount near the contractor's expected profit or fee for the project or, in any event, at a number not out of proportion with the commercial benefit the contractor expects to receive from the project.
Thus, while liquidated damage provisions are here to stay, thoughtful project owners and contractors are structuring them more judiciously, given inherent economic and commercial uncertainties in the current market.
Conclusion
Large capital and construction projects have always involved a certain level of intrinsic risk. However, the current environment has amplified this risk and created more significant pitfalls for the imprudent or unwary project participant. Now, more than ever, drafting contracts to account for difficult market conditions is essential for owners and contractors to navigate – and thrive in—these uncertain economic times. The above strategies are by no means a panacea, but are helpful tools to mitigate the risks of doing business in an increasingly uncertain world.
Originally Published by Global construction update The volatility issue
This article is presented for informational purposes only and is not intended to constitute legal advice.
