Under the US federal system, there is federal or national law and the laws of the 50 individual states. Commercial relations are principally governed by state law. Other than federal laws addressing specific federal policies, discussed below, there is no “national construction law” in the USA.
The Associated General Contractors of America (AGC) and the American Bar Association Forum on Construction Law (ABA), two large and respected national organisations, create and annually update the online Construction State Law Matrix. This practice guide references the AGC/ABA Construction State Law Matrix throughout.
The matrix can be found here: www.agc.org/industry-priorities/contracts-law/state-law-matrix.
This matrix is a starting point for identifying and researching state construction laws; it is not a definitive statement of the law on any topic in any state.
There is substantial similarity across state laws, but each state has its own constitution and statutes, and common law governs both. Model uniform laws enacted by many or most states reinforce similarities across state laws. When federal law applies and it conflicts with the otherwise applicable state law, federal law controls.
Standard contract forms are frequently used in the construction industry in the USA. The use of standard forms on private projects is voluntary and not mandatory. Parties are free to draft their own contracts, with limited exceptions that the contract terms cannot violate the public policy of a particular state.
On contracts with federal, state or local governments or involving public funding, the contract form or specific terms may be required by statute or regulation. The federal government, in particular, has extremely specific and detailed mandatory contract clauses that must be employed. Part 36 of the Federal Acquisition Regulation (FAR) regulates federal projects and prescribes policies and procedures unique to contracting for construction and architect-engineer services, and includes requirements for using certain clauses and standard forms that apply also to contracts for dismantling, demolition, or removal of improvements. These can be found at www.acquisition.gov/far/part-36.
FIDIC standard contracts are generally not used on projects in the USA, but there is nothing prohibiting the use of FIDIC standard contracts by private parties. The American Institute of Architects (AIA) publishes the most commonly used standard construction and design form contracts at www.aiacontracts.org/. The AIA has a large variety of standard forms depending on the project delivery system, the relationship between the parties, including Owner-Contractor, Owner-Design-Builder, Contractor-Subcontractor, Owner-Architect, type of contract pricing, etc.
In the USA, the term “employer” is not used. Instead, the term most widely used in the USA, including in standard construction contracts is “owner”, “project owner”, or if the owner is a public entity, the “government”. For consistency, the term "owner" rather than "employer" will be used throughout this practice guide.
The standard construction contract forms published by ConsensusDocs at www.consensusdocs.org/contracts/ are the next most frequently used set of forms after those published by the AIA. ConsensusDocs was founded under the leadership of the AGC, the largest national construction trade organisation, along with 19 other construction organisations. ConsensusDocs also offers a complete library of forms to cover a wide range of construction transactions, similar to the AIA’s offerings.
Other standard forms are published by the Engineers Joint Contract Documents Committee (EJCDC) at www.ejcdc.org/, and the Design-Build Institute of America (DBIA), https://dbia.org/contracts/. EJCDC documents tend to focus on heavy civil and industrial construction, rather than building construction. The family of standard forms published by the DBIA obviously focuses on construction under a design-build delivery system.
The construction market was impacted by the COVID-19 pandemic in various ways, including increased safety measures, work stoppages, shortage of skilled labour and supply-chain disruption. However, most construction projects were considered “essential” and were able to continue construction through 2020.
Some contractors experienced significant impacts throughout 2021 as a result of COVID-19 protocols to mitigate spread that impacted project execution, labour and material prices, and supply chain performance. By 2022, contractors are expected to price in or assume the risk of the potential costs of COVID-19. COVID-19 knock-on effects – in combination with other world events – have ushered in the resurgence of demand for escalation clauses in construction contracts as well as further scrutiny of force majeure clauses and their coverage.
In the USA, project owners are typically federal and state governments (public contracts), or private developers and builders (private contracts).
Owner’s Responsibilities on Federal Projects
As noted in 1.2 Standard Contracts, public contracts are subject to complex regulations established by federal and state governments including FAR Part 36. The government agency (such as the Army Corps of Engineers, the Department of Defense, or the Department of Agriculture) procures pre-qualified private contractors or design professionals to competitively bid on public contracts. The government agency may award the project based on a traditional sealed bid process or through a competitive negotiation process. Public owners have rights and obligations to disclose information, pay contractors, direct changes to the work and enforce the contract in the event of a contractor default or if the work is defective or incomplete.
Owner’s Responsibilities on Private Projects
On private contracts, project owners such as private developers, owner-builders and private investors may contract with multiple parties to assist with construction activities, including lenders (financing the project), design professionals and general contractors. A private owner’s typical duties include managing financing, land acquisition, providing accurate site data (geotechnical data, utilities, surveying), paying design professionals and contractors and interacting with local government agencies. Once construction is completed, a private owner may operate and maintain the project/facility, or sell the project/facility to a new owner.
The standard industry contract forms set forth specific owner responsibilities including providing information to the contractor and the design professional, describing the work site (surveys, drawings, subsurface conditions); securing permits; and reserving the right to stop, suspend, or carry out the work (AIA Document A201 – 2017 § 2; ConsensusDocs 200 § 4 (2011, Revised 2019)).
The traditional method of contracting in the USA is a design-bid-build process in which the owner contracts separately for design and construction services. Under this method, a “general” contractor is hired by the project owner to build, manage and oversee all aspects of construction from the start of construction through to completion, including providing the materials, labour, equipment and services necessary for construction.
General contractors are usually larger contractors with ample resources and manpower to oversee larger construction projects. During construction, general contractors work directly with the owner and the design professional and its subcontractors to schedule, plan and execute construction activities. On a day-to-day basis, general contractors are responsible for project safety, co-ordinating site access, monitoring schedules and managing subcontractors.
On public projects, a contractor is subject to more complex rights and obligations in performing its work. FAR Subpart 36.2, “Special Aspects of Contracting for Construction”, sets out detailed regulations relating to labour, liquidated damages and bonding requirements applicable to federal construction projects, which would not be applicable on private projects.
Subcontractors, including speciality trade contractors, suppliers and service providers, contract with the general contractor or other subcontractors to perform a specific scope of work. Subcontract agreements set forth the subcontractor’s rights, obligations, scope of work, conditions of payment and dispute resolution process. The industry standard contracts, including those supplied by ConsensusDocs and the AIA, have established a subcontractor series specific to subcontractors (ConsensusDocs 700 Series; AIA A401 (2017 ed)), which incorporate and consider important rights and terms unique to a subcontractor, including conditions of payment and “flow-down” clauses.
“Flow-down” clauses require the subcontractor to agree to have the same rights and privileges in relation to the general contractor as the general contractor has to the owner. Such clauses are common in subcontract agreements as they ensure consistency between the owner/contractor and contractor/subcontractor agreements. See, for example, AIA Document A201 – 2017 § 5.3 and ConsensusDocs 200 § 5.2 (2011, Revised 2019). More information on subcontracting is addressed in 8.2 Subcontracting.
