Pandemic-Related Rising Materials Costs: How Contractors Can Avoid Losses and Protect Themselves

The coronavirus or COVID-19 pandemic (or perhaps the resulting monetary policy) has caused materials costs to skyrocket. In the past year, as of early February 2021, steel prices are up about 27%; copper prices are up about 37%; rubber prices are up about 62%; lumber prices are up about 113%; and although oil prices are only up 7%, they have soared 476% above the lows reached in April 2020.

What can a contractor stuck in a fixed price contract or a contractor worried about price volatility do about these rising and volatile materials costs? This article sets out to explain just that. In particular, this article considers contractual provisions that may provide contractors with relief: (1) force majeure clauses, (2) escalator clauses, and (3) clauses requiring the counterparty to provide the materials.

Force Majeure Clauses

A force majeure clause permits a party to delay performance or to be excused from performance entirely upon the occurrence of a “force majeure event” that renders performance commercially impracticable, illegal, or impossible.[1] Few events have shook the business world like COVID-19, but is it a force majeure event? The coronavirus pandemic has engendered a wave of litigation about just that. It is becoming clear that the answer rests primarily, if not exclusively, on the language of the particular force majeure clause.

Force majeure clauses generally list a series of qualifying force majeure events. Clearly, events like “disease, epidemics, or pandemics” would include the coronavirus pandemic. However, few force majeure clauses contain these events. Instead, most litigation has involved whether events like “acts of god, compliance with governmental orders, or other circumstances beyond the reasonable control of the parties” are sufficiently broad to include the coronavirus pandemic. See In re Hitz Rest. Grp., 616 B.R. 374, 378 (Bankr. N.D. Ill. 2020) (finding that the governor’s stay-at-home order triggered the “governmental action” and “orders of government” provisions of the force majeure clause, allowing a 75% rent abatement); AB Stable VIII LLC v. Maps Hotels & Resorts One LLC, No. CV 2020-0310-JTL, 2020 WL 7024929, at *64–65 (Del. Ch. Nov. 30, 2020) (finding that broad force majeure language such as “act of god, natural disaster, or calamity” may include pandemic-related risk).[2]

Even if “pandemic” is an express force majeure event, however, the contractor suffering from pandemic-related price increases may not be able to obtain relief. Many force majeure clauses explicitly state that they will not excuse the parties from obligations to make payments. Moreover, the fact that performance will be less profitable or cause a loss will rarely excuse performance. See Seaboard Lumber Co. v. United States, 308 F.3d 1283, 1288 (Fed. Cir. 2002) (finding that government policies affecting the profitability of a contract but not precluding performance are not sufficient to trigger a force majeure clause); Langham–Hill Petroleum, Inc. v. S. Fuels Co., 813 F.2d 1327, 1330 (4th Cir. 1987) (rejecting a force majeure argument based on unprofitability arising from the collapse in world oil prices caused by the actions of Saudi Arabia’s government and noting that “[i]f fixed-price contracts can be avoided due to fluctuations in price, then the entire purpose of fixed-price contracts, which is to protect both the buyer and the seller from the risks of the market, is defeated”).

That is not to say that increased prices can never lead to excused performance. Extreme increases in prices can lead to excused performance. See Moyer v. Little Falls, 510 N.Y.S.2d 813, 815 (Sup. Ct. 1986) (holding that a price increase of over 650% “was not and could not have been within the contemplation of the parties,” that the price increases were “excessive,” and the “future performance by plaintiff must be excused”); American Trading and Production Corp. v. Shell International Marine, Ltd., 453 F.2d 939, 943 (2d Cir. 1972) (holding that an extra expense of 31.6% of the contract price, incurred because of the closure of the Suez Canal, did not excuse performance); see also Louisiana Power & Light Co. v. Allegheny Ludlum Indus., Inc., 517 F. Supp. 1319, 1324 n.4 (E.D. La. 1981) (considering the party’s profitability in general as a factor in deciding whether forcing the party to perform would have been “especially severe and unreasonable”).

