Force Majeure Application to Increase in Price of Materials

Kent B. Scott | Babcock Scott & Babcock

Is a substantial increase in the cost of materials covered by a force majeure provision? If so, what is the appropriate remedy?

Short Answer

In short, the answer is dependent on the terms of the specific contract. If a contract is a fixed price contract, an increase in the cost of materials likely will not be covered by a force majeure provision. Moreover, if a contract is a fixed price contract and it contains a “no damage for delay” provision, then it is very likely an increase in the cost of material will not be covered by a force majeure provision. Since it is unlikely a substantial increase in the cost of materials will trigger a force majeure provision, it is not necessary to determine what the appropriate remedy would be.

Analysis

Applying Florida law, the Eleventh Circuit found that a contractor who entered into a fixed price contract with a property owner and subsequently saw a substantial increase in its costs due to effects of a series of hurricanes, which caused a shortage of labor and material, was precluded from recovering additional labor and material costs from the force majeure events – i.e., the hurricanes. S&B/BIBB Hines PB 3 Joint Venture v. Progress Energy Fla., Inc., 365 Fed. Appx. 202, 203, 205 (11th Cir. 2010). In S&B, the parties’ contract required the contractor to “provide pricing for [all material, equipment, workmanship, labor, engineering, and any other items or labor performed or furnished] at a firm fixed price.” Id.at 203. The contract further contained a “no damage for delay” provision that provided “that in no event shall Contractor be entitled to any increased costs, additional compensation, or damages of any type resulting from such Force Majeure delaysId. at 204. The court ultimately found that:

“it would subvert the entire purpose of a fixed price contract to allow [the contractor] to recover additional labor and materials costs when the benefit of a fixed price contract is to protect against price increases, labor shortages, material shortages, and the like. In contracting for the fixed price construction job, ‘the parties thoroughly addressed and allocated the risks’ inherent in the project, and [the contractor] could have increased its prices to reflect the risks it was assuming.”

Id. at 205-06 (quoting Marriot Corp. v. Dasta Const. Co., 26 F.3d 1057, 1065-66, 1066 (11th Cir. 1994)). The court reasoned that “[t]he contract made plain that [the contractor] bore the risk of these additional expenses and could have negotiated an alternate contract containing an escalation clause, a cost-plus arrangement, or a higher fixed price to protect against unforeseen expenses or increased its contract price to account for such risks.” Id. at 206.

The Fourth Circuit similarly held that a force majeure clause does not protect against changes in market price. Langham-Hill Petroleum Inc. v. S. Fuels Co., 813 F.2d 1327, 1330 (4th Cir. 1987). In Langham-Hill, two parties entered into a fixed price contract for a lump sum number of barrels of oil, which would be purchased at the fixed contract price over four monthly installments. Id. at 1329. The first three installments concluded without dispute. Id. However, prior to the fourth and final installment there was a substantial drop in the world oil prices. Id. The purchaser invoked the contract’s force majeure clause and refused to perform any further obligations under the contract. Id. The Fourth Circuit reasoned that “[i]f fixed-price contracts can be avoided due to fluctuations in price, then the entire purpose of fixed-price contracts, which is to protect both the buyer and the seller from the risks of the market, is defeated. Id. at 1330. The Fourth Circuit adopted the Seventh’s Circuit reasoning in Northern Indiana Public Service Company v. Carbon County Coal Company, 799 F.2d 265 (7th Cir. 1986), which dealt with a utility company’s efforts to escape a fixed-price coal contract, that:

[the defendant] committed itself to paying a price at or above a fixed minimum and to taking a fixed quantity at that price. It was willing to make this commitment to secure an assured supply of low sulphur coal, but the risk it took was that the market price of coal or substitute fuels would fall. A force majeure clause is not intended to buffer a party against the normal risks of a contract. The normal risk of a fixed price contract is that the market price will change. If it rises, the buyer gains at the expense of the seller (except insofar as escalator provisions give the seller some protection); if it falls, as here, the seller gains at the expense of the buyer. The whole purpose of a fixed price contract is to allocate risks in this way. A force majeure clause interpreted to excuse the buyer from the consequences of the risk he expressly assumed would nullify a central term of the contract.