Lenders, banks, government agencies, real estate investment trusts, or other special purpose investment vehicles (“lenders”) regularly provide the financing to support construction projects. Owners enter into financing arrangements and contracts with lenders to receive financial support for the major components of construction such as land acquisition, design planning services (architect, engineer) and paying contractors.
A construction financing agreement sets forth the rights and terms between a lender and owner, including the lender’s financing obligations, the terms of the loan, the collateral or guarantee obligations of the owner, schedule requirements and conditions precedent to loan distributions. Although lenders are not involved with day-to-day construction activities, lenders may contract to have certain rights to approve qualified contractors, take over construction activities if the owner defaults, declare owner default, pay contractors and subcontractors, and accept project completion.
Private and Public Contracts
On private contracts, the owner is responsible for determining the scope of the work for the construction contract. Owners typically engage a design professional and possibly other consultants to assist the owner and handle much of the detailed development of the scope of the work and to ensure that the scope of the work is complete and accurate to meet the needs of the project. On public contracts, heavy civil and infrastructure projects, larger government agencies, especially the federal government and state departments of transportation, are more likely to develop the scope of the work in-house. Governments, regardless of size and sophistication, will almost always engage an outside design professional for building construction scopes of work. Smaller government entities are more likely to engage outside resources to develop the scope of the work, regardless of the type of construction.
In building construction, the process will typically start with the development of the owner’s programme of requirements, but ultimately result in detailed plans and specifications, unless design-build is used. For infrastructure projects, the process will typically start with the conceptual design, but also result in detailed plans and specifications, unless design-build is used. Even on design-bid-build projects, contract specifications often include at least some element of performance specifications, which require the contractor to “design-build”. Performance specifications generally provide less specific information but give the desired result of the construction, and require the contractor to design that element of the work, subject to review and approval by the owner through its design professional.
Changes or variations, whether initiated by the owner or the contractor, are typically addressed through the changes clause of a contract. A changes clause typically defines what constitutes a change, which party is entitled to request the change, notice requirements once a change is identified, practical steps involved in requesting and implementing a change, and procedures to determine adjustment of the contract price and performance time. A changes clause is commonly utilised to address issues such as differing site conditions, design conflicts, scope changes and force majeure events.
Industry Standard Construction Contracts
The industry standard construction contracts specifically address how such changes will be managed by the parties during construction, whether requested by the owner or contractor (A201 – 2017, Article 7; ConsensusDocs 200; Article 8 (2011, Revised 2019)). Owners have the right to change the contractor’s work, but the problem often arises when the parties cannot agree on a price for the changed work. If the parties cannot agree on the adjustment of the time or contract sum, the contractor can submit a claim in accordance with the contract; however, the contractor will be required to perform the work to avoid delays (A201 – 2017, Article 7.3; ConsensusDocs 200; Article 8.2 (2011, Revised 2019)).
Federal Government Construction Contracts
On federal government construction projects, the changes clause gives the government the right to make changes to the contract scope of the work, including changes to the specifications, method or manner of performance of the work, and to direct acceleration of the work. Along with that authority, the government also has an obligation to issue an equitable adjustment and modify the contract if the directed changes cause an increase or decrease in the contractor’s costs or the time of performance (FAR Part 52.243-4). Like the industry forms, if the parties cannot agree to any adjustment of the contract cost or time of performance, the contractor is required to submit a claim in accordance with the disputes clause of the contract (FAR Part 52.243-5).
Traditional Delivery Method
The project architect or engineer (design professional) is responsible for the project design under the traditional delivery method where an owner executes separate contracts for design and construction. The contractor is typically not responsible for design services, except for design services specifically delegated by the contract and services within the construction means, methods, techniques, sequences and procedures employed by the contractor and its subcontractors in connection with construction activities (ConsensusDocs 200 § 2.3 (2011, Revised 2019); AIA Document B201-2017).
On design-build projects, the standard form of agreement between the owner and design-builder provides a set of owner’s criteria establishing the owner’s requirements for the project. The design-builder will typically review the owner’s criteria, develop a preliminary design and provide a proposal to the owner. Upon mutual agreement, the parties will execute amendments to the design-build contracts, setting forth the complete design and scope requirements (AIA A141–2014; ConsensusDocs 410 (2017)).
The general contractor is typically responsible for all major construction activities, including planning and scheduling, and providing all the labour, materials, equipment and services necessary to complete the work. Relying upon the project design documents to perform construction, the general contractor is responsible for its own construction means, methods, techniques, sequences and procedures utilised (ConsensusDocs 200 § 3.1.3 (2011, Revised 2019)). Subcontractors are also responsible to the general contractor to perform their respective scope of work in accordance with the subcontract and project requirements.
Design professionals may have certain construction administration tasks requested by the owner in the design professional’s contract with the owner. For example, a design professional may be responsible for reviewing the contractor’s proposals, approving shop drawings, reviewing a contractor’s applications for payment, issuing changes and certifying completion of the project. Unless contractually agreed to, a design professional is not responsible for the contractor’s means and methods of performing its construction work.
Owners may also elect to perform construction activities themselves and to award separate contracts to contractors other than the general contractor. The AIA A201 form expressly reserves this right for the owner (see AIA Document A201 – 2017 § 6.1.1).
Through the parties’ contracts, owners typically assume the risk of the project site and conditions, such as underground obstacles, geotechnical conditions and any archaeological findings. Such issues are not typically governed by mandatory or regulatory law, although the FAR clauses do specifically govern differing site conditions on public projects and provide that the government assumes the risk of differing site conditions (FAR Part 52.236-2).
Typically, a contractor will be required to provide the owner with prompt notice of a concealed or unknown condition when the conditions are encountered. The AIA General Conditions form provides that if the contractor encounters site conditions that differ from those expected, the contractor may be entitled to an equitable adjustment in the Contract Sum or Contract Time, or both (AIA Document A201 – 2017 § 3.7.4). A similar clause and relief are set forth in ConsensusDocs 200 Standard Agreement and General Conditions between Owner and Constructor (ConsensusDocs 200 § 3.16.2 (2011, Revised 2019)).
Different forms of permits may be required to access, construct and operate a building or facility (ie, building, safety and occupancy permits). Typically, owners place the burden on the general contractor or design-build contractor to obtain building and construction permits, and the contractor will be responsible for the fees, licences and inspections by government agencies necessary for proper execution and completion of the work. If the permit relates to land acquisition (easements or surveys) or use modifications (residential, commercial, mixed use), the owner is generally responsible for obtaining the permit and the associated fees (AIA Document A201 – 2017 §§ 2.3.1 and 3.7.1; ConsensusDocs 200 § 4.3 (2011, Revised 2019)).
During construction, the contractor is typically responsible for maintenance of the works. Maintenance can include a broad range of activities such as storage, signage, waste disposal, debris removal, clearing roads and pavements, and providing electricity to the project. Once a project reaches final completion, the owner will typically assume maintenance responsibilities. The division of maintenance responsibilities is addressed in the industry form contracts (ConsensusDocs 200 § 9.6.2 (2011, Revised 2019); AIA Document A201 – 2017 § 9.8.4).
