In today’s ever-fluctuating market, the necessity of price escalation clauses is increasingly becoming important. While some material costs are rising and others are declining, traditional lump sum contract structures do not account for these cost changes. Cost-plus contracts have been created with this sort of price volatility in mind. However, many owners may prefer lump sum contracts due to their specific budgeting capabilities. It is important to evaluate all options when considering construction project pricing structure – particularly during times of risk like now.
Including a price escalation clause in a contract is a potential mechanism to account for volatility.
What is a price escalation clause?
- A clause utilized to account for price fluctuation in construction costs for specifically identified materials particularly susceptible to fluctuations like steel or lumber.
What are the benefits of a price escalation clause for an owner?
- The risk of contractors overpricing materials is reduced
- Such a clause may allow a project to move forward in an uncertain market and may even expand the number of bidders
What are the drawbacks of a price escalation clause for an owner?
- The risk of a price increase is shifted to the owner.
What are the benefits of a price escalation clause for a contractor?
- The contractor is protected if market conditions worsen and material prices increase.
What are the drawbacks of a price escalation clause for a contractor?
- Price escalation clauses may take away the upside that a contractor can charge for taking on greater risk
- Additionally, more cost information must be disclosed by the contractor
What are some of the best practices for drafting a price escalation clause?
- Identify the specific types of materials to which the clause applies.
- Define the baseline cost upon which the contract pricing is based.
- Define the price increase/decrease that triggers the clause – material prices must increase/reduce by a certain amount or a percentage over the base amount before the clause is triggered.
- Consider whether the clause will be cost-based or index-based
- The clause should include a written notice requirement tied to when the contractor becomes aware of the material price increase or decrease.
Contact our office today if you need help drafting a price escalation clause. These clauses are complicated and require both parties to consider multiple legal and commercial terms.