This article originally appeared in the Daily Business Review on November 30, 2022, and was written by Elizabeth Coppolecchia.
Over the course of the past year, public and private entities have witnessed unprecedented increases in the cost of materials for construction. And while South Florida remains a hub for development, both private developers and municipalities face an ongoing challenge—volatile changes to market conditions affecting the price of construction. The cause of these changes is diverse and dynamic. The COVID-19 pandemic, which surged in 2020 and 2021, has left a lasting mark on the industry. While markets appear to be stabilizing, material and labor shortages run rampant, making it increasingly difficult for property developers (including municipalities) to accurately price their upcoming construction projects. To make matters worse, in 2022, military conflict in Ukraine further exacerbated the impacts of COVID-19 in the following ways: increasing the cost of fuel, which increased operation costs for construction projects; and contributing to supply chain disruptions, which increased procurement lead times.
Despite material and labor shortages, development continues. To that end, property developers are actively searching for means to mitigate the risk of ever-increasing prices resulting from such shortages. At a time when certainty is lacking, property developers should consider the following approaches to protect their interests as they negotiate new contracts for construction.
The Broad Clause
When negotiating contracts for construction, property developers should consider including in their contracts a broad provision that precludes contractors from seeking any contractual price increases or time extensions arising from certain delineated events. In essence, the contractor must warrant that in entering into this particular construction contract, it has first taken into account the potential impacts of COVID-19, other current pandemics (such as monkeypox), and the Ukraine military conflict in pricing the project and preparing the project’s schedule. Property developers should carefully craft this provision to include specific warranties by the contractors concerning labor and material shortages, inflation, recession, and other potential impacts of the delineated events. Such a provision offers the clearest approach for mitigating the risk of changing market conditions by imposing an express contractual requirement on the contractor and barring all future claims for additional time and money based on delineated events. It is worth noting, however, that a provision of this magnitude will be met with contractor disdain. Nevertheless, property developers with significant bargaining power are in the best position to push for its inclusion.
The Force Majeure Clause
In addition to the foregoing price escalation clause, property developers should consider modifying their current force majeure clauses to account for changed circumstances. Typical force majeure clauses address unforeseen circumstances that result in delays or increased cost to a project. In the past three years, property developers have been flooded by force majeure claims by contractors seeking increased payments and time extensions stemming from the impacts of COVID-19.
While this article is not aimed at addressing the validity of such disputes, it is worth noting that the impacts of COVID-19 can hardly be called unforeseen at this point in time. To that end, property developers should consider modifying their force majeure clauses to expressly exclude COVID-19 (and other current delineated events, such as monkeypox and the Ukraine military conflict) from their scope. It is possible that if litigated, a force majeure clause that remains silent on these issues may be deemed by a court as offering protection to a property developer with respect to the foregoing events. Nevertheless, an express exclusion constitutes a best practice in this instance.
Critically, a modified force majeure clause can work in tandem with the foregoing price escalation clause, but may also be used as a fallback measure where a contractor is unwilling to provide an express warranty concerning price and time for construction. At a minimum, property developers should examine their current force majeure clauses before entering into new contracts for construction.
The Compromise Clause
To the extent a property developer is unable to negotiate the foregoing protections into their construction contracts because a contractor has particular leverage, the property developer should nevertheless push for some express language addressing changes in price.
One option for consideration is a price increase/decrease clause that allows for mutual recovery. Specifically, property developers may negotiate a provision into their construction contracts that requires a contractor to notify the developer of any price increases or decreases affecting the project. This clause should apply with specificity to changes in material pricing as well as labor pricing. Where a substantiated price increase exceeds 5% of the previously quoted price of a certain material or item, the contractor may pass along such price increase to the property developer. Similarly, where a price decrease constitutes a price reduction of over 5% for an item or material, the full amount of such savings will be passed along to the property developer to reduce the overall cost of the project. In this context, a price increase or decrease is substantiated through documentation from subcontractor bids or supplier unit costs for material procurement. To demonstrate that such increases will, in fact, affect the project, property developers should require a minimum of three substantiating bids from local subcontractors.
Where contractors are unwilling to bear the entire risk of a changing market, the foregoing provision offers a structured and balanced approach to mitigating risk. The foregoing provision also provides somewhat of a gamble for property developers and contractors alike. In the event prices escalate, the contractor is protected, but in the event prices drop, the property developer gains a windfall.
All that being said, as the school of legal realism has taught us, rational breach is always an option. While property developers should certainly consider the foregoing contractual provisions to protect their interests, they should remain vigilant of their ongoing contractual relationships. If material prices continue to skyrocket, contractors will weigh their options. Where the cost of finishing a project is significantly higher (due to increased material or labor costs) than at the time a contractor entered into an agreement, the contractor may decide that breaching that agreement makes financial sense. This is especially true in a world where litigation costs are also rising, often leaving property developers more willing to negotiate price increases in lieu of filing suit against throngs of contractors.
As with all aspects of the law, the foregoing recommended clauses will evolve as the construction industry and the lawyers who service it gain further insight into the most efficient and effective practices for resolving price escalation issues. Until then, however, property developers should remain cognizant of the protections available to them.
Elizabeth Coppolecchia is a partner at Weiss Serota Helfman Cole + Bierman and represents private entities in complex commercial litigation and municipalities and other governmental entities in disputes throughout Florida.
Read the original article published in the Daily Business Review here.