Other functions of the construction process, such as operation, finance and transfer of ownership are generally addressed between the owner and third parties, not the owner and contractor.
The contractor typically assumes responsibility for the costs of tests, inspections and approvals, including co-ordinating with third parties or public authorities (AIA Document A201 – 2017 § 13.4.1; ConsensusDocs 200 § 3.7.1 (2011, Revised 2019)). However, an owner may be responsible for inspections deemed necessary after contract execution, as the contractor was unable to account for such costs in its pre-contract bid (AIA Document A201 – 2017 § 13.4.1; ConsensusDocs 200 § 3.7.2 (2011, Revised 2019)). If procedures for testing, inspection or approval reveal portions of the work that fail to comply with the requirements established by the contract, the contractor will bear responsibility for the costs to meet the standards necessary to pass the tests, inspections or approvals (AIA Document A201 – 2017 § 13.4.3; ConsensusDocs 200 § 3.7.3 (2011, Revised 2019)).
Achieving substantial or final completion, takeover and delivery of the project generally occurs when the work has been performed in accordance with the contract documents such that the owner can occupy or utilise the work for its intended use. After inspections are complete and the work is designated as substantially complete, the design professional will prepare a certificate of substantial completion that will establish the date of substantial completion, at which time the warranties required by the contract documents will commence and the owner will take over the project (AIA Document A201 – 2017 § 9.8).
The owner may occupy or use any completed or partially completed portion of the work at any stage when such portion is designated by separate agreement with the contractor, provided such occupancy or use is consented to by the insurer and public authorities (AIA Document A201 – 2017 § 9.9; ConsensusDocs 200 § 9.6 (2011, Revised 2019)).
In the United States it is standard for the contractor to cure defective work for a period of one year after substantial completion of the work (AIA Document A201 – 2017 § 12.2.2; ConsensusDocs 200 § 3.9 (2011, Revised 2019)). Owners are required to provide the contractor with prompt notice of defective work discovered after substantial completion, otherwise the owner may risk waiving its rights for the contractor to correct the defect (AIA Document A201 – 2017 § 188.8.131.52; ConsensusDocs 200 § 3.9 (2011, Revised 2019)). If after receiving prompt notice the contractor fails to correct the work in a reasonable time period, the owner may correct the work under its contractual right to carry out the work and issue a deductive change order for the cost of correcting the defective work, or recover the costs from the contractor (AIA Document A201 – 2017 § 12.2.4; ConsensusDocs 200 § 3.9.3 (2011, Revised 2019)).
The one-year warranty period will not release the owner’s right to breach of contract claims alleging defects in the work (AIA Document A201 – 2017 § 12.2.5; ConsensusDocs 200 § 3.9.6 (2011, Revised 2019)). The breach of contract claim remains available to the owner for the applicable law and statute of limitations. The time period to assert a claim for a construction defect is set by state statutory law and varies from state to state. A general survey of state statutes of limitation and repose can be found here: www.agc.org/industry-priorities/contracts-law/state-law-matrix.
Like the statutory time periods mentioned above, the remedies for construction defects vary from state to state. Generally though, remedies for construction defects include recovery for diminished value of the project or building, loss of income (ie, loss of rent) and costs of repairs.
In the USA, the owner generally determines the method of establishing the contract price through the owner’s selection of its preferred contract structure and means of procuring price bids or proposals from contractors. In design-bid-build construction, the owner typically solicits lump-sum price bids through a competitive bidding process. The contract price may also be established through competitive negotiations with competing contractors, or by directly selecting the contractor and negotiating the price.
Selecting a Contractor by Competitive Bid
The contract award from a bidding process may be based solely on the lowest price, or on the best value, experience of the contractor, proposed work plan, schedule and other factors. The bidding process and manner of award is determined by the owner and whether the project is funded or owned by public or private entities. Public entities are subject to specific laws that determine the manner in which the procurement is conducted and how the contract is awarded. A private owner can select whatever contractor it prefers and the owner is not required to engage in any competitive process.
Determining the Type of Contract Price Structure
The project delivery structure selected by the owner will affect the contract price structure, the status of the project design when the construction contract price is determined and the various project components that will be included in or excluded from the contract price. The contract price can be structured as a fixed, lump-sum price; unit price; cost reimbursement with a fixed fee or a percentage fee; or a guaranteed maximum price.
In the USA, construction contracts generally provide certain remedies for late payment and non-payment. The construction contract may provide a rate of interest for late payments or provide the contractor with the right to stop work (after providing proper notice concerning the non-payment) without the contractor breaching the contract. Non-payment or late payment can also be a breach of the construction contract that results in the contractor being entitled to damages or, if on a prolonged basis, the right to stop work and/or terminate the contract (AIA Document A201 – 2017 §§ 9.7, 14.1; ConsensusDocs 200 §§ 9.5, 11.5 (2011, Revised 2019)).
In addition to contract remedies, there are specific federal statutes that address prompt payment of subcontractors and suppliers on federal construction projects (31 U.S.C. §§ 3901-3905). Numerous states have also enacted specific statutes similarly addressing prompt payment of contractors and/or subcontractors and suppliers. A survey of such prompt payment statutes can be found here: www.agc.org/prompt-payment-state-state-map.
State mechanic’s and materialmen’s lien laws provide extra-contractual remedies to contractors for non-payment. The lien laws allow an unpaid contractor, including subcontractors and often sub-subcontractors and suppliers, to place a lien on the property improved by the contractor's labour, services, and/or materials. State lien laws also frequently authorise the lien claimant to recover its attorney’s fees in a court foreclosure action.
A lien claimant may bring a lawsuit against the property owner to foreclose the lien and sell the property to pay the amounts owed to the contractor. Lien rights and requirements are a matter of state law. There is no federal or national lien law. The substantive rights and required procedures vary significantly from state to state. A general survey of state lien laws can be found here: www.agc.org/industry-priorities/contracts-law/state-law-matrix.
Federal, state and local public construction projects are generally not subject to liens; payment protection for subcontractors and suppliers, but not contractors, comes through statutorily required payment bonds.
Payment bonds, whether required by state and federal law or at the direction of the owner, provide protection to subcontractors for non-payment. A payment bond is an agreement between a contractor and a surety where the surety guarantees payment for the labour and materials to be employed on a project. Claimants may be subcontractors, suppliers or labourers who perform work for a contractor on the bonded project.
To protect subcontractors and suppliers, the Federal Miller Act requires that federal government construction contractors on projects over USD100,000 provide a payment bond, typically with the required value or “penal sum” equal to the value of the construction contract (40 U.S.C. §§ 3131-3134). The Miller Act also requires the contractor to provide a separate performance bond equal in value to the contract price. The performance bond is generally for the protection of the federal government as project owner.