Langham-Hill, 813 F.2d at 1330 (quoting N. Ind. Pub. Serv’s., 799 F.2d at 275).

Utah courts seem to follow this reasoning. In Kilgore Pavement Maintenance, LLC v. West Jordan City, 2011 UT App 165, ¶ 2, 257 P.3d 460, a pavement contractor provided a city with a fixed price bid that was based on liquid asphalt oil being priced at $350 per ton, which the city accepted, and the two parties subsequently entered into a contract. Id. Shortly after the parties entered into the contract, the price of liquid asphalt increased to $1005 per ton. Id. at ¶ 3. The court ultimately held that the contractor “assumed responsibility for supplying all materials necessary for its performance, and therefore, assumed the risk of supply cost increaser”, which ultimately precluded the contractor from relying on a claim of impossibility or commercial impracticability. Id. at ¶8, 12. While a force majeure clause is absent from the reasoning in Kilgore, Kilgore does provide that under Utah law, a fixed price contract is prima facie evidence of an allocation of risk of the change in the contracted material’s market price.

Conclusion

Assuming the contract between an owner and contractor is a fixed price contract, it is likely the substantial increase in price cannot trigger the force majeure clause since the contractor assumed the risk of an increase in the market price of lumber when it entered into the fixed price contract. the contractor had the opportunity to bargain for an escalation provision, a cost-plus contract, or a higher contract price to reflect its risk. Thus, the contractor is contractually obligated to purchase lumber at the higher market price so long as lumber is available for the contractor to purchase.

It is important to note that although it is likely Burton Lumber is precluded from relying on a force majeure provision, it may still have a claim under an excuse doctrine, such as “frustration of purpose, impossibility, and commercial impracticability.” § 7:322. Relief from disruption caused by COVID-19 pandemic, 2A Bruner & O’Connor Construction Law § 7:322. However, pursuant to Kilgore, it is unlikely such a claim would be successful. 2011 UT App 165, ¶ 8, 12, 257 P.3d 460.

Material Cost Escalation: Who Bears the Cost Now? And, What Can Be Done to Address the Problem in the Future?

Sherman Botts | Stinson

While an increase in construction costs for materials is not new to the industry, the extent of the cost increases during this COVID-19 time may be beyond anyone’s experience. Prior to COVID-19, material costs have spiked for many products, such as oil, asphalt, concrete and plywood. Those cost increases may have arisen from certain tragedies involving Mother Nature’s hand, such as flooding, hurricanes, fires and tornadoes. In other instances, increased costs may have been prompted by tariffs recently implemented over the past few years by governmental actions. In each case, the increased cost is usually unforeseen and the parties are faced with the basic dilemma: who should bear the cost of the increased costs? Owner? Contractor? Subcontractor? Or, some or all of the above?

With the COVID-19 pandemic, the increased costs and delays appear to affect far more materials than ever before. Beginning in early 2020, construction projects are facing increased costs with structural steel, lumber, copper, plumbing and electrical materials. There is no uniform assessment as to the degree of increase in prices, which have ranged from 25% for tariff-affected materials to more than 70% to 300% for lumber. Some have observed that structural steel has increased by more than 250%.

Coping with Cost Increases and Delays on an Existing Project

A common scenario now involves a construction client who calls and asks two essential questions: (1) who must bear the brunt of the increased cost for a particular material; and (2) whether the increase can be passed on to other parties associated with the project. The construction lawyer’s first response should be: “What does your contract provide?” Indeed, the first step in any analysis must start with the contract that the parties negotiated (or maybe just blindly signed) at the outset of the project. Does the prime contract or subcontract include a “force majeure” clause? (For those new to construction contracts, the title “force majeure” may not appear in the body of the contract but the concept is often present.) The French term “force majeure” means a “greater force” and usually excuses delays experienced by a contractor or subcontractor when the delays are unforeseen and caused by reasons beyond their reasonable control. A common example of a force majeure clause is found in AIA Documents A201, in the underscored portion of Section 8.3.1 below:

§8.3.1 If the Contractor is delayed at any time in the commencement or progress of the Work by (1) an act or neglect of the Owner or Architect, of an employee of either, or of a Separate Contractor; (2) by changes ordered in the Work; (3) by labor disputes, fire, unusual delay in deliveries, unavoidable casualties, adverse weather conditions documented in accordance with Section 15.1.6.2, or other causes beyond the Contractor’s control; (4) by delay authorized by the Owner pending mediation and binding dispute resolution; or (5) by other causes that the Contractor asserts, and the Architect determines, justify delay, then the Contract Time shall be extended for such reasonable time as the Architect may determine.

Would delays and dramatically increased costs in materials caused by COVID-19 be covered by this contract clause in one of the most common contract templates in the construction industry? First, stating the obvious—this clause does not expressly refer to COVID-19 nor does it refer to “epidemics” or “pandemics.” (These words may be found in other published templates.) Because the provision in this instance makes no mention of the pandemic, should the contractor’s or subcontractor’s delayed performance be excused because of a COVID-19-caused event? There is no black and white answer in this regard.

Some would argue that the use of the word “unusual” in Section 8.3.1 means that the event must be unforeseen and that the COVID-19 events are NOT unforeseen or “unusual” because all parties in the construction industry have been dealing with COVID-19 for a long time, at least since the President declared the Coronavirus to be a pandemic on March 13, 2020. The argument continues that, since COVID-19 is a known event, experienced contractors and subcontractors should have learned how to address the risk of cost increases by locking down quotes from suppliers or advanced ordering of materials.

Many would argue, though, that the pandemic need not be expressly mentioned in the provision and that it should certainly qualify as an “unusual delay…. or cause beyond the Contractor’s control.” This is an important delay claim for the contractor or subcontractor to submit, particularly if the contractor or subcontractor faces the risk of a liquidated damage assessment. But an extension of contract time may be the only remedy available to the contractor or subcontractor under this provision. The potential for an increase in the contract sum is not mentioned here and its absence may be damning to a contractor’s request for increased compensation, unless the remedy of increasing the contract sum was negotiated into the contract.

It is important to note, however, that Section 8.3.1 may refer to only contract time extensions but it does not absolutely bar requests for increased costs. Indeed, Section 8.3.3 provides:

§ 8.3.3 This Section 8.3 does not preclude recovery of damages for delay by either party under other provisions of the Contract Documents.”

As such, the request for increased cost recovery may still be submitted provided that the subcontractor’s or contractor’s claim complies with the applicable notice provisions in the contract. In addition, the claimant should consider submitting the claim in the in the form of an equitable request for additional compensation as discussed below.

If the contract provides no relief to the contractor or subcontractor for significantly increased costs, an equitable argument must be presented to deal with the facts at hand. The subcontractor may be placed in such a position that it is not able to perform its duties under its subcontract if it is forced to bear the burden of all increases in costs. Obviously, an assumption of a 300% increase in materials would likely put many subcontractors out of business. If a subcontractor walks off the project for that reason, the project will likely face substantial delays and increased costs that others would have to bear if the project is to continue and if there is no performance bond relief available.

The subcontractor should consider making a very prompt request for equitable adjustment in compensation under the doctrine of impracticality or impossibility to address the increased costs. The equitable claim should be submitted to the tier contractor above it so that it can be processed up the contracting chain. The claim must emphasize that the dramatic increase in costs is unforeseen and renders the subcontractor’s performance an impossibility and that the increased costs will negatively impact the subcontractor’s ability to successfully and timely perform if no relief is provided.

The net result of the increase and the subcontractor’s inability to perform can cripple the completion of the project, which is not in the best interest of any party to the project. Through timely communication among the parties, there may be acceptable alternatives to avoid a shutdown to the project. Perhaps other materials can be used? Perhaps there can be a sharing in the cost? Perhaps design changes can be made?

