Since the onset of the COVID-19 pandemic and the massive social and economic consequences it has wrought, owners and contractors alike have taken a harder look at their contracts.  Do the contracts have force majeure, waiver of consequential damages, or no damages for delay clauses?  Are the clauses written broadly enough to encompass the pandemic and its aftershocks?  It is safe to say that contracts negotiated pre-2020 look a lot different from those prepared after the pandemic was declared.

One provision not regularly included in pre-pandemic construction contracts, but now standard in nearly every one is a price escalation clause. The see-sawing price of materials and seemingly ever-increasing cost and scarcity of labor since 2020 have forced owners and contractors to negotiate price escalation clauses into new contracts to reallocate risk for cost and time overruns.  Price escalation is also finding its way into litigated claims. In claims involving cost overruns where the construction contract does not have a price escalation clause, the claimed damages incorporate significant price escalation, above and beyond even the normal inflation associated with litigated damages.  And, Claimants and plaintiffs are including large price escalation factors in their damage models to account for the general uncertainty and fluidity of the market.

Typically, a price escalation clause will either limit or expand contract time or cost attributable to but not necessarily limited to material price increases (likely of a certain percentage) associated with any act of God, industry wide supply chain disruptions, pandemics, weather, increased export taxes, and/or any related shipping disturbance. Many general contractors often, by necessity, try to negotiate broad price escalation allowances in the prime contract and at the same time, narrow to no price escalation allowances in their subcontract agreements. In turn, many subcontractors are either demanding price escalation clauses in their subcontracts or holding their pricing firm for very short periods of time, e.g., 7 days.

A price escalation clause may have the effect of subtly changing the chosen construction delivery method. A lump sum or guaranteed maximum project that contains a price escalation clause may more closely resemble a cost-plus contract. This may have a significant impact on construction budgeting, financing and pro formaexpectations for performance of the property.  If and when price escalation clauses are agreed upon, every affected party, from the investor/lender to the material supplier, should consider the risk of whether the project can move forward or be completed within a reasonable budget and reasonable time constraints.

Texas courts carefully protect the parties’ freedom of contract. Cases from the mid- to late 1970s, the last prolonged period of stagflation, which dealt with the inflated prices for oil brought about by the 1973 oil embargo indicate that absent price escalation clauses or an ambiguity in the contract, Texas courts will likely treat lump sum contracts as exactly that: negotiated fixed sum contracts.  However, when a construction contract is ambiguous or an argument can be made that performance is impossible or impracticable, the parties can choose to negotiate a middle ground to allow the project to be completed or instead, litigate.

The attorneys in our Austin and Dallas offices have significant experience assisting owners, developers, general contractors, subcontractors, suppliers and design professionals assess risk and build risk management into their contracts.  Price escalation clauses are an important risk transfer and management tool, made relevant again by the pandemic.  If you should have any questions about price escalation clauses or other provisions in your contract, please contact us at info@gstexlaw.com.

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