Many states have enacted laws similar to the Federal Miller Act that require payment and performance bonds from contractors on state and local construction projects. The state statutes are generally referred to as “Little Miller Acts”. A general survey of state laws addressing payment and performance bonds can be found at the state law matrix site listed in 1.1 Governing Law.
Private owners may also require payment bonds from the contractor. Such bonds are not required by statute and are generally governed by traditional state commercial or contract law, or state statutes separate from Little Miller Acts.
A construction contract is typically invoiced:
Monthly payments based on percentage completed against an agreed-upon schedule of values is the most widely used method. Milestone payments are usually restricted to large industrial projects. Advance payments are not typical in construction contracts; however, contractors are generally paid an upfront amount for mobilisation.
As discussed in 4.2 Payment, monthly payments based on percentage completed against an agreed-upon schedule of values is the most widely used method. Most construction contracts and many state and federal laws stipulate the time by which payment must be made after invoices are submitted. This is usually as soon as 15 days after receiving the contractor’s invoice. Otherwise, late payments will incur interest and entitle a late-paid contractor to other remedies (AIA Document A201 – 2017 § 13.5; ConsensusDocs 200 § 9.9 (2011, Revised 2019)).
The project owner generally dictates the planning of projects in the USA. The project delivery method selected by the owner will largely dictate how project planning is organised, especially the choice between design-bid-build, design-build or engineering, procurement and construction (EPC), and construction manager at risk.
The transition from project planning to project execution is generally tied to development of the design. In the USA, the progress of the design is typically measured against the following milestones:
These phases or milestones are tied to the design-bid-build project delivery system. In design-build or EPC contracting, drawing up a contract with the designer-builder or EPC contractor will take place long before final construction documents are completed. In design-build, EPC contracting and construction management at risk, parts of the design can be fast-tracked, meaning that parts of the design are finalised early to release fabrication and installation and construction before the entire design is complete.
Most construction contracts and all standard construction contracts include detailed requirements for the contractor to provide notice, explanation and documentation of delays anticipated or experienced.
Generally, contracts oblige the contractor to provide written notice to the owner in the event of delay. Such initial notice and documentation may be the first step in the contract change order-claim-disputes procedures if the parties disagree over entitlement to relief. See, for example, ConsensusDocs 200 § 6.3.3 (2011, Revised 2019).
Under the FAR, a contractor’s claim for government-caused delay may not be allowed “[u]nless the claim, in an amount stated, is asserted in writing as soon as practicable after the termination of the delay or interruption, but not later than the day of final payment under the contract” (FAR 52.242-17).
In addition to initial notice, the process to determine the cause and responsibility for delay also generally requires the contractor to document the events giving rise to the delay, related communications, the effects of the delay and efforts to mitigate the delay. If the contractor fails to provide timely notice and otherwise fails to comply with contract procedures to seek a time extension, the contractor may lose the right to an otherwise valid request for a time extension.
Owners have several remedies against the contractor for delays that do not merit a time extension (inexcusable delays), including:
Under FAR 52.249-10, for example, the government may “terminate the right to proceed with [a contract] that has been delayed” (FAR 52.242-17).
A contractor may be able to defeat or reduce an owner’s claim for liquidated or actual delay damages if there is a separate, excusable delay that is concurrent with all or part of the contractor’s delay. In the event of concurrent delays, the owner and contractor typically each bear their own costs for the delay and the contractor is entitled to a time extension for the duration of the concurrent delays.
Typically, when requesting a time extension, a contractor must provide formal notice to the contract administrator in the manner and within the timeframes specified in the contract, as well as all documentation supporting the claim. After the request has been sent, the owner’s designated representative will determine if the evidence is sufficient to justify a time extension.
If the owner’s designated representative agrees and grants an extension, a change order is issued to the contractor. If the request is denied, the contractor may escalate or appeal in accordance with the dispute resolution provisions in the contract. These procedures are generally set forth in the standard industry contracts. See, for example, ConsensusDocs 200 §§ 6.4, 8.4 (2011, Revised 2019).
Under US law, “force majeure” commonly refers to natural and unavoidable catastrophes that affect contract performance. Most standard form construction contracts do not specifically use the term “force majeure”. Instead, relief for force majeure events is addressed in delay and time-extension remedial clauses. See, for example, AIA Document A201 – 2017 § 184.108.40.206.
For public projects, the relevant FAR provision (Excusable Delays) includes examples of force majeure events, such as, “(1) acts of God or of the public enemy, (2) acts of the Government in either its sovereign or contractual capacity, (3) fires, (4) floods, (5) epidemics, (6) quarantine restrictions, (7) strikes, (8) freight embargoes, and (9) unusually severe weather” (FAR 52.249-14 May 2007).
It is also possible to contractually limit or exclude certain circumstances from being qualified as force majeure or what the AIA describes as “unavoidable casualties” and “other cause beyond the Contractor’s control” (AIA Document A201 – 2017 § 14.1.1). One way to do so is for the contract to contain a very specific list of qualifying events (eg, epidemic, earthquake, or hurricane) or other certain terms. In that case, the precise language of a force majeure clause may be interpreted to exclude events that are not specifically identified.
Standard form construction contracts, such as AIA and ConsensusDocs, do not have specific clauses to address “unforeseen circumstances”. These contracts do, however, contain excusable delay clauses that may cover unforeseen circumstances. The relief offered in these contracts could be a time extension, and for either party, the opportunity to terminate the contract.
Even if a contract does not contain an express clause addressing “unforeseen circumstances”, “force majeure” events, or other similar language addressing “acts of God” or unanticipated delays beyond the contractor’s control, a contractor may still have a legal right to relief against the owner under the common law doctrines of frustration of purpose or impracticability.
Contract clauses that limit or relieve parties from liability are generally referred to as “exculpatory clauses”. In the USA, exculpatory clauses are not favoured and will generally be narrowly construed. At a minimum, for exculpatory clauses limiting liability to be enforceable, they must be clear, unambiguous, unmistakable and conspicuous. Even when these criteria are met, state law, whether by statute or court precedent, may prohibit or limit certain exculpatory clauses as against public policy. Examples of impermissible exclusions of liability include indemnity of a party against a claim caused by the sole negligence, gross negligence or intentional misconduct of the party claiming the indemnity. Many states have enacted specific statutes that limit such indemnities in construction contracts. A general survey of state anti-indemnity clauses can be found here: www.agc.org/industry-priorities/contracts-law/state-law-matrix.
The concepts of “wilful misconduct” and “gross negligence” exist under US law. The definitions of gross negligence and wilful misconduct also vary from state to state and the conduct that the courts consider as falling under those definitions depends on the facts of each case. Typically, states prohibit limiting liability in construction cases if the conduct giving rise to the claim constitutes wilful misconduct or gross negligence. A general survey of state laws prohibiting limiting liability if the conduct involves wilful misconduct or gross negligence can be found here: www.agc.org/industry-priorities/contracts-law/state-law-matrix.
