Roofing contractors have faced challenges recently because of volatile pricing and some material shortages. Although the problem became more acute for roofing contractors midway through 2004, other construction industry trades have been facing the problem for more than a year.
Rising material prices now are a part of doing business and may remain so for the foreseeable future given China's voracious appetite for steel and other construction materials, production shortages and rising transportation costs. Steel prices have been particularly volatile. Prices for copper, aluminum, cement, petroleum, natural gas, wood products and gypsum also have increased dramatically, and spot shortages have been reported.
Although the problem may seem unprecedented to roofing professionals, it is not new. Following the 1973 Organization of Petroleum Exporting Countries (OPEC) oil embargo and political instability in the Middle East during the 1970s and 1980s, gas and oil prices dramatically increased. Unexpected material price increases caused by diverse factors threatened numerous industries. In response to these circumstances, companies that were bound to fixed-price contracts when confronted by steep, unexpected production costs sought legal relief by asking courts to relieve them of their contractual obligations. Various legal theories have been attempted. None have been particularly successful.
The general rule of law is the risk of material price increases in fixed-price construction contracts are borne by the contractor. The fact that performance has become economically burdensome or unattractive is not sufficient legal grounds for performance to be excused. In the absence of a specific contract provision, courts rarely will rule a party is excused or entitled to a price increase because of unexpected, substantial price increases with regard to obtaining materials. If a material is unavailable, courts will be more receptive to reforming a contract compared with when a material can be obtained at a higher price than expected.
Parties seeking relief from dramatic, unexpected price increases have asserted various legal theories. With limited success, the legal doctrines of "impossibility," "commercial impracticability," "frustration of purpose" and "force majeure" have been used by parties seeking to be excused from fixed-price contracts when faced with price increases that made contract compliance economically disastrous. These doctrines have much in common; each requires a showing of certain facts to satisfy legal criteria established in statutes or previous court decisions.
The doctrines
A party may be excused from a contract obligation if performance has become objectively impossible as a result of an unexpected event. Numerous cases have stated the impossibility doctrine will not apply if performance will be excessively expensive. For example, if a contract calls for a specific entertainer to perform a concert and the entertainer dies between when the contract was made and concert was scheduled, the impossibility doctrine could be applied.
The theory of "commercial impracticability" applies to a situation when there has been an unexpected change in circumstances that makes contract performance infeasible. The requirements to establish commercial impracticability are less demanding than impossibility but still are difficult to establish. Unforeseeability is an important factor. Courts have ruled the doctrine of commercial impracticability cannot be invoked merely because performance has become more expensive.
The commercial impracticability doctrine has been adopted by statute in Section 2-615 of the Uniform Commercial Code (UCC), which applies to the sale of goods. If performance has been made impractical because of a contingency, the nonoccurrence of which was a basic assumption of the contract, the doctrine may apply. The Official Comment to UCC Section 2-615 states increased cost alone does not excuse performance unless the rise in cost is a result of some unforeseen contingency that alters the essential nature of the performance. According to UCC, a rise or collapse in the market is not a justification because that is exactly the type of business risk fixed-price contracts are intended to cover. But a severe shortage of raw materials or supplies caused by war, embargo, local crop failure, unforeseen shutdown of major sources of supply or the like that causes a marked increase in cost or prevents a seller from securing supplies necessary to his performance is within UCC's realm.
UCC applies to contracts for the sale of materials from a seller to a buyer, such as a manufacturer's or distributor's sale of roofing materials to a roofing contractor. UCC typically does not apply to construction contracts, which generally are classified as service contracts, unless the sale of the goods is the predominant aspect of the transaction. Nevertheless, a court could follow UCC's approach and refer to cases decided under UCC if a construction contractor sought to be excused from a fixed-price construction contract because of an unforeseen event (such as a fire at the plant producing a specified material) that constituted commercial impracticability.
A supplier who cannot meet all obligations to furnish materials and satisfies legal criteria to be excused from performance on the grounds of commercial impracticability must allocate production and deliveries among customers. A supplier is required to allocate deliveries in a fair manner and may include shipments to regular customers not currently under contract.