The courts have reviewed whether dramatic increases in cost of materials will excuse performance by a contractor but jurisdictions vary as to the outcome. On the excused performance side, consider the analysis by the New York court in Moyer v. City of Little Falls, 134 Misc. 2d 299, 301–02, 510 N.Y.S.2d 813 (Sup. Ct. 1986), and its observation and ultimate conclusion that:

[T]here is a growing trend that performance should be excused (1) if governmental action or other contingencies create a substantially unjust situation totally outside contemplation of the parties and (2) which an experienced draftsman would not reasonably anticipate. In this instance, it is stipulated that the 666% price increase [in dumping costs at the required landfill] was not and could not have been within the contemplation of the parties. Such a massive cost escalation is ‘excessive’ as a matter of law and future performance by plaintiff must be excused.

In Pennsylvania, in Aluminum Co. of Am. v. Essex Grp., Inc., 499 F. Supp. 53, 70 (W.D. Pa. 1980), new regulations for oil and pollution control dramatically increased the seller’s smelting costs and would have caused the seller to lose more than $75 million during the life of the contract while the buyer conversely stood to gain a windfall profit. The court found that regulatory changes of this sort were an unforeseen supervening circumstance, not within the contemplation of the parties at the time of contracting. To the relief of the seller, the court found that the seller’s performance became commercially impracticable.

By contrast, some courts in the Eighth Circuit have found that even excessive increases would not excuse performance by a contractor. In Iowa Electric Light and Power Company v. Atlas Corporation, 467 F. Supp. 129, 140 (N.D. Iowa, 1978), the U.S. District Court for the Northern District of Iowa held that an increase in seller’s costs by 52.2%, resulting in the seller’s loss of approximately $2,673,125.00, failed to constitute commercial impracticability, and precluding judicial adjustment or discharge of the contract for supply of uranium concentrate. In making such a determination, the court noted that cost increases of 50-58 percent had generally not been considered of sufficient magnitude to excuse performance under a contractual agreement. Iowa Electric was cited shortly after by Missouri Pub. Serv. Co. v. Peabody Coal Co., 583 S.W.2d 721, 726 (Mo. Ct. App. 1979), where the Missouri Court of Appeals for the Western District found that an escalation in costs did not render the contract “commercially impracticable” or excuse the contractor’s performance: “[i]ncreased cost alone does not excuse performance unless the rise in cost is due to some unforeseen contingency which alters [t[he essential nature of the performance.”

Proactive Steps for Future Projects

For new projects and new contracts, contractors and owners should consider discussing how the risk of cost escalation can be minimized or shared in the future. If past contracts did not provide any answers, a price escalation clause is often discussed for future contracts. The clauses come in all shapes and forms. Frequently, the clause describes a certain limitation or percentage guideline as to when a cost increase will be considered significant enough for cost relief. Consider the following:

Cost Escalation: In the event of significant delay or price increase of material, equipment or energy occurring during the performance of the contract through no fault of Contractor or its subcontractors, the contract sum, time of completion or contract requirements shall be equitably adjusted by change order in accordance with the procedures of the contract documents. A change in price of an item of material, equipment, or energy shall be considered significant when the price of an items increases ___% or more between the date of this contract and the date of installation. If the increase in price is at least ___%, but less than ___%, the equitable adjustment shall be based only on the amount of increase or decrease greater than ___%, but if the price increase is ___% or more, then the equitable adjustment shall be based on the entire amount of the price increase. If Contractor makes a request for an equitable adjustment to the contract price based on an increase in price, Contractor shall be required at that time to disclose its original price that has increased.

Richard A. Stockenberg, Material Price Escalation Clauses, as contained in The Anatomy of a Construction Contract, The Missouri Bar 2004.

Contractors may find some owners unwilling to consider a price escalation clause. From an owner’s perspective, the owner will expect the contractor or its subcontractor to take all necessary steps to control material costs at the outset of the project. These may include:

  1. Requiring the contractor or its subcontractors to purchase materials in advance.
  2. Requiring the contractor or its subcontractors to “lockdown” the price with its supplier.
  3. If a supplier is unwilling to lock down its pricing, an owner would expect the contractor or subcontractor to shop with another supplier. The problem with this alternative is that the market is changing and a growing number of suppliers are unwilling to lock down pricing for an entire project and will sell their materials at whatever price may exist at the time of the delivery.