Limitations of liability are considered exculpatory clauses that are disfavoured and narrowly construed under US law. Nonetheless, limitations of liability are enforceable if they are clear and unambiguous and do not violate an applicable law or public policy.
Construction contracts in the USA limit liability by waiving liability consequential damages. By establishing a ceiling for damages for delay, liquidated damages provisions can also serve as limitations of liability. Other limitations often found in construction contracts include limiting liquidated damages to a specific cap and limiting all damages to another specific cap, whether expressed as a specific dollar value or percentage of the contract price. If clear and unambiguous, such limitations of liability in construction contracts are regularly enforced.
Many states have anti-indemnity statutes, which limit and make void certain liability-shifting agreements as being against public policy, to the extent that the provision requires an indemnitor to indemnify a party against a claim caused by negligence or intentional misconduct, a violation of statute, or breach of the contract by the indemnitee.
Indemnity clauses – sometimes referred to as “hold harmless” clauses – are key components of a construction contract to help manage and mitigate liability and risks. Indemnity clauses can address a broad range of risks on a construction project including but not limited to breach of contract, negligence, personal injury, property damage, third-party claims and loss of profits. A general survey of state anti-indemnity clauses can be found here: www.agc.org/industry-priorities/contracts-law/state-law-matrix.
Parties on a construction project are sometimes required to obtain guarantees of performance from other parties that may take the form of a personal guarantee by a corporate shareholder or a guarantee by a parent of a subsidiary company. However, on US construction projects, surety bonds are the most common form of guarantees used to limit risk for parties.
A surety bond, which is not insurance, is a guarantee in which a third party – often an insurance company – agrees to assume a defaulting contractor's performance or financial obligations under the construction contract. The key difference between sureties and insurance is that sureties can seek reimbursement from the defaulting contractor if the surety is forced to take over and fulfil the defaulting contractor’s obligations under the contract.
An owner can require the contractor to guarantee its bid commitments, payments to subcontractors, and performance of the work by requiring the contractor to obtain a (i) bid bond, (ii) payment bond, and (iii) performance bond, respectively, from a licensed and financially responsible surety experienced in the needs of the construction business. Whether a public or private project, these three bonds generally protect the owner against the following risks.
Contractors may also require subcontractor payment and performance bonds to obtain the security of the same type of financial guarantees.
Lastly, letters of credit may also be used as financial guarantees on construction projects in the USA; however, their use tends to be fairly rare as compared to surety bonds. In fact, most statutes requiring payment and performance bonds on public construction contracts require surety bonds rather than letters of credit.
There are many different types of insurance tailored to protect owners, contractors and other project participants through all phases of a construction project. The insurance coverage typically required under US construction contracts is reflected in standard contracts (eg, Section 10.2 of ConsensusDocs) and includes:
Insolvency of any important player on a construction project can have significant consequences for the project and all the participants.
Standard industry contracts such as the AIA and ConsensusDocs do not provide generally for any consequences if a party ceases to pay its debts in the ordinary course of business, cannot pay its debts as they become due, or seeks bankruptcy protection under federal bankruptcy laws.
Furthermore, US bankruptcy law restricts enforceability of “termination-on-bankruptcy” provisions if conditioned on the insolvency of the debtor or its financial condition, or the commencement of a bankruptcy case. Importantly, when an owner, contractor or other project participant in the USA seeks bankruptcy protection, federal law and other applicable laws will affect, and in many cases dictate, the parties’ remaining obligations under the construction contracts at issue, including obligations related to surety bonds.
Reasonable and equitable risk-sharing is common practice and a core principle for modern-day construction projects in the USA.
Standard form contracts such as those offered by ConsensusDocs and the AIA, as well as government contracts, seek to equitably allocate project risks to the party in the best position to control the risk and also to permit the parties to concentrate on key variables when negotiating the construction contract.
Provisions of critical importance to risk-sharing include: time extensions and time for completion, differing site conditions, damages for delay, change orders, excusable delays, defects in design, notice requirements, dispute resolution procedures and terms of payments.
Construction contracts in the USA typically include contractual provisions regarding the contractor’s personnel. These provisions typically address project oversight and supervision, safety, quality control, removal of personnel and the supply of adequate labour forces. Much less frequently, construction contracts may also limit the contractor’s ability to remove or replace the contractor’s own key personnel.
Project Oversight and Supervision
Parties will typically be required to designate a single project supervisor, such as a project manager or superintendent, who is regularly present at the project work site with full responsibility for the oversight, supervision and management of the contractor’s workforce. This designated supervisor will often have authority to make decisions for the contractor and bind the company to change orders and other contractual matters (AIA Document A201 – 2017 §§ 3.1, 3.9). Other key personnel are safety and quality control managers, who can be required under the contract.
Contractors and subcontractors are generally required to provide adequate labour forces to carry out their work as necessary to achieve substantial completion within the time allowed by the contract (AIA Document A201 – 2017 § 8.2.3). Schedules incorporated into construction contracts typically do not establish a specific head count for the contractor’s labour force, unless the schedule is resource-loaded.
Right to Require Removal of Personnel from the Project
The employer/owner regularly retains the right to require removal from the project of any employee of the contractor or subcontractors who does not follow safety procedures, or is unfit or unskilled for the assigned work (ConsensusDocs 200 § 3.4.3 (2011, Revised 2019)). Contractors typically maintain in their subcontracts the same right to remove subcontractor personnel.
Contractors in the USA are generally free to employ subcontractors to execute the work, provided the subcontractor has a licence to perform its scope of work and is authorised to do business in the location of the project. Employers/owners are generally given the right to reasonably and timely object to selected subcontractors (AIA Document A401 – 2017 § 5.2.3; ConsensusDocs 200 § 5.1 (2011, Revised 2019)).
Some limitations on the contractor’s ability to subcontract may come in the form of the requirement that all subcontractors be pre-approved by the owner or that the contractor utilises subcontractors from an owner pre-approved list or uses a subcontractor or supplier specifically designated by the owner. In state and local public contracting, the contractor may be required to list their subcontractors in their bid proposal.
In the USA, intellectual property that may be at issue in a construction contract includes patents, copyrights, trade marks and trade secrets. Federal law alone governs patents and copyrights. What constitutes trade secrets or proprietary information is generally a matter of contract or state law. Construction contracts typically address intellectual property issues on two fronts:
Federal copyright law typically governs ownership of intellectual property in design documents. Copyright in a work vests initially in the author or authors of the work. Authored works include the engineering and architectural drawings and specifications that are typically the basis of all construction contracts. Federal law provides the owner of a copyrighted work the exclusive right to reproduce, adapt, publish, use or display the copyrighted work (17 U.S.C.S. § 106).
Ownership of intellectual property can be modified by contract. As a result, a designer can grant the owner a perpetual licence to use the design for the intended project while simultaneously retaining the copyright or the rights to any patents or trade secrets developed during the project.
