Escalation Clauses in Construction Contracts

Construction costs can be difficult to estimate in today’s quickly changing economic climate.  Skyrocketing costs of fuel, steel, asphalt, and other building materials are negatively impacting contractors’ and subcontractors’ profits on fixed-price price projects.

For the near future, the increasing cost of fuel and materials will continue to be absorbed by contractors. As fuel and building materials costs continue to be unpredictable, contractors can expect to pay higher prices for deliveries and receive higher bids from subcontractors. This is especially true for contractors with large fleets of automobiles and heavy equipment. Contractors would be wise to factor these increased costs into project budgets and to include provisions in their contracts to address the issue.

One way contractors can protect themselves from lost profits because of rising gas and material prices is to include in their contracts and subcontracts an escalation clause. An escalation clause is a provision in a contract that calls for an increase in price in the event of an increase in the cost of materials. Without a price escalation clause in the contract that allows for an adjustment to the contract price in the case of an unexpected rise in the market prices of key materials, it will be impossible to avoid a loss in profits.

For owners, the idea of a price escalation clause may be seen as writing a blank check. However, such a clause may protect the owner and save the owner money as well. If the contract is based on current prices and any actual increases, rather than a fixed-price quote that builds in a hypothetical and speculative price increase, owners may save money.

Assuming a price escalation clause can be agreed on, it is important that the price escalation clause be carefully drafted. The clause should identify the specific materials that are volatile and the unit prices for such materials at the date the contract is executed. The clause should further provide that the owner will become liable for any price increases in those materials that cause the total contract price to be increased by an agreed upon percentage. Further, a well-written clause will set out notice periods for identification of price increases, identify the type of documentation that will be required to evidence the increase as well as what events trigger an increase in contract price, identify the appropriate measure of market price, state how many times the contract price can be increased, and set forth what time periods are covered. These clauses will typically involve a series of notice and documentation protocols which must be followed strictly to be effective. Such safeguards are essential to protect the contractor from accusations that bad purchasing practices are simply to blame for the price differences.

Drafting and implementing an effective escalation clause can benefit everyone; the contractor, the subcontractor, and the owners.

Consult with a construction attorney familiar with your industry and the local economy and regulations to review your construction contracts and subcontracts and determine if an escalation clause may benefit your company.

If you have any questions, you are invited to contact any of the employment lawyers at Lemons, Grundy & Eisenberg.