This article originally appeared in the April/May issue of HBA Building Home.
Since taking office, President Trump has promised, threatened, imposed, revoked, re-imposed and delayed tariffs on a range of products from Canada, Mexico, China and other countries, causing uncertainty for consumers and contractors alike. Not only would tariffs increase the costs of many construction materials, but they could also result in material delays or lack of availability due to supply chain issues. Despite the uncertainty of if, when and how tariffs might be imposed, those in the construction industry have various tools available to them to manage the risks posed by tariffs.
Which party bears the risk of material cost increases in a construction project is typically dictated by the contract. For instance, where the parties enter into a so-called “lump sum” contract with a fixed price, the general contractor generally bears the risk of material costs increases over and above the lump sum price. Conversely, where the parties enter into a so-called “cost plus” contract, pursuant to which the owner pays for the materials plus a contractor’s fee, the owner typically bears the risk of material costs increases. The risk of material cost increases can be shared where the parties to a cost plus contract agree to a guaranteed maximum price (“GMP”) pursuant to which the contractor bears the risk of cost increases over the GMP.
Regardless of the type of contract, tariffs are best addressed directly by including a so-called price “escalation clause” in a contract, where the parties acknowledge that there may be material cost increases due to tariffs or other factors outside of the parties’ control and specifically address which party will be responsible for such increases. Where material availability is a concern, a contract can include a provision allowing for the substitution of comparable materials in order to avoid cost increases or project delays due to the increased price and/or unavailability of the originally specified materials. Of course, where a party requires the use of a specific material, that party should generally bear the risk of cost increases, delays and lack of availability of that material. Typically, such provisions require the contractor or product supplier to notify the owner of such cost increases or lack of availability, and the parties to agree to a change order to account for the change.
Although not directly intended to address material cost increases, a contract may also include contingencies and/or allowances for materials whose costs may fluctuate. A contingency is generally used for materials that may or may not be necessary for a project, allowing the costs of such materials to be added to the contract price if/when the materials become necessary. Whereas an allowance is typically for materials the required amount of which is not known at the time of contracting, allowing for flexibility between minimum and maximum amounts. Again, neither provision directly addresses material price increases, rather they are intended to address quantity.
A contract can also include termination and/or force majeure provisions, allowing one or both parties to terminate the contract in the event of unexpected material cost increases, delays or lack of availability. However, termination based merely on increased costs may prove difficult unless the provision in question specifically allows for termination based on cost increases or the increase is attributable to something within the contract’s definition of “force majeure,” which is traditionally defined as an act of god or war and not mere imposition of tariffs. Even where the definition includes a “change” in the law, it is arguable whether a presidential executive action imposing tariffs would qualify unless the provision specifically says so.
Finally, some other techniques for addressing the risks of tariff-related price increases include specifying that cost estimates and bids expire if not accepted prior to a certain period of time (e.g., 15 or 30 days), thereby allowing a contractor or product supplier to requote the price. Parties can also establish set pricing with product suppliers, order materials in advance and/or in bulk, or specify in advance preapproved comparable products to allow for flexibility when any particular product becomes prohibitively expensive or unavailable. A general contractor can also shift the risk of material cost increases and delays to its subcontractors by entering into so-called “turnkey” subcontracts wherein the subcontractors supply both labor and materials. Of course, subcontractors face the same risk of cost increases as general contractors do and, therefore, can demand cost-plus subcontracts, impose GMP’s, as well as include escalation and substitution clauses in their subcontracts.
Finally, there is no substitute for candid conversations about project issues, including cost increases and delays. Parties are more likely to be receptive to paying for or at least sharing in unexpected material cost increases when there is timely communication about the issue, especially when they understand that they have little/no control over the issue.
In summary, tariff-related material cost increases, delays and lack of availability affect the entire construction industry. As such, parties should be proactive in addressing these risks in advance so that they do not delay a project. As always, parties who are considering making changes to their contracts to address tariffs and/or other such issues should consult with experienced legal counsel.