Ownership of the Design on Design–Bid–Build Projects
On design-bid-build projects in which the owner provides a complete design for the contractor to construct, the contractor is typically authorised to use and reproduce the drawings and specifications for the execution of the construction (AIA Document A201 – 2017 § 1.5.2). The rights to the ownership of the design are determined by the contract between the owner and the designer.
On design-build projects, the design–build contract typically addresses the disposition of intellectual property rights over the design. For example, the design-build contract will outline the ownership of the electronic design documents (ie, the drawings and specifications); the copyright over the designs; and whether the parties can reuse the designs for other projects (ConsensusDocs 400 §§ 3.1-3.4 (2007, Revised 2011)).
Breach of contract is a cause of action available to two contracting parties in direct privity with one another. Contract damages available to parties for breach of contract include direct, indirect and consequential damages. The aggrieved party has an obligation to mitigate damages and typically cannot recover damages that could have been avoided through reasonable diligence and ordinary care.
Owner’s Remedies Against the Contractor or Design Professional
In the event of a contractor’s breach, an owner typically has the right to carry out the work, terminate for cause, the right to withhold payment (set-off), and the right to recover direct, indirect, and/or consequential damages, subject to any remedy waiver or limitation of liability language expressly agreed to in the contract. See, for example, ConsensusDocs 200 § 11 8 (2011, Revised 2019); AIA Document A201 – 2017 § 14.
Design professional's breach
If the design professional is in breach, the owner may seek similar remedies as against the contractor, as well as seek economic loss if the construction is unusable or defective. The design professional owes a duty of care generally defined as the professional skill and care that other professionals in the profession would use under similar circumstances in that area or jurisdiction. The design professional can be held liable to the owner if the design professional fails to meet the requisite standard of care.
Contractor’s remedies against the owner
A contractor’s breach of contract claims against the owner are typically based on contract changes from changed conditions or additional work, as well as requests for extensions of time for issues such as owner delays, change orders, design errors, or delays outside the contractor’s control (eg, weather and force majeure). If an owner refuses to acknowledge impacts to the contractor’s work caused by the owner or an owner’s representative, or the parties cannot agree on a price, the contractor may assert a breach of contract claim in accordance with the dispute resolution provisions of the contract. Common contractor claims for breach of contract against the owner include wrongful termination, delay and disruption, defective drawings, and loss of productivity. Subcontractors have similar breach of contract remedies against the general contractor that the general contractor has against the owner as part of the flow-down rights and obligations in the subcontract.
Remedies may be limited by contract or statutory law. For example, both the AIA A201 – 2017 and the ConsensusDocs 200 form agreements mutually waive consequential damages against the other party (AIA Document A201 – 2017 § 15.1.7; ConsensusDocs 200 § 6.6 (2011, Revised 2019)). Consequential damages do not flow directly from a breach of contract, but may indirectly relate to the breach, eg, loss of profits and loss of bonding capacity. It is inherently difficult to prove consequential damages, which is why it is common for the parties to agree to a mutual waiver.
Liquidated damages clauses are an example of sole remedy clauses common in construction contracts that define the owner or contractor’s damages if a project is delayed. Liquidated damages clauses provide for the recovery of a fixed sum specified by the contract (typically a certain sum applied on a daily basis) for the party injured by a delayed project. Liquidated damages clauses are generally enforceable but cannot be a penalty, and must be based on a reasonable estimate of a party’s anticipated damages at the time of contract execution if a project is delayed.
No damages for delay clauses are another example of sole remedy clauses. No damages for delay clauses provide that a contractor’s sole remedy in the event of owner-caused delay is an extension of time to complete the work. These clauses are upheld to varying degrees depending on the state. Some states limit the enforceability of no damages for delay clauses for public contracts or based on concepts of culpability (eg, bad faith or intentional delay by the owner). Even though the FAR, AIA, and ConsensusDocs do not include no damages for delay clauses, no damages for delay are sole remedy provisions that are used in the construction industry.
With some exceptions, punitive damages are typically excluded from liability in construction contracts. Punitive damages are not compensatory, but are rather intended to punish the wrongful actor. Punitive damages can be awarded in the context of intentional acts of fraud, malice, or wanton and wilful conduct. Punitive damages are rarely awarded in the construction industry and are typically specifically excluded from construction contracts.
Suspension rights are generally available in construction contracts. For example, an owner will generally have the right to suspend a project for convenience or for any reason the owner finds necessary (AIA Document A201 – 2017 § 14.3; ConsensusDocs 200 § 11.1 (2011, Revised 2019)).
Retention is typically withheld at a rate of 5% or 10% of monthly invoices or progress payments. Upon achievement of substantial completion or final completion, the owner is typically required to pay the withheld retention to the contractor; however, the owner will generally have the right to withhold retainage if the contractor is in breach of the agreement and the owner’s claim exceeds the value of retainage (AIA Document A201 – 2017 § 9.8.5; ConsensusDocs 200 § 9.2.4 (2011, Revised 2019)).
In the USA, disputes concerning construction contracts may be adjudicated before federal courts or state courts. Parties also frequently agree to arbitration in lieu of courts. Disputes on construction contracts with the federal government and with some state and local governments must be adjudicated before specialised administrative boards.
Jurisdiction and Venue
Personal jurisdiction and subject matter jurisdiction are necessary predicates for determining which court, whether federal, state, or either, is proper. Personal jurisdiction requires that the parties have certain geographic or transactional minimum contact with a court’s geographic boundaries for the court to exercise jurisdiction over the parties.
Subject matter jurisdiction requires a court to have the legal authority to hear the claim brought before it. To be in federal court, the dispute must arise under federal law, or there must be diversity of citizenship jurisdiction, in that the parties are from different states. Diversity is usually the basis of construction disputes in federal courts with two major exceptions:
Unlike federal courts, state courts are courts of general jurisdiction, meaning there are no requirements for special statutory or citizenship bases for subject matter jurisdiction.
Another issue that determines the appropriate court for a dispute is proper venue – whether the court is the proper court based on its physical location. In order to avoid venue issues, construction contracts frequently stipulate the venue and such stipulations are generally enforceable.
The procedural rules of the court hearing a construction dispute generally control the litigation proceedings. The question of which state’s substantive law controls a dispute can be and is often stipulated in construction contracts. Many standard form contracts refer to the law of the state where the project is located as being the controlling law. Parties also frequently stipulate by name the laws of a particular state that may or may not also be the location of the project.
Right to a Trial by Jury and Waiver of That Right
Parties to construction disputes generally have a near absolute right to have their dispute heard by a jury, whether in federal or state court. The major exceptions to the right to a jury trial are an arbitration agreement and federal, state and local government construction disputes that must be heard by special courts that decide cases without juries or before specialised administrative boards.
Based on the concerns about a jury of lay people deciding large and complex construction disputes, parties often stipulate in construction contracts to the waiver of the right to jury trial.