To counter an owner’s refusal to consider a cost escalation clause, a contractor may include a very healthy contingency in its bid to accommodate the fluctuation in material costs. Is this what the owner wants?

The circumstances for recovery or rejection of increased costs in an existing project or drafting of an escalation clause for future contracts will require consultation with an experienced construction lawyer. Please contact Stinson for questions and assistance with these matters.

Construction Costs Must Be Reasonable

David Adelstein | Florida Construction Legal Updates

When it comes to proving a construction cost, particularly a cost in dispute, the cost must be REASONABLE.   Costs subject to claims must be reasonably incurred and the party incurring the costs must show the costs are reasonable.

An example of the burden falling on the contractor to prove the reasonableness of costs is found in government contracting.

“[T]here is no presumption that a [government] contractor is entitled to reimbursement ‘simply because it incurred…costs.’”  Kellogg Brown & Root Services, Inc. v. Secretary of Army, 973 F.3d 1366, 1371 (Fed. Cir. 2020) (citation omitted).  Stated differently, a federal contractor is not entitled to a presumption of reasonableness just because it incurs costs.  Id.

In government contracting, the Federal Acquisition Regulations (known as “FAR”) puts the burden of reasonableness on the contractor that incurred the costs.  Id.

FAR s. 31-201-2(a) [Determining allowability] provides, “A cost is allowable only when the cost complies with all of the following requirements: (1) Reasonableness….”

FAR 31-201-3 [Determining reasonableness] maintains:

(a) A cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business. Reasonableness of specific costs must be examined with particular care in connection with firms or their separate divisions that may not be subject to effective competitive restraints. No presumption of reasonableness shall be attached to the incurrence of costs by a contractor. If an initial review of the facts results in a challenge of a specific cost by the contracting officer or the contracting officer’s representative, the burden of proof shall be upon the contractor to establish that such cost is reasonable.

 (b) What is reasonable depends upon a variety of considerations and circumstances, including-

            (1) Whether it is the type of cost generally recognized as ordinary and necessary for the conduct of the contractor’s business or the contract performance;

            (2) Generally accepted sound business practices, arm’s-length bargaining, and Federal and State laws and regulations;

            (3) The contractor’s responsibilities to the Government, other customers, the owners of the business, employees, and the public at large; and

            (4) Any significant deviations from the contractor’s established practices.

In Kellogg Brown & Root Services, a government contractor on an international project received a task order from the government to provide accommodations and life support services which equated to trailers for temporary housing for army personnel.  The government was to provide protection / security for the contractor.  The contractor subcontracted the procurement of the trailers.  The contractor claimed due to delays from the Army’s failure to meet its protection obligations, there were delivery delays resulting in storage costs and additional double handling costs (e.g., loading and unloading of trailers more than once) incurred by its subcontractor.  The contractor submitted a claim of “$48,754,547.25 in equitable adjustments for idle truck costs due to the backup of trailers at the border and double handling costs” due to the government’s failure to provide protection, along with associated markup.  Kellogg Brown & Roof Services, supra, at 1369.   The contracting officer’s final decision denied all of the claim but $3,783,005 which pertained to land that had to be leased to store the trailers due to the delay.

The contractor appealed the final decision to the Armed Services Board of Contract Appeals.  The Board concluded that the contractor had NOT demonstrated its costs were reasonable.  In particular, the Board found: (a) the contractor did not demonstrate a prudent person conducting a competitive business would have resolved its subcontractor’s delay claim upon the same model submitted by the subcontractor; and (b) the contractor did not demonstrate the double handling costs were reasonable.  The contractor submitted estimates from its subcontractor and did not submit any actual costs; thus, the Board found the damages models (estimates) were unreasonable and flawed.  For this reason, the Board denied all recovery prompting the contractor to appeal to the United States Court of Appeals for the Federal Circuit.

