Managing the Risk of Material Price Increases Due to Trump’s Tariffs

By:  Joseph M. Leone

According to many economists and construction industry advocates, the new tariffs on steel and aluminum and other trade restrictions enacted or threatened by the Trump Administration may have a drastic effect on construction industry economics.  The Associated General Contractors of America (AGC) reports that steel and aluminum tariffs, which went into effect on May 31, caused a surge of orders that exceed current mill capacity.  This could lead to delays, budget problems and possibly cancellation of some projects altogether.  The producer price index (PPI) for aluminum mill shapes and steel mill products rose 17.3% and 10.5% respectively from May 2017 to May 2018.  Those increases do not include data gathered after the tariffs went into effect, so, expect the PPI of steel and aluminum to continue to rise.

The primary means Owners and Contractors use to manage post-contract price escalation risk is through the use of a material price escalation clause.  Generally, a material price escalation clause will entitle a Contractor to a change order where the price of certain types of materials increases either between the time of bid submission or the time the contract is effective and when the Contractor orders the material.  The amount of additional compensation the Contractor is entitled to is typically based on either the actual price of the material versus the amount included in the bid or by using a commodity index to calculate the increased amount.  There are certain situations where an Owner may request a price escalation clause (which effectively acts as a de-escalation clause) anticipating a price reduction.  For example, where the price of a certain material shot up quickly prior to bid and is expected to go back down by the time the material is ordered.

Owners may choose to negotiate a modification to the material price escalation clause whereby the Contractor takes the risk on the first, say, 5% or 10% of the material price increase so that the Owner and Contractor are sharing the risk.  Sometimes the Owner will request a cap on their risk, however, as long as the Owner has a termination for convenience clause in the contract they are protected against a price increase that is so great that the project does not make business sense anymore.  Contractors should carefully consider the risks involved before agreeing to a cap on the Owner’s risk.

Instead of a material price escalation clause, the parties may choose to limit the Owner’s risk to material price increases caused by the enactment of a new law, instead of the Owner taking the risk for price increases due to any market force regardless of cause.  The ConsensusDocs Standard Agreement and General Conditions Between Owner and Constructor contains such a clause.    “The Contract Price . . . shall be equitably adjusted by Change Order for additional costs . . . resulting from any change in Law, including increased taxes, enacted after the date of this Agreement.”  ¶ 3.21.1 ConsensusDocs 200 – 2016.   This clause ties together the change in the law with the cause of the price increase to entitle the Contractor to a change order for the additional cost resulting from the new tariffs.

Not all clauses which address the enactment or change in the law entitle the Contractor to additional compensation, however.  The American Institute of Architects General Conditions of the Contract for Construction (AIA A201 – 2017) limits the Contractor’s right to a change order to the payment of “sales, consumer, use and similar taxes for the Work provided by the Contractor” that are enacted after “bids are received or negotiations concluded. . . ”  ¶ 3.6 AIA A201 – 2017.  This clause ties the payment of the tax by the Contractor itself to the new law.  Therefore, the Contractor is not entitled to a change order where the material price increased because of the new law, only when the amount of the tax to be paid by the Contractor increased because of the new law.

It is important that both Owners and Contractors consider the risks involved in changing material prices between the time of the bid and ordering of the materials and establish each party’s expectations through specific contract terms prior to contract execution.