Federal Boards of Contract Appeals
Construction disputes with the US federal government must be brought in one of two specialised forums: the United States Court of Federal Claims or in the corresponding administrative board. The two boards that handle the vast majority of construction disputes are the Civilian Board of Contract Appeals and the Armed Services Board of Contract Appeals.
Arbitration and mediation are regularly used for construction disputes in the USA, as alternative means of dispute resolution. Arbitration is a matter of contract and requires the agreement of all parties to the dispute. Construction contracts frequently establish an agreement to arbitrate, but the parties can agree to arbitrate at any time. Mediation is also generally required by agreement of the parties, but some court rules and state statutes may mandate mediation at some point in the proceeding.
United States Law Favours Arbitration
United States law enforces arbitration agreements under the Federal Arbitration Act (FAA). For the FAA to apply, the relevant contract must evidence a transaction of interstate commerce – meaning transactions across two or more states. Because of the extensive movement of construction services, and especially materials, across state lines, this is typically an easy hurdle to overcome on almost any construction contract.
In addition to the FAA, each state maintains a separate set of laws regarding arbitration. The majority of states have adopted either the Uniform Arbitration Act or the later Revised Uniform Arbitration Act. The FAA and state law generally align. When in conflict, however, the FAA supersedes state law in both federal and state court. The standard form contracts most widely used in the construction industry routinely include arbitration clauses enforceable under these laws (AIA Document A201 – 2017 § 15.4.1; EJCDC C-700 ¶ 17.01B (2018 ed.); ConsensusDocs 200 § 12.5 (2011, Revised 2019)).
Dispute Review Boards
Dispute review boards or DRBs are sometimes used on major construction projects in the USA to offer non-binding assistance and “recommendations” for resolving disputes during the course of construction. Although the use of DRBs is growing, their use is still relatively limited, even on major projects. Large public infrastructure projects utilise DRBs more frequently, especially transportation projects. Use of DRBs is a matter of contract and is not required by statute or regulation, even on public construction projects. The AIA standard form construction contract incorporates procedures for the use of an “Initial Decision Maker”, who serves a similar function to a DRB (AIA Document A101 – 2017 § 6.1, AIA Document A201 – 2017 §§ 1.1.8, 15.2).
Broad Price Spikes in Construction Materials Reinvigorate Focus on Escalation Clauses
The risks associated with material price fluctuations are not new to the construction industry. Contractors typically take on the risk of foreseeable price increases in agreeing to fixed-price or lump-sum contracts. When markets are predictable, price increases are predictable and contractors can manage price risk because they can reasonably predict within an acceptable range what prices will be during the execution of the project. But, when unexpected world events take hold, markets become unstable and may lead to dramatic spikes in prices.
As we enter 2022, we are seeing those dramatic price increases across raw materials, energy and currency markets. The construction industry faces an almost unprecedented wave of material price hikes across nearly every sector of the global supply chain. Pandemics, military wars, trade wars, blocked canals, clogged maritime ports, labour shortages and a whole host of other issues have all conspired to drive up costs at an astounding rate over the past two years. For example, the price of lumber increased almost 400% from March 2020 to April 2021. The price of steel increased over 275% from March 2020 to March 2022, while the price of diesel fuel has increased over 100% since 2020.
Dealing with this broadside of material price escalation is a key trend in the construction industry today. This article discusses clauses found in industry standard contracts issued by the American Institute of Architects (AIA) and ConsensusDocs and guidance from federal procurement law (primarily the Federal Acquisition Regulations (FAR)) as well as practical concerns in selecting standard indexes to govern material escalation clause benchmarks.
Ultimately, drafting and negotiating an effective material price escalation clause is an important step to protecting against the price fluctuations prevalent throughout the global economy. Industry standard clauses are a good place to start, but there is no single perfect clause. Because this is not a one-size-fits-all issue, to the extent possible, clauses should be tailored on a contract-by-contract basis to address potential material escalation impacts on the specific scope of work involved, as well as the overall project itself.
Standard Contract Clauses Addressing Material Price Escalation
Standard contract clauses addressing material price escalation exist across multiple platforms, including AIA, ConsensusDocs and FAR. AIA and ConsensusDocs are both construction industry-specific organisations that have prepared various standard forms contacts, which are used widely throughout the industry. The FAR provisions are specific to US federal government procurement, but federal procurement law related to construction contracts is often looked to as instructive, if not authoritative, by state courts and alternative dispute resolution bodies.
Although these standard provisions are not new, they are nonetheless being tested in new and extreme ways under the current strains facing the global economy. These provisions certainly represent a good starting point to address material price escalation issues. But they are not without their own flaws and inherent risks. So it remains incumbent upon practitioners, when possible, to approach these standard clauses with a diligent eye to revising them as needed to suit the specific needs of each contract and each project. Indeed, one size does not fit all.
The AIA standard contract documents do not contain a specific material price escalation clause. AIA-issued guidance on the matter specifically states that owners and contractors should endeavour to address unanticipated price escalations through allowances: "Unanticipated price escalations in construction materials after the contract is executed have caused concern to owners and contractors. If the owner and architect are concerned about facing such price escalations in certain materials, they should identify those materials prior to the bid and provide for them in the bidding requirements as allowances."
See AIA Guide for Supplementary Conditions, including Amendments to AIA Documents A201 and the Owner-Contractor Agreements.
For example, AIA A201-2017 § 3.8 requires the contractor to include in the contract sum “all allowances stated in the contract documents” for materials and equipment to be delivered to the site. If the cost of those materials moves above or below the identified allowance, the contract sum “shall be adjusted accordingly”. AIA A201-2017 § 220.127.116.11. This structure provides a vehicle to account for material price escalations (or de-escalations).
But this approach is not without limitations. For example, this setup requires the parties to proactively identify upfront all materials and allowances required for the work. This may be difficult on complex or prolonged projects. This setup also fails to provide any measure to objectively determine when “the costs are more or less than the allowances”. AIA A201-2017 § 18.104.22.168.
ConsensusDocs issued a specific Amendment – titled ConsensusDocs 200.1 Amendment No 1 Potentially Time and Price-Impacted Materials – that can be added to the ConsensusDocs 200 Standard Agreement and General Conditions Between Owner and Constructor (Lump Sum Price) to specifically address material price escalation. The 200.1 Amendment requires the owner and contractor to “agree upon a method for establishing the market price” (ie, a baseline price) for specifically identified commodities and to further agree upon a “method for calculating an adjustment in the pricing” for these commodities if there is “an increase or decrease” in the baseline price. ConsensusDocs 200.1 Amendment No. 1 §§ 2 and 3. Section 3 then requires either party to provide notice within 30 days of the pricing change that contains “the basis for an equitable adjustment” and “appropriate documentation substantiating such adjustment”. ConsensusDocs 200.1 Amendment No 1 §3. Importantly, this approach allows the owner to enjoy the financial benefits if there is a decrease, and the contractor’s risk is hedged if there are material price increases.
