Is an Escalation Clause the Answer?

In October, the National Association of Surety Bond Producers released an article highlighting the soaring cost of construction materials that made national headlines earlier this year, and made headaches for contractors and owners who were stuck with project over-run costs.  Although there has been some improvement, the latest data from the Bureau of Labor Statistics still indicates approximate 19% increase in cost over the last 12 months.

This problem continues. As you review and/or amend contracts, you might consider using an escalation clause as a part of the contract on your future contracts.

The NASBP defines an escalation clause as a contractual provision that allows for an adjustment to the contract price to account for certain fluctuations in the cost of materials. To determine who bears responsibility for certain material prices, the parties simply need to apply the conditions of the escalation clause to the material price increase at issue. Normally, the owner and the contractor are likely to share the increase.

Without this clause, NASBP says the viability of a contractor’s claim for a price adjustment will largely depend on the contract language, the cause of the price increase, and the owner’s attitude. Price increases can be caused by a variety of factors, including delays by the owner or delays in getting materials for the project, force majeure, or a pandemic.

According to the NASBP, price escalation provisions are not one-size-fits-all and must be carefully drafted so that the escalation clause covers the majority of the contractor’s pricing risk.

Ultimately, the price escalation provision will be negotiated between the parties. Most owners want price certainty and will likely push back against the inclusion of a price escalation provision. However, if the owners understand that, without such protection for the contractor, the pricing may be significantly inflated to hedge against the contractor’s risk of materially increased costs in the future.

You should consult legal assistance from an experienced construction attorney to make sure that any escalation clause that is selected fits the needs of the specific project you are bidding on and is in compliance with various state and federal laws. Contact INSURICA today to help you with your risk management needs.