Controlling The Booming Cost Of Construction With Escalation Clauses

The Surging Cost Of Building Materials

The cost of building materials in construction projects, namely steel, and lumber, is currently surging. And despite this surge in costs, there remains a boom in commercial and residential development. The demand for housing and development persists and is driving this rapid increase in prices. Prices that were set even a few months ago are now unobtainable.

This rapid increase in price affects everyone involved in the construction development process: the owner, the general contractor, the subcontractors, and the suppliers. And because construction projects take months and years to complete, the parties to these construction contracts are often locked into old and unobtainable prices. Profit margins are shrinking. So what can these parties do?

Escalation Clauses

An escalation clause is a provision written into a construction contract with directions on how to handle an unexpected or significant increase in the cost of building materials. An escalation clause does not control the cost of materials – that’s done by the market. But an escalation clause can help shift the responsibility of the increase in materials to a different party.

For example, the general contractor hires a subcontractor for wood framing. The subcontractor uses the local lumber yard to supply the wood. The lumber yard uses a supplier. The supplier increases the cost of wholesale lumber, which drives up the lumber yard’s prices. Two months ago, the lumber yard was selling lumber at $1,000 per thousand board feet. Now, the lumber yard has to increase this amount to $1,200 per thousand board feet. The subcontractor has to pay more for the lumber for wood framing, which drives up its operational cost. The subcontractor needs to make a profit, so it passes the cost up to the general contractor, which reduces the general contractor’s expected profit. Somewhere along this line, the increased price in lumber has cut into the general contractor’s bottom line. The general contractor notifies the owner of the increased cost in construction and that the original price of the owner/builder contract is going up. This creates contractual problems for everyone.

An escalation clause can determine who is responsible for paying this increased cost, usually the owner if the costs cross a certain percentage. The escalation clause can identify that the market for materials is volatile and all parties are using their best efforts to properly estimate the cost. The parties acknowledge that the price of these materials may go up and that someone in the construction process – the owner, the general contractor, the subcontractor, or the supplier – has to be responsible for this increased cost. The escalation clause can identify the types of materials subject to escalation, the requirement that any increased cost is supported by documentation (receipts, invoices, etc.), and that written demands have to be made up and down the chain identifying the increase in cost. A properly drafted escalation clause will identify what happens when these material costs increase and the rights of all parties under the owner/builder agreement, the subcontractor agreements, and the supplier agreements.