Thus, a contractor’s ability to have its performance excused will depend on the facts of the case. What does the contract say? Was the anticipated or actual barrier to performance contemplated by the parties at time of contracting? How much has the cost of the project increased? How profitable is the contractor’s business more generally? Has the value of the project to the counterparty increased? These questions, among other, are fact intensive determinations that will influence whether pandemic-related price increases can excuse performance.

Escalator Clauses

An escalator clause, also known as an escalation clause, is a provision allowing for an increase in the price of a contract upon the occurrence of certain defined events. For example, an escalator clause might shift the marginal cost of lumber to a counterparty if lumber prices increase by more than 30%. Because the parties can craft the escalator clause in advance, escalator clauses are a more predictable way for contractors to protect themselves against price risk than force majeure provisions.

However, beware of unintended consequences; If a contractor includes an escalator clause in its contracts, it ought to draft the clause carefully. Expressio unius est exclusio alterius (the inclusion of one thing implies the exclusion of another) is a fundamental rule of contract interpretation. Accordingly, if a contract includes an escalator clause governing lumber, but not for steel, it may be presumed that the parties intended that the contractor bear the price risk for steel.

For example, in Moonlit Waters Apartments, Inc. v. Cauley, 666 So. 2d 898, 899 (Fla. 1996), the Florida Supreme Court considered whether Fla. Stat. § 719.401(1)(f), which required a lease of recreational facilities to cooperatives to include an option to purchase, included the underlying land lease. The court looked to another statute in Chapter 719, Fla. Stat. § 719.4015(1). Because that statute declared void the inclusion of escalator clauses in land leases made to cooperatives, and because Fla. Stat. § 719.401(1)(f) makes no reference to land leases, expressio unius est exclusio alterius implied that Fla. Stat. § 719.401(1)(f) did not include land leases.

Therefore, the inclusion of an escalator clause in a construction contract may prevent the contractor from later raising a defense based on a force majeure clause or impracticability. See Louisiana Power & Light Co. v. Allegheny Ludlum Indus., Inc., 517 F. Supp. 1319, 1328 (E.D. La. 1981). Care must be taken to draft the escalator clause such that it encompasses most, if not all, of the contractor’s price risk.

The remedies of unforeseen construction or materials price escalation contemplated by escalator clauses in construction contracts can vary based upon how the provision is drafted. Some contractors may prefer the right to cancel the contract if one of the parties does not agree to the increase in price, and others may require continued performance without room for the parties to consequentially disagree to the price increase or adjustment.  Effective business planning and proactive contractual negotiation of the escalator clause before the contract is signed will help address these risks and enumerate adequate remedies. It should be noted that in construing enforceability of escalator clauses, some courts have required the contractor to show that it took reasonable steps to avoid incurring the increased material costs, and that it did not cause the materials to increase in price. Addressing these issues through representations and warranties in the contract may be a way to circumvent second guessing by the courts on these issues.

Clauses Requiring Counterparty to Provide Materials

Another way that a contractor can protect itself going forward is to include a provision in its contracts that requires the counterparty to purchase or provide the materials. This option is the simplest for the contractor, and it obviates the need for a contractor to provide the funds for the materials up front.

For small construction projects, or projects involving unsophisticated counterparties, this option may not be feasible. However, the sophisticated counterparty often exercises some level of oversight over the procurement of materials. For those borderline projects, a small push by the contractor may reduce its ultimate risk from volatile materials prices.

Common Law Contract Principles

Rescission (a remedy that terminates a contract) or equitable reformation (a remedy that allows for a contract to be modified) may be available if litigation is unavoidable.  Rescission is the abrogation of a contract, effective from its inception, thereby restoring the parties to the positions they would have occupied if no contract had ever been formed. In the event of a breach of a contract, rescission is the remedy sought to bring the contract to an end, allowing the innocent party to perform no further, recover any part performance and seek damages. It is an equitable remedy and will not be granted unless the parties can be returned to their pre-contractual state. What this means is that in litigation, a mutual mistake concerning a material fact (i.e. unforeseen tariffs, trade wars, pandemics, etc.. causing dramatic materials price increases) may entitle the party adversely affected by the mistake to rescind the contract unless the contract has already been completed and rescission would be an injustice to the other party. Rescission can also be allowed even for a unilateral, or one-sided, mistake in order to prevent an unjust enrichment of the other party.