Another legal theory that sometimes has been used when performance has become prohibitively expensive is "frustration of purpose." This doctrine applies to a situation when one party's purpose in entering the contract has been completely or almost completely frustrated by a supervening event. The change in circumstances makes one party's contract performance virtually worthless to the other.
Impossibility, impracticability and frustration of purpose generally require the party seeking relief to prove an unforeseen event; no allocation of risk of the unexpected occurrence in the contract; and the unexpected event renders performance commercially impracticable. Proving each of these elements can be problematic.
For example, higher prices are neither an event nor likely to be found to be unexpected. If a contractor was scheduled to obtain material from a particular plant where an explosion or fire occurred, the ensuing shutdown of that plant might satisfy the first criterion, but higher prices resulting from a confluence of market forces is not considered an unforeseen event. Indeed, in the current marketplace, contractors would be hard-pressed to argue future material price increases were unexpected.
Some roofing contractors have questioned whether a force majeure clause would excuse them from fixed-price construction contracts when material availability and substantially higher prices become major problems.
A force majeure clause is inserted into a contract to protect the parties in the event that part of the contract cannot be performed as a result of events that are outside the control of the parties and could not be avoided by exercising reasonable care. The purpose of a force majeure clause is to excuse parties from exceptional events that are beyond the control of either party.
To determine the applicability of a force majeure clause, the clause will need to be examined. Construction contracts often include force majeure clauses, but generally, such clauses are included in the context of allowing a contractor additional time to perform because of circumstances beyond the contractor's control. Floods, earthquakes, fires, explosions, hurricanes, strikes and lockouts are common excusable grounds to extend time for performance.
The widely used The American Institute of Architects' General Conditions AIA Document A201-1997, for example, includes a provision (Article 8.3.1) stating that if a contractor is delayed by labor disputes, fire, unusual delay in deliveries, unavoidable casualties or other causes beyond his control, the contract time shall be extended.
Although a force majeure clause may provide a contractor with additional time to obtain materials because of shortages, a force majeure clause generally will not be effective to excuse the contractor who is forced to pay much higher prices for materials than estimated. However, if a specified material is not available at any price because of an unforeseen contingency (such as a fire at the sole plant that produced the material), a force majeure clause might well be effective. The applicability of a force majeure clause will depend on the specific text of the clause and circumstances of the case, but economic hardship does not qualify as force majeure.
Courts' views
Courts generally do not view price increases, even when dramatic, to be unforeseen. A case often cited to support this is the 1975 case Eastern Airlines Inc. v. Gulf Oil Corp. In this case, Gulf Oil sought to be excused from supplying jet fuel to Eastern Airlines at the negotiated contract price because of dramatic increases in fuel costs caused by the OPEC oil embargo and events in the Middle East. The Florida U.S. District Court hearing the case declined to relieve Gulf Oil from its contract, finding the instability in the Middle East and price volatility were not unforeseen.
The second criterion also is difficult to establish. By their nature, fixed-price construction contracts allocate risk. A contractor is required to perform the contracted work at an agreed-upon price. Absent an explicit contract provision or a cost-plus contract, a contractor is not entitled to change the price for the same work just because the cost to produce the job has increased. Just as an owner is not entitled to reduce the amount paid to the contractor if material prices decrease, a contractor is not entitled to pass cost increases to the owner.
A material price increase that makes a job unprofitable typically does not excuse a contractor. Only in few cases where the price increase was so dramatic because of an unforeseen occurrence and the loss was of such an exceptional magnitude have courts excused performance at the contract price. The only significant, widely reported case fitting the exception was Aluminum Co. of America (Alcoa) v. Essex Group Inc., a 1980 Pennsylvania U.S. District Court decision. In this case, Alcoa was experiencing a 485 percent increase in production costs as a result of increased electricity costs instigated by the 1973 OPEC oil embargo and would lose $75 million if the contract were enforced as written and the buyer would receive a concomitant unexpected gain.
Potential relief
There may be grounds for relief in an underused and often neglected provision of AIA A201-1997, which often is incorporated into construction contracts. Article 4.3.6 of AIA A201-1997 allows a contractor to make a claim for additional compensation if he incurs additional costs for several stated reasons (such as a written interpretation from the architect or an order by the owner to stop work when the contractor was not at fault) and "other reasonable grounds." Sharp, unexpected increases in material prices because of events beyond the control and foreseeability of the parties might well constitute a "reasonable ground" for additional compensation particularly if there has been an unusually lengthy period between when the job was bid and when the job is ready for the material that is in short supply.
