Do Recent Materials Price Increases Threaten Your Bottom Line?

Do Recent Materials Price Increases Threaten Your Bottom Line?

An Overview of Their Legal Effect on Fixed-Price Contracts

By

William C. Last, Jr.

Attorney at Law

As everyone involved in the construction industry knows, the price of steel products and other construction material costs have been increasing geometrically. Those price increases have been attributed to national shortages of such materials.

As a result of the surprising and enormous price increases, a number of speciality contractors, who are bound to fixed-price construction contracts, will suffer substantial losses if they fulfill their contractual obligations. There have also been reports of specialty contractors closing their doors rather than sustaining large financial losses. Recent construction trade articles have suggested that certain legal doctrines may be asserted to excuse contractors, who are burdened with these unforeseen and abnormal price increases, from performing their contractual obligations.

This article will discuss two of those doctrines. The article will also discuss occasions when a contractor may be able to recover materials escalation costs. Finally, the article will discuss bid and contract clauses that may address the issue.

This article is intended to provide an overview of some of the legal concepts that may be applicable to recent price spikes. Whether or not these concepts are applicable to a specific price spike that you may be confronted with should only be determined after discussing the situation with competent legal counsel.

The Doctrines of Force Majeure Doctrine and Commercial Impracticability

The two legal doctrines that have been suggested as the possible basis for excusing non-performance due to excessive and unforeseen price increases that resulted from regional and national material shortages are: (1) the doctrine of force majeure, and (2) commercial impracticability. These two doctrines are very similar. For one, both doctrines require a showing of something more than an increase in the difficulty in fulfilling your contract obligations.

The doctrine of force majeure is based on the concept that a party's duty to perform under a contract is excused if the contemplated contractual performance is impossible due to unforeseen events that are beyond the control of the contracting parties. The doctrine is based on equitable principles. Most construction contracts include a force majeure clause which excuses performance if certain enumerated events occur. The events can include unusually bad weather, strikes, fire and other similar natural and man-made disasters.

Generally, the doctrine of force majeure can only be applied if the party's duty to perform is commercially impracticable. Unless the parties' fixed-price contract provides otherwise, the doctrine does not, generally, apply to changes in the normal market price for goods that are being acquired. That rationale is based on the fact that most parties enter into fixed-price contracts due to the very nature of the risk associated with such price changes. Quite simply, when the parties enter into a fixed price-contract the seller assumes the risk of the price going up and the benefit of price decreases prior to actual performance.

The doctrine of commercial impracticability excuses a seller from timely delivery of the contracted-for materials when the ability to perform has become commercially impracticable due to unforeseen, supervening circumstances that were not within the contemplation of the parties when they entered into the contract.

The United States Court of Claims recognized and applied the doctrine in Blount Bros. Corp. v. U.S. (Fed. Cir. 1989) 872 F. 2nd 1003. In that case, the Court of Claims held that because a certain type of aggregate could not be found in the specific geographic region needed, the specification and thus performance was commercially impracticable. The Blount Court stated: AIn Hol-Gar Manufacturing Corp. v. United States (citation omitted), the court stated that 'when the Government contracts for supplies to be manufactured in accordance with government specifications, there is an implied warranty that if the specifications are followed, a satisfactory product will result.' It necessarily follows that the government also impliedly warrants that the specifications are possible to meet. See Ordnance Research Inc. v. United States (citation omitted) ('Specifications having major safety defects are fully as much in breach of the implied warranty as defects in the feasibility, practicability, or commercial possibility of performance as specified.').@

The doctrine has also been embodied in the Uniform Commercial Code at section 2615. Most cases that interpret that section of the Commercial Code conclude that rises in the cost of materials in themselves do not make the performance of the contract commercially impracticable. The rationale for that conclusion is simply that the increase and decrease of material costs is the very same foreseeable risk that lead the parties to fix the price of the material in the contract.

However, if there is another, unforeseen factor that is outside the party's reasonable control and which causes a severe shortage of raw materials (e.g. war or an unforeseen shutdown of major sources of supply) or a major price increase, other cases suggest that the section provides relief. In essence, if a party seeks relief under the doctrine, there must be evidence of an event that impacted the price of material in a manner different than the overall swings in product prices.

The existence of a force majeure or commercial impracticality are factual issues. The exact showing needed will depend on the terms of the agreement, the diligence of the party seeking an excuse, and the causes of the price increase. Generally, the contracting party who is seeking the relief has the burden of proving that such doctrines are applicable. The party seeking relief will also have the burden of proving that they sought other alternatives before they can rely on the doctrines.

It is possible to recover material increases as a result of a course-of-construction delay?

