At the beginning of the COVID-19 pandemic, supply chain challenges caused production and transportation delays, as well as price increases, for construction materials. At that time, many contractors looked to include provisions in their construction contracts to account for performance delays and price escalation. Those provisions may be here to stay.
Other market-related issues have also gained prominence recently. Inflation has driven up the cost of goods significantly. There has also been a labor shortage, due to many workers leaving the labor force during the pandemic and worker retirements outpacing new hires. Under these conditions, construction companies may choose to increase employee wages to keep workers from leaving.
In addition, interest rates are climbing as the Federal Reserve attempts to reduce inflation. Rising interest rates increase the servicing cost of construction loans and lines of credit that are vital to the construction industry.
The convergence of these factors has caused the costs of construction to increase substantially, leaving many projects underbid. Contractors may want to structure their contract price to address these volatilities. A fixed bid project is normally a better gamble under predictable market conditions, when the market allows the contractor to better and more accurately estimate the actual construction costs. Contractors and owners almost certainly know that is no longer the case under these current market conditions.
To protect against potential increases in the costs of materials, labor, and financing, contractors may want to focus on cost plus or time and material pricing structures. These pricing paradigms give the contractor flexibility in the event that costs spike during the construction of the project. Additionally, if a contractor is concerned that labor costs will increase during the project, that potential increase could be factored into the labor rates used in these contract price terms.
If an owner absolutely insists on a fixed bid contract, then other protections can include a cost escalation clause and similar provisions, as well as allowance items for the most volatile line items expected for the project. Also, the contract can provide that the contract sum is based on the price of materials as of the date of the contract, and that the contract sum will be equitably adjusted if certain specified events occur after the contract’s effective date. The contractor can also attempt reduce risks by committing downstream contractors and suppliers to fixed prices, but chances are that the subcontractors and suppliers have quote expiration dates or price escalation clauses of their own.
Overall, it makes sense to consider adapting the construction contract to meet the challenges caused by market volatility. Contractors should consider the nuances of each project to determine the most suitable approach for that project’s contract. Owners presumably should not be surprised when presented with these protective terms
