The New Reality of Risk:
Techniques for Managing Changing Market Conditions for Materials

1. The Construction Industry’s New Reality
2. The Doctrines of Impossibility, Impracticability and Frustration
1. Impossibility
2. Commercial Impracticability
3. Frustration of Purpose
3. The Doctrine of Force Majeure
1. Standard Clauses
1. AIA General Conditions
2. Associated General Contractor
3. Design-Build Institute of America
4. Statutory Force Majeure
4. Other Methods of Risk Allocation
1. Escalation Clauses
2. Futures Market and Hedging
3. Supply Contracts
4. Price Protection Clauses
5. Allowances
6. Insurance
7. Further Elimination of Risk
5. Conclusion

Appendix A: Tips for Drafting Force Majeure Clauses App. A1
Appendix B: Tips for Drafting Escalation Clauses App. B1-B2
Appendix C: Sample Clauses App. C1-C15
Appendix D: AGC General Conditions Form 200.1, Schedule A

The Construction industry has long enjoyed the relative price stability of raw materials. This came to an abrupt end starting in August 2003. The price of steel has increased so dramatically that it is nearly 65% over what it was 18 months ago. In fact, some products have spiked as much as 200%. While McGraw Hill’s ENR report indicates that the price of steel is stabilizing, most experts do not feel that the price will drop in the near future. The volatility in the price of steel has also affected the cost of all steel products such as hot rolled steel, pipe, wire mesh, and rebar to the extent that the prices for these products are 40% higher than they were at the same time last year. Other construction materials, such as copper, plywood, cement, drywall, insulation, and lumber have also seen remarkable price increases, and shortages in these materials have become more commonplace. Cement shortages and increased costs have resulted in availability only by allocation and limited weekend pours. The reasons for these conditions are many, but the most significant ones are: (1) the elimination of tariffs on imported steel at a time when the dollar is weak; (2) China’s ever-increasing consumption of steel, scrap and other raw materials ; (3) Russia’s halt of scrap export; (4) the demand by the world market (e.g., Iraq, Afghanistan and India) for more raw materials needed for growth; 5) high energy prices; and (6) the consolidation of available sources of supply such that only a few sources remain while demand remains high. As a result of these sustained conditions and unprecedented price increases, construction contractor’s and supplier’s profit margins have been severely squeezed. The rise in steel prices represents an overall project cost increase of over 18%, and depending on the fabrication type, in some cases as much as 30%. To some extent, this has resulted in fewer contractors who are willing to bid fixed-price contracts on long-term projects. Subcontractors have been especially hard-hit with increases in price from the suppliers and fabricators, yet facing resistance to contract price adjustments from the owner and higher-tier contractors who are dependent on the fixed-price nature of most contracts. Without legal relief, bankruptcy has been the unfortunate consequence of some contractors who were faced with this type of price volatility.

While it is well recognized that firm price contracts are the preferred method of contracting for most entities, it is equally the case that most risk of price escalation for materials is routinely allocated in the contract primarily to the contractor, subcontractor or supplier. A contractor’s reality is that there is only so much risk he can absorb before it impairs his ability to perform the contract and stay in business! For the owner, the cost of finding a replacement contractor, who might have even greater problems finding the same materials, might ultimately exceed the perceived benefit of avoiding all escalation costs. While it can be demonstrated that there are many benefits to cooperation, good will and common sense in the allocation of risk in the contract negotiation phase, how does a supplier, contractor or subcontractor deal with price and delivery problems in existing contracts that have no price protections? This is not to suggest that a contractor, subcontractor or supplier is without recourse, and there are a number of legal theories that might allow a contractor to recover its increased costs should rapid price escalation occur. Some are more successful than others, and I will attempt to first address the difference between these remedies.

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