The COVID-19 pandemic is having a substantial influence on the global economy resulting in numerous changes to the construction industry. There has been a rapid increase in the cost of construction materials with an ever-growing demand for certain types of commercial and residential projects alike.
Rapidly shifting construction material prices can be financially detrimental to your profits. The construction law experts at Frank Feldman Law are knowledgeable about the challenges your business is facing on a day-to-day basis. Here are some effective ways to allocate the risk and protect your business:
Including Escalation Clauses in your construction contracts can help mitigate the risk of rising material costs. These clauses are composed of two elements: (1) a triggering condition and (2) scope of the materials. The triggering clause creates a set point at which the Escalation Clause takes effect. For example, if the cost of material increases past an agreed upon percentage or the completion of a project is delayed beyond a set date. The scope of materials element determines which materials are subject to the escalation clause. For example, a clause could cover the increase in the price of lumber but not apply to other materials such as fuel or steel, or could apply to all of these. Once an Escalation Clause is triggered, the increased cost of materials will be allocated to the designated party.
Escalation Clauses can help to protect your profit and reduce your risk due to the current unpredictability of the global economy.
A traditional Cost-Plus contract reduces risk by allowing you to be reimbursed for costs incurred plus a specific amount of profit. For example, a contract could specify the compensation payable to the contractor as the contractor’s cost of the project plus a 25% profit. In this situation if the contractor’s costs total $10,000 in expenses, the contractor would receive a $12,500 payment.
Another way to employ a Cost-Plus contract is by stating a fixed price for a more predictable expense, (i.e., labour), with the opposite party being responsible for the cost of materials, (at the date of delivery to the Project or etc.). For example, if the fixed price for labour is $5,000 and the cost of materials upon delivery is $7,000 then the total owed would be $12,000. This method would protect the contractor from fluctuations in material costs.
Integrated Project Delivery
A further alternative, Integrated Project Delivery allows risk to be shared by more than one party. Contracts using this method would set a Target Price, (i.e. an anticipated price for specified materials). If the actual cost of the materials specified ends up being less than the Target Price, the parties would share the cost savings as allocated in the Contract. However, if the actual cost of the items specified exceeds the Target Price, the excess cost would be shared based on the percentages agreed upon.
For example: a contract could stipulate that cost savings or cost overruns for specific items will be shared 50% to the owner and 50% to the contractor, based on a Target Price.
Integrated Project Delivery is a commonly used tool by construction professionals and provides a valuable and fair method for contractors to manage relations with long term valued customers, as it provides an opportunity for sharing risk.
The uncertainty of material costs can create a difficult situation for construction professionals in today’s economic climate. Let the construction law experts at Frank Feldman Law help you build a contract that best fits your needs and helps grow your bottom line.
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