Since the tariffs on steel and the first wave of the COVID-19 pandemic, the construction industry has been reeling from the impact of material shortages and price increases, labor shortages, breakdowns in the supply chain and the inflationary effect of these issues. Unfortunately, the war in Ukraine has only exacerbated the situation.
International conflicts can constrain supply, resulting in delays and price increases for contractors, subcontractors and suppliers. The disruption caused by the war is expected to be particularly acute due to the role that Russia and Ukraine play in the world economy and the effect of the economic sanctions that have been imposed on Russia by the United States and other countries. Russia controls approximately 10% of the global copper reserves and is estimated to produce about 10% of the world's nickel supply. It also provides at least 30% of Europe's oil and natural gas. Ukraine is a significant source of raw materials, such as iron. Thus, the war will cause significant shortages and price increases to the global construction industry. There are already reports of delays and cost increases for commodities such as nickel, aluminum, copper and—most importantly—steel, which have resulted in impacts to construction costs and schedules. Suppliers are especially sensitive to the volatile markets caused by these conditions. Some are insisting on automatic price increases in their purchase orders.
All of this, not to mention the anticipation of what may come next, points to the necessity for a new paradigm to achieve a successful project. It is more important today than ever that owners, contractors, subcontractors and suppliers reasonably address the economic and time impacts of these unforeseeable events in preparing contracts for future work and in administering existing contracts. Otherwise, the risk of a default on more than one level may put projects in jeopardy, to no one's benefit.
During periods of economic stability, fixed price contracts without clauses providing relief for escalation and delay may work fine. The contractor can protect itself against unanticipated events through a reasonable contingency in its price. However, during periods of extreme unanticipated escalation and delays resulting from events for which neither party to the contract are at fault, such as the time and cost impacts of the tariffs on steel, the pandemic and the Russian invasion of Ukraine, it is important for the parties to have explicitly dealt with the problems in their contracts through price escalation, time extension (i.e., force majeure) and delay damage clauses.
A price escalation clause in the contract, which allows the contractor, subcontractors and suppliers to recover some compensation from the owner for unanticipated increased material costs is often advisable, particularly in the current volatile conditions. An escalation clause can take many forms, from a dollar-to-dollar increase in price based on actual purchase orders and invoices to an objective formula based on a cost index. The owner can absorb the entire escalation cost, or the escalation cost can be shared between the owner, contractor, subcontractors and suppliers. The escalation clause can be limited to substantial increases in cost and/or certain listed materials. Another way to reduce or limit escalation costs is to provide for the purchase of materials upfront by subcontractors, with a provision for early payment for stored materials and storage costs. The key is to negotiate clauses that spread the risk of unanticipated escalation between the parties in a fair manner.
Most construction contracts contain force majeure clauses that provide a time extension for unanticipated delays that are beyond the control and without the fault or negligence of the contractor. However, some owners argue that delays resulting from tariffs, COVID-19 and the Russian invasion should have been anticipated in contracts entered into after the commencement of these events. To avoid these arguments, the contract should include provisions specifically allowing schedule relief for these events to the extent the impact of the events is not known or possible to predict and price at the time of contracting.
Finally, the parties should consider clauses that address delay damages resulting from the tariffs, the pandemic, the war in Ukraine or other similar unanticipated events, particularly if the owner caused or contributed to the cost impacts of those events.
So, what do the parties do about cost impacts that the owner, contractor, subcontractors and/or suppliers incur on existing contracts due to tariffs, COVID-19, the war or other similar events if the contracts do not include a clause providing compensation for escalation or delay damages resulting from unanticipated events that occur through no fault of a party? Foremost, it is imperative that the parties develop and maintain an open dialogue with everyone on the construction team. Efforts should be made to minimize and mitigate the cost and time impact of the unanticipated events regardless of which party bears responsibility.
The contractor then needs to examine its contract to identify provisions that will allow it to recover a time extension or additional costs for the events. Most contracts provide schedule relief, but no damages, for acts of war, a pandemic or, more generally, for events beyond the contractor's control and without its fault or negligence via a force majeure provision. If the owner refuses to grant a time extension to which the contractor is entitled, the contractor may be able to recover for constructive acceleration to overcome the delay. To reduce or eliminate a contingency in the contract price, sophisticated owners may have included a price escalation clause that provides complete or partial relief for escalation costs. Finally, the contractor should examine clauses relating to contingencies, allowances, changes in law, suspensions of work, differing site conditions or unknown or concealed conditions, changes and termination to see if they might allow some recovery. To recover damages from the owner, the contractor must find a clause that provides a basis for relief. The owner, subcontractors and suppliers should perform the same review of their contracts as the contractor to find clauses that provide them a basis for relief or a defense.
In any event, it is important for the contractor to issue the appropriate notices and claim letters promptly to the owner to preserve all rights and remedies. Since many contracts have strict notification deadlines, it is not advisable to wait to send the letters until the full impact is known. It is best, at least, to immediately send preliminary notices and provide further details as new information on the impacts is discovered or obtained. It is important for the owner to know that a claim is coming so it can protect itself and possibly mitigate damages. Likewise, the subcontractors and suppliers should meet the notice and claim requirements in their contracts.
In addition to sending notices upstream, particular attention should be given by the contractor to the impact of these problems on its subcontractors and suppliers, particularly those who may not be able to weather the impacts of the tariffs, COVID-19 and the war in Ukraine. And the impact is not limited to this specific project but includes the ripple effect of financial and cash flow problems the subcontractors and suppliers may have on other projects. If a subcontractor or supplier fails to perform or goes into bankruptcy, the impact can be tremendous, and a lawsuit seldom provides the contractor with full recovery.
On a management level, it is even more essential than normal for the entire team to review each party's performance to make sure its work is on schedule and long-lead items have been ordered and are in production. If a party sees schedule slippage, reduced manpower levels or delayed material deliveries, it should take immediate action to mitigate damages and overcome the impacts. In addition, the parties need to meet the notice and claim requirements of their contracts.
Reducing and fairly allocating the impacts of events like the tariffs, COVID-19 and the war in Ukraine starts with negotiation of contract clauses that provide at least some protection to the contractor, subcontractors and suppliers from increased costs and delay. A bad contract will make recovery very difficult, if not impossible, and may leave the contractor, subcontractors and suppliers at the mercy of the owner and put the project in peril.
To assure successful completion of a project when unanticipated events occur, collaboration and cooperation are key. Notice letters (up and down) are only the first step to ensure the preservation of rights, but they are not the end of the story. Everyone on the project should be part of a broader team working together to overcome these challenges. Without waiving any rights, reaching out to subcontractors and suppliers to determine what can be done together to ease the burden could help mitigate the impacts. At the same time, working with the owner and its team will make them aware of the difficulties and may lead them to participate and be part of the solution. It is more important than ever for all project participants to collaborate and coordinate in this effort.
Originally Published by Construction Executive, 10 May 2022
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