Yes, if a contractor can establish that the price increases occurred during a delay chargeable to another party, one possible element of damages is increased material costs. If the scope of work is increased or if the material cost increases during the delay period, the contractor should be entitled to recover those increased costs.

However, the right to recover such delay damages is dependent on the impacted contractor proving four items. Generally, four tests must be satisfied before recovery for delay costs will be allowedC a contractor must prove that the delay was (1) excusable, (2) compensable, (3) critical, and (4) non-concurrent. Assuming that the delay is excusable to the impacted contractor, the resulting damages are compensable per the terms of the contract or due to legal precedent, the delay was on the critical path and the delays were not concurrent with delays chargeable to the impacted contractor, the impacted contractor should be able to recover such material escalation damages.

Applicable Bid and Contract Clauses

For all intents and purposes, contracts are risk shifting devices. The general categories of risks that are addressed in construction contracts are: (a) scheduling, (b) performance, and (c) cost or financial.

As to the latter category, a typical fixed-price construction contract shifts the risk of material price increases from the owner to the prime contractor. The longer the duration of the project, the greater the risk that material costs may escalate. When bidding on a contract that will take a long time to perform, the bidder makes certain judgmental decisions concerning materials costs. Whether or not those assumptions were reasonable can only be determined after the project is completed.

In light of the volatile steel and plywood markets, the owner, lender, contractor, sub-contractor or supplier should analyze his relationship with the parties he is contracting with in terms of who is bearing the greater risk associated with such price increases. Due to the current market conditions, the contractor must decide exactly how much risk he or she will take for such increases before signing the contract..

One possible method for decreasing such a risk is including a price escalation clause in the contract. Such a clause sets the base price for a specific product and then states that if the price of that product rises over a certain period the contractor will be entitled to an equitable adjustment in the contract price for the amount of the increase.

On a similar note, the force majeure clause in the typical construction contract can be modified to include increasing the contract amount due to materials price increases. The clause can include materials shortages or substantial materials cost increases as force majeure events. Similarly, the contract price clause can be drafted to provide that the contract amount will be increased if the certain materials exceed a base amount. Such escalation clauses are typically included in commercial real estate leases. Those clauses often provide the rent will be increased by the percentage increase in the consumer price index.

CPost-Bid Price Increases and Promissory Estoppel

While the legal issues concerning the acceptance of and reliance on bids are far more complex then what can be addressed in this article, a bidding contractor may be able to limit its liability for any post-bid but pre-contract price increases.

Typically, this issue arises in construction industry when the a prime contractor relies on a subcontractor's bid in submitting its bid to the owner. If the prime contractor is awarded the contract, and the subcontractor upon whose bid the prime contractor relied refuses to sign a contract, the prime contractor can file a promissory estoppel lawsuit against the subcontractor. Such a lawsuit could result in an award of the difference of the subcontractor=s bid and the cost of completing the subcontractor=s scope of work The subcontractor, however, has defenses to such a lawsuit.

One defense is that the prime contractor did not rely on the bid. If a subcontractor includes in its bid a clause a provision that puts the prime contractor on notice that they should bear the risk of any price increases, it should be difficult for the prime contractor to claim that they relied on the pre-escalation price. The more prominent the bid price escalation provision is the stronger the argument is for non-reliance.

Suggestions

In light of the severe price increases for steel products it is clearly foreseeable that the steel market will remain volatile for the near future. Since such price increases are foreseeable, it is incumbent upon a contractor who is about to enter into a contract to provide for such increases.

If you are impacted by such excessive material prices, your contract should be modified to include an escalation clause. Your bids should also include such provisions. In essence, the applicable clauses in those documents should be modified to shift the risk associated with severe material cost increases to the owner.

As discussed, the definition of a force majeure could be broadened to include material price increases due to national and/or regional material shortages. For that matter, the clause could be broadened to include all events that are beyond the control of the contractor. Such a definition could remove the typical requirement that the event be unforeseeable. Alternatively, the contract price clause could be modified to include an escalation clause.

If you are currently bound to a contract that limits your right to recover the increased materials costs that have resulted from materials shortages, you should discuss the possibility of asserting the doctrines of force majeure and commercial impracticability to your specific situation with competent legal counsel.

82004 This article was written by attorney William C. Last, Jr. Bill Last has specialized in Construction Law for more than 24 years and represents contractors throughout California. Bill holds a California AA@ and AB@ license and is active in a number of construction trade associations. He can be contacted at 415-764-1990 or 650-425-7679. A number of his past articles can be found on his website (www.lhfcon structlaw.com). This bulletin is published periodically to provide general information about current legal issues. The articles are not intended to be a substitute for the advice of an attorney as to a specific problem. If you have a specific legal question or need legal advice, you should contact an attorney.