During the recession of 2008-2009, contractors learned important lessons about the issue of unpredictability in the economy. There were problems with labor, supply, and financial unpredictability, which impacted contractors’ ability to timely complete projects and stay within anticipated budgets. Many times, contractors accepted projects just to keep its labor pool employed and engaged and to ensure that it could continue in operation once the economy rebounded.

Predicting market conditions 6 to 8 months in the future can seem like an impossible task when changes in the economy cannot be predicted from one day to the next. Understanding your contractual rights and obligations in uncertain economic times is even more important now.  The wave of construction litigation that washed ashore after the 2008-2009 Great Recession and the enormous construction boom that followed provide valuable lessons on the types of contract clauses that can mitigate business risks in a post-pandemic world.  We discuss 3 important risk transfer clauses that every contractor and owner should carefully consider including in their contracts.

1.    Cost Escalation Clauses

Cost escalation clauses allow for price adjustments to account for fluctuations in the costs of labor and materials. The clause shifts the burden for these increased costs from the contractor to the owner or developer.  In the recovery following the Great Recession, many contractors found themselves caught between the rock of increased costs  (with outright labor shortages in some trades) and the hard place of low-bid contracts entered into pre-economic recovery.  Had those contractors included cost escalation clauses in their contracts, they could have passed along the increased costs to the owner/developer rather than incur the increased costs themselves and thereby perform work at little or no profit. Including cost escalation clauses in contracts entered into during the current economically uncertain times may preclude the dilution of the contractor’s net margin when the economy rebounds.

2.    Liquidated Damage Clauses

Liquidated damage clauses set a fixed amount, usually measured on a per day basis, that an owner may collect for delays in completing construction.  The fixed amount is intended to estimate the actual damages the owner will incur due to the delay.  Although the Texas Supreme Court has recently elaborated on how to effectively challenge such clauses, they remain powerful tools for the owners to use.

During the recovery following the Great Recession, several key trade subcontractors experienced labor shortages.  Projects fell behind schedule.  Owners, facing increasing demand for completed projects, sent notices of default to contractors and offset amounts due to contractors with liquidated damages.  This reduced contractors’ cash flow and further hampered their ability to timely complete the projects.

Even during the COVID-19 pandemic, some construction trades, particularly those serving the residential construction market, have continued to experience severe labor shortages.  Owners and contractors should plan for those shortages to become more acute during a post-pandemic economic recovery.  Including specific pandemic-related language in force majeure clauses or as carve-outs in liquidated damage provisions may prevent imposition of liquidated damages from impinging cash flow and further impacting project completion.

3.    Waiver of Consequential Damages Clauses

Waiver of consequential damage clauses eliminate a party’s right to recover certain types of damages such as lost profits.  Texas courts use a fact-intensive test to determine whether a damage type is actual or consequential. If the owner and contractor, therefore, do not define the specific types of damages they intend to waive, they may not actually be waiving what they wanted to.

One of the defining features of the construction litigation that followed in the wake of the Great Recession was the staggering increase in the amount of claimed consequential damages.  Lost profits, lost income, and lost sales arising from projects coming online during the nadir of the Recession were immense.  Contracts that had waiver of consequential damages clauses with clearly defined damages being waived significantly reduced contractors’ exposure compared to contracts that lacked such clauses or failed to specifically define the types of damages being waived.

In the post COVID-19 market, particularly in construction of retail and commercial office space—two sectors that expected to see significant volatility—having well defined waiver of consequential damages provisions can assist contractors (and owners, too) in managing and ultimately reducing risk.

The attorneys in our Austin and Dallas offices have significant experience drafting, negotiating, and litigating construction contracts, and are available to answer any questions you may have.

Legal Disclaimers

This blog is made available by Gerstle Snelson, LLP for educational purposes and to provide general information about the law, only.  Neither this document nor the information contained in it is intended to constitute legal advice on any specific matter or of a general nature.  Use of the blog does not create an attorney-client relationship with Gerstle Snelson, LLP where one does not already exist with the firm.  This blog should not be used a substitute for competent legal advice from a licensed attorney.

©Gerstle Snelson, LLP 2020.  All rights reserved.  Any unauthorized reprint or use of this material is prohibited.  No part of this blog may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage or retrieval system without the express written permission of Gerstle Snelson, LLP.