Tariffs and Other Cost Escalations: Some Contract Remedies

At the beginning of the Republic, tariffs were the primary source of money for the federal government. They were, and are, basically a tax. Since then, tariffs have been imposed, and the rates set, for innumerable justifications: to overcome trade deficits, to limit unfair competition from cheaper foreign goods, and even as a punitive measure to choke off domestic purchases of goods from selected foreign countries. The imposition of tariffs is somewhat unpredictable, as opposed to economic cycles, and so is the cost impact on construction.

Of course, the construction industry has always adjusted for other surprises, such as increased costs of labor, fuel, steel and shortages that drive up these prices. The questions that arise are: what contracts are most affected by these price escalations, and is there anything that can be done contractually to offset the damage to your profit margin?

Where the worry is the greatest

Certainly, price escalations can negatively affect every construction contract. Multiyear contracts demand the closest attention. These agreements include long-term maintenance contracts, major construction projects that have a lengthy construction period, unit price agreements and even cost-plus contracts where there is a fixed fee for overhead.

For these agreements, a bump in prices for labor, materials, equipment rentals, etc., over the long term can have financial significance. None of the standard contract clauses offer any assistance. New tariffs, increased fuel taxes, an increase in dump fees, and other escalations are not expressly addressed in, for example, a changes clause or differing conditions provision.

For lump sum competitively bid jobs, there may be little opportunity for inserting an escalation provision in your contract. Arguments have been made to owners that such a provision can help increase competition (more companies may bid the jobs if the risk of rising prices is reduced). However, if you insert an escalation provision in your proposal without prior discussion with the owner you can probably expect an owner’s rejection.

Where there are options

With the federal government, the largest number of contracts issued are competitively bid, but the largest amount of money spent is on negotiated agreements. As a result, federal agencies have had extensive experience with escalation clauses, and they have developed a range of approaches. Samples of clauses are contained in, for example, FAR 52.216-5 for unit price contracts.

Keep in mind that, where an owner is willing to discuss an escalation provision, there are options to consider in your proposal. These options range from targeting specific items of materials or labor to more global adjustments based on, for example, the Consumer Price Index, which is published by the U.S. Department of Labor and available through the AGC of America. In addition, the U.S. Bureau of Labor Statistics publishes the Producer Price Index (PPI), which is available at bis.gov/PPI, and it suggests a contract clause. For each of these indices, there are multiple options, depending on the industry and region of the country.

Considerations

Drafting an escalation clause can pose challenges, and the language can become complex. Below is a partial list of considerations you may want to review to see what issues create the greatest risks or concerns for your company.

  • Do you want a clause that targets specific items that may experience sharp price increases?
  • Do you want a price adjustment to be based on some objective criteria such as a published price index?
  • When would the price adjustment occur—periodically or based on some other criteria?
  • What kind of documentation will be needed to establish the amount of the price increase?
  • Will there be a minimum increase before the escalation clause becomes effective?
  • Will the price adjustment be marked up for overhead and profit?
  • How will disputes be resolved?

Whether the contract is lump sum or unit price, the owner will want information from you to confirm the reasonableness of your bid price for the commodities at issue. This information can then be used to establish a baseline for comparing future cost increases. Any price adjustment clause for your contract will obviously require some careful study.

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