By most accounts 2022 was supposed to be a year of growth for the construction industry. Many forecasted that the Infrastructure Investment and Jobs Act would be the primary source of that growth across health care, public safety, and generally in the public infrastructure arena. High inflation, increased energy costs, and material shortages, however, have turned what were originally forecasted to be mild headwinds into a full-scale weather event likely to extend well into 2023. Those issues, combined with an economy teetering on the brink of recession and an unprecedented shortage of skilled labor, have made managing project risk critical to project success and profitability.
Proactive and cost-conscious contractors are managing risk by:
Supply Chain. Maintaining good relationships with suppliers, prioritizing orders, and utilizing sound contract negotiation and enforcement practices.
Material Escalation. Modifying designs to utilize available materials and locking in raw material prices by ordering materials early and storing them until needed.
Skilled Labor. Broadening recruitment efforts, endeavoring to better engage workers, and developing new policies to attract and retain employees. Indeed, the skilled labor shortage has been particularly tricky for employers to navigate in virtually all sectors. The cornerstone of any organization is its talent, and the market for and retention of skilled labor has changed dramatically since the pandemic. Companies must think differently about how they go about attracting, managing, and retaining their workforce. Gone are the days when there was a surplus of skilled labor, and an employer could project an attitude of “you are just lucky to have a job here.” In today’s world, in addition to expanding talent searches beyond traditionally targeted groups, construction employers are implementing innovative policies and practices for maintaining and developing their employees. For example, some companies are offering career development programs designed to chart a path for professional growth, providing childcare, and offering regular family visits to project sites to better engage both employees and their families.
But despite the broader economic challenges facing all sectors of the industry, the single most effective way to manage project risk remains proactive and diligent contract negotiation and enforcement. The contract remains the greatest tool for containing risk and maximizing profit in the face of uncertainty. Negotiated improperly, however, or simply thrown in the project file and ignored, the contract can also present a hindrance to project success and profitability.
Although there is no one-size-fits-all approach to mitigating risk on a construction project, contractors should pay close attention to the following critical provisions:
- Cost Escalation Clauses: Specific cost escalation clauses increasingly are becoming the go-to mechanism for a contractor to pass through to the owner – at least partially – increases in material costs in lump-sum or GMP contracts. Although such clauses are not found in many “form” agreements, ConsensusDocs publishes an amendment to the standard lump-sum contract that allows owners and contractors to agree up front on permissible cost adjustments to specific baseline cost and schedule elements, and similar cost-escalation clauses can be crafted to meet the particular needs of any given project.
- Allowances: In a lump sum or GMP contract where the parties are required to determine a set price at the time of contracting, allowances enable the parties to address the “known-unknowns.” Allowances may be used to permit flexibility in material selection or where a scope of work is anticipated, but the associated cost is unknown at the time of contracting. Allowance clauses can also be tailored to address specific supply disruptions. But allowances are not escalation clauses in the strictest sense and do not provide nearly the same flexibility to address mid-stream material and labor cost market fluctuations.
- Contingencies: Contractor contingency clauses specify an amount in a contractor’s anticipated price for the “unknown unknowns” that cannot otherwise be accounted for in a schedule of values. Similar to a force majeure clause, a contingency provision can cover any number of unknown risks (strikes, accidents, weather, interest rate increases, etc.), but likely does not provide the same measure of flexibility as a cost-escalation clause.
- Substitution Provisions: Substitution provisions allow contracting parties to agree up front on acceptable substitutions in the event of material scarcity, cost increases, or newly available products, and can forestall significant disputes down the line.
- Force Majeure Clauses: The pandemic brought force majeure closes to the fore. In general, this clause is designed to protect contracting parties if they are delayed or prevented from performing because of causes outside the parties’ control. But force majeure provisions come in all shapes and sizes, and Ohio courts typically construe them narrowly, so they must be drafted with care. And beware: Typically, these clauses only provide additional time to perform and do not allow for the recovery of additional costs.
Final point: None of these contract provisions, standing alone, represent a cure-all for the nearly limitless set of circumstances that could give rise to project risk or cost escalation. But when taken together, and thoughtfully negotiated and managed across the contract as a whole, these provisions provide critical tools to limit risk and maximize profit in uncertain times.