The United States Court of Appeals agreed with the Board that the contractor failed to show the costs it incurred were reasonable.  Even if the contractor established the government’s liability for the costs, the claim failed due to the failure to show the reasonableness of the incurred cots.

In addressing this issue, the Court noted that the contractor was not required to show the actual costs incurred by the subcontractor, but it was required to show the payments to its subcontractor—costs incurred—were reasonable.  The problem for the contractor was that it failed to show in any of its cost calculations that the methodology used to calculate the delay costs was reasonable.  Instead, the Court picked apart, based on what the Board concluded from the evidence, the model employed by the contractor for being inconsistent and unreasonable based on a number of different grounds as the contractor’s damages model did not depict actual events that occurred.  The Court explained, “[the contractor] supplied no meaningful evidence to the Board showing the reasonableness of its costs, nor has it explained the inconsistencies between its proposed cost model and the factual record.”  Kellogg Brown & Root Services, supra, at 1374.

Regardless of the type of project, it is important to remember that a party (e.g., contractor) still must demonstrate that the cost it is claiming as damages is a cost that it is reasonably incurred!

Increased Material Costs Leave Contractors Asking about Contract Protections

Jodie Clark McDougal | Davis Brown Law Firm

We are hearing about a budget pinch from many homebuilder and general contractor clients tied to the substantial increases in the cost of lumber and other materials; HBA Iowa reports about an 80% increase in lumber costs since mid-April. As the cost of materials for build projects soars, builders and contractors should review their contracts carefully to see if they have options to get some or all of the increased costs covered by the owner and consider revising their future contracts to help protect themselves against abnormal material cost increases.  

Cost-Plus Contracts

Contractors and builders who signed cost-plus contracts with their owner-clients are breathing a sigh of relief, as these contracts fully protect them in this regard, all material costs are directly passed on to the owner-client. Though, contractors should carefully review any provisions in their cost-plus contracts regarding guarantees on any estimated budget and/or a guaranteed maximum price, as modifications may be prudent to these types of provisions.

Stipulated Sum Contracts

Conversely, contractors are much less protected in the typical stipulated sum contract, as contractors generally bear the risk, and gain the benefit, of downward or upward changes in material and labor costs. That said, contractors should review whether the contract has any provisions addressing delays caused by the owner-client, as such provision may provide relief. For example, as the virus took hold, many buyers reconsidered their project – putting the project on hold or delaying decisions as they dealt with the health and safety of their families. If your contract contains this type of provision and you can show that without that delay, costs would not have increased, the owner-client may be liable for the increased cost.

Recommendations for Future Contracts

To help protect themselves from substantial market-wide material cost increases in the future, contractors and homebuilders should consider the following:

  • Should you start using cost-plus contracts, instead of stipulated sum contracts?
  • Should you add one or more of the following provisions in your stipulated sum contracts?
    • Provision RE: Market-wide Material Cost Increases: Generally, this type of provision provides that the contract price is subject to change if there is an unexpected market-wide increase in the cost of a certain material above X% (often 10% or more) and if the contractor cannot obtain the same or similar material for a lesser amount; in such event, the contract price is subject to increase in the differential amount of the material cost increase.
    • Price Lock Provision: This type of provision mandates only a 30- or 60-day price lock guarantee, such that the contract price is subject to increase at the commencement of the project does not occur until after that price lock period.

These two provisions should help contractors and builders with future substantial material cost increases in the future, but contractors should ensure that their owner-clients understand the effect of these types of provisions.

Finding Relief

We echo our friends at NAHB – if your business is suffering from the increased costs of materials costs, reach out to your members of Congress. Although some of the increased costs can be attributed to the coronavirus – low supply and high demand and the ongoing trade war adds other layers to the issue. Ask your members of Congress to work with the administration to address lumber prices.

Going Forward

Coronavirus continues to teach us new ways to move forward. For builders, this includes adding contract provisions to address everything from government forced shutdowns to material cost changes. Builders are encouraged to work with their attorney to address contractual changes going forward to avoid being on the hook for these massive cost increases.