Based on existing case law, you should not expect judicial relief will be readily available if you have to perform an unprofitable contract because of increased material costs. However, if you already are bound to a fixed-price contract, you can and should use contract language to avoid getting yourself in an economic quagmire for jobs not yet under contract. There are two approaches to take to avoid being placed in the position of being locked into a fixed price with a general contractor or owner while facing continuously rising material prices from suppliers.
First, make sure the commitments you receive from a supplier parallel the obligations to a customer. If a material supplier says he only can provide quotes for materials ordered or shipped within a certain number of days, be certain your proposal and contract contains an identical provision. You need to lock in the supplier's quote for the designated period so you are contractually entitled to rely on the supplier's quote and make sure whatever conditions and contingencies that are part of the supplier's quote are part of your proposal and contract with your customer. If you intend to rely on an oral or written quote from a supplier, follow up with a written communication to the supplier, confirming the quote and your reliance in making a proposal or contracting with a customer.
Given current market conditions, your role as a middleman and coordinator between material suppliers and building owners becomes more demanding and critical. A successful contractor is able to work with suppliers to obtain quotes and conditions acceptable to an owner and work with owners so they understand and accept conditions that will allow a job to proceed in a timely, cost-effective manner. If you are unable to make parallel arrangements with a supplier and customer, consider a different supplier and/or substitute products that will satisfy the owner's needs.
Second, with respect to jobs not yet under contract, include contract provisions that address price escalation, particularly if the conditions of the supplier's quote are not satisfied. The purpose of a price-escalation clause is to shift the risk (or possibly the benefit) of price changes to the owner.
Although at first blush the idea of including a price-escalation contract clause might seem anathema to an owner, the owner benefits from the escalation clause because in a volatile market with rising prices, a prudent contractor will build a huge contingency into his price. A negotiated price-escalation clause, which could allow an owner to benefit if material prices declined or might be triggered by increases of a stipulated magnitude, allows an owner to have greater knowledge and more control over material pricing than if the contractor simply includes a high number in the contract price. In the current market, an owner might save money by basing a contract on current prices charged to the contractor and actual increases than if the owner received only fixed-price quotes that included speculative contingencies.
AGC support
General contractors already have expressed their support for escalation clauses. In March 2004, the Associated General Contractors (AGC) of America adopted a resolution calling on public and private owners to include "equitable adjustments" for material price increases in fixed-price construction contracts.
AGC also promulgated Amendment No. 200.1 to AGC Document No. 2000, which is intended to address market fluctuations. The amendment requires parties to agree on a method to establish the "baseline price" of a material and calculate an adjustment so the baseline price can be based on market conditions. AGC's proposed provision allows for upward and downward adjustment of the baseline price. Either party can request a price adjustment upon providing written notification to the other and furnishing appropriate substantiating documentation. Equitable adjustments are not retroactive; they apply only to those materials delivered on or after the date of written notice seeking the adjustment. Adjustments may not include overhead and profit.
With regard to federal contracts, there is a Federal Acquisition Regulation permitting inclusion of economic price adjustment clauses in situations when "there is serious doubt concerning the stability of market or labor conditions that will exist during an extended period of performance." A contracting officer has the discretion to include this clause in contracts. If you are contemplating working on government projects, request this provision be included in the contract documents.
Review
You should not expect judicial relief from the economic consequences of fixed-price contracts that have become unprofitable because of material price increases.
The best course of action is to work with suppliers and customers to try to mitigate the effect of material price increases. Also, work closely with suppliers and customers so your legal obligation to the owner matches the supplier's legal obligation to you. Price-adjustment clauses should be negotiated and included in contracts as a mechanism to allocate the risk of material price volatility, particularly in situations where you cannot obtain firm, legally binding prices from a supplier.
Stephen M. Phillips is a partner with the law firm Hendrick, Phillips, Salzman & Flatt, Atlanta.
Sample contract language
Following are examples of escalation clauses you can use or modify to address the problem of being bound to a fixed price while facing unknown, uncontrollable and volatile material prices:
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