The 200.1 Amendment also allows the parties to place caps on total increases and decreases in the contract price. ConsensusDocs 200.1 Amendment No. 1§ 3.3. Finally, the amendment outlines a procedure to address contractor delays caused by material unavailability, which is also a key area of risk under the world’s currently strained supply chain.
But as with the AIA standard contracts, the ConsensusDocs approach is not without limitations. For example, while the flexibility given to the parties to select mutually agreeable methods for establishing a baseline commodities price and calculating any increase is nice, the parties must still pay diligent attention to the details when establishing these methods. For example, what constitutes “appropriate documentation substantiating an adjustment”? Failure to outline this could certainly lead to back-and-forth disputes. And what happens if prices for materials constantly fluctuate up and down, as has happened recently in the world? The parties could easily find themselves in a never-ending cycle of contract administration merely to address prices changes, much less all of the other endless contract administration tasks that often accompany large projects.
FAR 16.203; 52.216
Federal procurement in the USA is primarily governed by the FAR, other administrative regulations, and applicable case law developed by courts and federal boards of contract appeal. This body of law, and specifically the FAR, allows for material escalation clauses (“economic price adjustment”) when market volatility is afoot. And although federal procurement law, including primarily the FAR, is not controlling outside of federal contracts, it is nonetheless often considered informative and persuasive within the state, local and private context.
Pursuant to the FAR, material escalation is permitted when there is serious doubt concerning the stability of the market, the contingencies can be identified in the contract, and there is a determination that the adjustment clause is necessary to protect the contractor and the government against significant fluctuations: “A fixed-price contract with economic price adjustment may be used when (i) there is serious doubt concerning the stability of market or labour conditions that will exist during an extended period of contract performance, and (ii) contingencies that would otherwise be included in the contract price can be identified and covered separately in the contract.” 48 C.F.R. 16.203-2 (2022).
“A fixed-price contract with economic price adjustment shall not be used unless the contracting officer determines that it is necessary either to protect the contractor and the government against significant fluctuations in labour or material costs or to provide for contract price adjustment in the event of changes in the contractor’s established prices.” 48 C.F.R. 16.203-3 (2022).
The FAR addresses four different contracts situations – contracts for standard supplies, semi-standard supplies, identifiable labour or material, or extended performance with significant costs beyond one year – and provides different contract clauses respectively. For the contract situation involving “identifiable labour or material cost factors [that] are subject to change,” the contract also must not include any major element of design engineering or development. 48 C.F.R. 16.203-4(c). This subsection 4(c) – which is based on changes to the contractor’s actual costs – is differentiated from subsection 4(d), which is based on changes in cost indexes of labour or material and requires a determination that the economic variables are too unstable to permit a reasonable division of risk between the government and the contractor at the time of contracting. Compare 48 C.F.R. 16.203-4(c) with -4(d).
The respective contract clause to address changes to the contractor’s actual costs related to “identifiable labour or material cost factors” is found at 48 C.F.R. 52.216-4 “Economic Price Adjustment – Labour and Materials”. This FAR labour and materials escalation clause provides for both increase and decrease of the contract unit price attributable to changes in the contractor’s actual unit costs (assuming no fault on the part of the contractor). The market price change, however, must be significant enough to warrant adjustment, “at least 3% of the then-current total contract price.” 48 C.F.R. 52.216-4(c)(3). While the government is entitled to an unlimited decrease in the contract price, the contractor is capped at a maximum 10% increase to the original unit price. Id. at 52.216-4(c)(4).
Indexes: Identifying the Proper Measuring Stick
How does a party select the “method” to properly identify a baseline price for materials and a subsequent method to address prices increases? A reputable, industry-standard index seems like a logical starting place. Indexes such as the Bureau of Labor Statistics Producer Price Index (PPI), the Engineering News-Record (ENR) Construction Cost Index and Building Cost Index or, in some cases, commodity-specific indexes, are often relied on by parties in construction contracts. Identifying and understanding the index used is important. Indexes like the PPI, for example, track price increases up to the point of sale and do not consider freight, storage or installation costs. On the other hand, the ENR indexes are specific to designated cities in the USA and Canada.
Occasionally, the parties select indexes at the time of contracting that no longer exist years down the road when disputes arise. In Southern Coal Corp. v Drummond Coal Sales, Inc., 2022 U.S. App. LEXIS 8010 (11th Cir. 2022), for example, the United States Court of Appeals for the Eleventh Circuit determined that a contractual material price escalation clause was unenforceable because the commodity index upon which it relied no longer existed and the parties failed to identify pricing method. Specifically, Southern Coal entered into a four-year agreement with Drummond under which Drummond would sublease port capacity located in Newport News, Virginia to Southern Coal. In exchange for Drummond's services under the agreement, Southern Coal agreed to transfer a minimum of 2 million metric tonnes of coal per year through Drummond’s port and pay to Drummond a “minimum monthly throughput fee of USD1,000,000”.
Importantly, the agreement provided that the base amount for the throughput fee would be adjusted upward based on increases in the “Peak Downs metallurgical benchmark price”. “Peak Downs” referred to a mine in Australia owned by Australian mining company BHP Billiton (BHP) and “benchmark” referred to a yearly (and later quarterly) benchmark price that BHP negotiated with Japanese Steel Makers for its high-quality metallurgical coal. This benchmark was published in industry newsletters. In short, the Peak Downs benchmark was a well-known and respected index within the coal industry at the time of contract, so it made sense for the parties to rely upon this benchmark in their agreement.
But after the subject agreement was executed, BHP moved away entirely from providing the “Peak Downs” index, which resulted in published quarterly benchmark prices being set by other Australian coal producers. Almost inevitably, halfway into the four-year term of the agreement, the benchmark price of coal, set by a company other than BHP, rose significantly. It continued to rise significantly thereafter. As a result, Drummond asserted that these price increases triggered the material escalation clause and it invoiced Southern Coal for the increased amounts (over USD1 million in total increases) accordingly.
After a trial, the Georgia-based federal district court found the clause unenforceable because the Peak Downs benchmark no longer existed. The Eleventh Circuit upheld the district court’s ruling that the clause was unenforceable, primarily because the BHP index no longer existed and the escalation clause was tied directly, solely and exclusively to this index – if there is no more index, then there is no way to enforce a contract clause that relies solely on this index. The court also noted that if the parties had so desired, they could have added a clause stating that if the BHP index ceased to exist, then the parties could agree on a different index. But the parties – which the court notes were both sophisticated and well-versed in industry standards – elected not to add such a clause.
Conclusion: Material Escalation Clauses Are Trending
With the rising tide of rising prices comes a renewed interest in the construction industry for finding ways to manage the risk of unpredictable prices. One way for contractors to manage this risk is through the use of well-drafted material escalation clauses, a contracting trend that has re-emerged in the past two years as a critical negotiation point between owners and contractors.
Industry standard clauses are a good place to start. But there is no single perfect clause and this is not a one-size-fits-all issue. As a result, clauses should be tailored to address material escalation impacts on the specific scope of work, as well as the overall project itself.