By Skip Smith and Allison Mikulecky
On March 8, 2018, President Trump’s administration signed two proclamations levying a twenty-five percent tariff on imported steel and a ten percent tariff on aluminum, both of which went into effect on March 23, 2018. Although last-minute exemptions for several U.S. trade partners may soften their effect, the new tariffs likely will adversely impact a construction project in various ways, including imposing significant costs and delaying or cancelling projects. Moreover, it is foreseeable that other tariffs could develop from future trade wars or imbalances. The following addresses key contract clauses that can be used to tackle increased costs that are a consequence of the steel and aluminum tariffs, as well as recommended steps moving forward.
Useful Contract Clauses
If you are already under contract and facing significant pricing impacts from tariffs, evaluate whether your contract documents have a material escalation clause, change of law clause, force majeure clause, or change order clause.
Material Price Escalation Clause. Although material price escalation clauses can greatly differ in structure and operation, generally speaking, such a clause allows a price adjustment based on: (1) the difference between the bid amount of the material and the as-delivered amount; or (2) material price indexes. A material price escalation clause can benefit owners and general contractors alike, to the extent it establishes how the parties will address material price increases once a project is underway. Additionally, such clauses often distribute the risk of price increases equally between the owner and the general contractor.
Change of Law Clause. A “change of law” clause can also be useful to address significant increases in material prices once a project is underway. How the term “change of law” is defined in the contract (if at all) will impact the usefulness of a “change of law” clause. For example, if the contract limits “change of law” to state and local statutes and regulations, it is unlikely the clause will apply to tariffs established by the federal government. If, on the other hand, the contract includes all statutes and regulations applicable to the project within its definition of “change of law,” there is a strong argument the clause will apply to tariffs. Another important consideration is whether the contract contains any limitations on the timing of the “change of law,” that is, whether the change must occur post-bid, post-execution of the contract, post notice-to-proceed, or at some other specific time in order to be compensable.
Force Majeure Clause. Force majeure clauses may provide contractors with relief from changes in material prices because they allow a contractor to suspend or terminate its performance or obligations under a contract due to the occurrence of an event beyond the contractor’s control and/or receive an equitable adjustment for the impacts of the occurrence. Force majeure clauses are most often used to address delays caused by an “Act of God,” but such clauses also typically include strikes, wars, or, relevant to tariffs, governmental acts or restrictions. As with a change order clause, a force majeure clause may be applicable to the extent it includes “catch all” language such as “including but not limited to,” – the argument being that an imposition of a tariff on a building material is an event beyond the control of the contractor. Although force majeure clauses may provide some relief, it is critical to note they often include “no damages for delay” language, meaning the contractor is only entitled to additional time – not money – related to a force majeure event. Consequently, the other contract provisions described in this advisory may provide better opportunities to recover the costs of tariff-induced changes in material prices.
Change Order Clause. A change order clause may sometimes be used to recover costs for increases to material prices due to a tariff, particularly if it contains “catch all language” similar to that of a force majeure clause (i.e., “including but not limited to”). This option, however, is weaker than the above clauses and should be relied on as a last resort.
Procedural Requirements. Aside from these clauses, it is critical that owners, general contractors, and subcontractors/suppliers carefully review their respective contracts to determine the procedural requirements (e.g., notice requirements) to recover increased costs and lost time. The usefulness and applicability of the above-cited clauses may be contingent upon the satisfaction of simple, but often-overlooked, procedural requirements.
Considerations Moving Forward
It appears the steel and aluminum tariffs are here to stay for the foreseeable future, but it is too early to tell whether the specter of trade wars will bring additional cost impacts to the construction industry. Owners, general contractors, and subcontractors/suppliers should address the following specific considerations when drafting or reviewing contract documents for new work.
Owners. If a general contractor insists on including a material price escalation clause in the prime contract, an owner should consider including a minimum and maximum limit on escalation. The general contractor will be at risk for all price increases that are both below the minimum limit and above the maximum limit. This creates a cost-sharing situation that generates certainty from the beginning. Owners may require a general contractor to provide support for bid prices to ensure the bid reflects actual market prices, which are tracked by many construction industry publications. A careful review of bid pricing may provide an owner with additional confidence and protection if the material price escalation clause is based on the difference between bid prices and at-delivery prices of the material.
General Contractors. General contractors should: 1) advocate for material price escalation clauses in the prime contract with the owner and 2) ensure any prime contract material price escalation clause is flowed-down consistently in its subcontracts, lower tier subcontracts and purchase orders. General contractors should also consider educating the owner regarding the potential volatility of certain materials prices, such as steel and aluminum, which may help manage the owner’s expectations and create the opportunity for value engineering. Going forward, general contractors must ensure they do not get caught in the middle with subcontractors/suppliers having clauses protecting them from material price escalation, but not having such clauses in their prime contract with the owner.
Subcontractors/Suppliers. Subcontractors and suppliers should be cautious of any bid requirement where they bear the sole risk of any material price escalation or their recovery for such escalations is confined to the general contractor’s recovery from the owner. Subcontractors and suppliers also should advocate for the right to recover both time and additional money related to material shortages or significant price increases.
If you have any questions about this advisory, including how best to protect yourself from material price escalations, please contact any of the attorneys in Sherman & Howard’s Construction Industry Practice Group.