Additionally, under the right sets of circumstances, courts have the ability to rewrite contracts to achieve the parties’ original intent. Reformation is a remedy utilized by the courts to correct a written instrument so that it conforms to the bargain that the parties believe they had reached. Courts, in their discretionary capacity to render equitable relief in the administration of justice, will generally only reform a legal instrument in the event that fraud or mutual mistake occurred in its execution. Because reformation is an infrequently used remedy of course, it will not likely be granted relief where a newfangled agreement would result between the parties, or where unwarranted hardships would be imposed upon them. It is worth noting that only an actor who has conducted itself in good faith can request the court invoke equitable reformation. While reformation is not available as a remedy to correct every negligible contractual error, such as clerical mistakes, reformative relief is available where there has been a mutual mistake that substantially affects the parties’ rights and obligations. When the mistake derives from a party’s failure to exercise due care or diligence with respect to the project or contract at issue, recission or reformation of the contract will likely not be given. For contractors, these remedies may be available in some circumstances where there is no escalator clause if an increase is so impactful that performance under the contract may cause financial ruin or otherwise threaten the going concern of the business.  Contractors who have no choice but to litigate upside down contracts should examine the doctrines of mistake, frustration, impossibility, and/or duress as a means to testing the enforceability of the unconscionable contracts.

Conclusion

Most standard fixed price contracts contain force majeure provisions.[3] Therefore, for those contractors currently looking for relief from standard fixed price contracts, force majeure provisions are your best bet. For those contractors concerned about the future and looking for contract drafting tips, consider adding an escalator clause; a clause requiring the counterparty to provide or purchase the materials; and as to force majeure clauses, consider specifically defining the force majeure events and crafting language making it clear what will happen at the end of the force majeure event, i.e. whether the party can terminate or merely delay performance. Of course, each project is different. Therefore, careful drafting on the front end can save you much time, effort, and expense on the back end.

[1] One might understandably wonder what the purpose of a force majeure provision is if it only applies when a force majeure event renders performance impracticable, illegal, or impossible. The common law of contract already provides for excused performance in the case of impracticability, illegality, or impossibility. The answer is that force majeure provisions can define the force majeure events, the types of performance excused, and the remedies given to the parties. See Stein v. Paradigm Mirasol, LLC, 586 F.3d 849, 857 (11th Cir. 2009) (citing several state court opinions and noting that “force majeure clauses broader than the scope of impossibility are enforceable under Florida law”). The applicability of a force majeure provision is very much a contract by contract issue.

[2] In AB Stable VIII LLC v. Maps Hotels & Resorts One LLC, No. CV 2020-0310-JTL, 2020 WL 7024929, at *65 (Del. Ch. Nov. 30, 2020), the Delaware Chancery Court explained some of the policy reasons for construing broad force majeure events like “act of god” or “calamities” as including pandemic related risk:

Drafters of [force majeure clauses] must contemplate the three Rumsfeldian categories of risk: known knowns, known unknowns, and unknown unknowns. Drafters can use specific terms to address known knowns and known unknowns, but only broad terms can encompass unknown unknowns. To read a term like “calamities” narrowly would interfere with drafters’ ability to allocate systematic risk for as-yet-unknown and as-yet-unimaginable calamities. By contrast, reading a term like calamities broadly allows drafters to carve out known knowns and known unknowns through exclusions. For instance, if parties believe that the seller is better suited to shoulder the risk of a pandemic than the buyer, then the drafters can say “natural disasters and calamities (excluding pandemics).”

[3] An example of a standard force majeure provision can be found in the AIA’s A201 General Conditions:

8.3.1 If the Contractor is delayed at any time in the commencement or progress of the Work by an act or neglect of the Owner or Architect, or of an employee of either, or of a separate contractor employed by the Owner; or by changes ordered in the Work; or by labor disputes, fire, unusual delay in deliveries, unavoidable casualties or other causes beyond the Contractor’s control; or by delay authorized by the Owner pending mediation and arbitration; or by other causes that the Architect determines may justify delay, then the Contract Time shall be extended by Change Order for such reasonable time as the Architect may determine.