Up, Up and Away
June 2008

The forecast regarding the price of gas is grim. Gas prices are expected to exceed $4 per gallon this summer. The increasing cost of fuel is a cost that will continue to be absorbed by contractors. As gas prices continue to rise, contractors can expect to pay higher prices for deliveries and receive higher bids from subcontractors. This is especially true for contractors with large fleets of automobiles and heavy equipment. Contractors would be wise to factor these increased costs into project budgets and to include provisions in their contracts to address the issue.

One way contractors can protect themselves from lost profits as a result of rising gas prices is to include in their contracts and subcontracts an escalation clause. An escalation clause is a provision in a contract that calls for an increase in price in the event of an increase in the cost of materials. Without a price escalation clause in the contract that allows for an adjustment to the contract price in the case of an unexpected rise in the market prices of key materials, such as gasoline, it will be impossible to avoid a loss in profits. For owners, the idea of a price escalation clause may be seen in effect as writing a blank check. However, such a clause may actually protect the owner and save the owner money as well. If the contract is based on current prices and any actual increases rather than a fixed-price quote that builds in a hypothetical and speculative price increase, owners may actually save money by allowing such contacts.

Assuming a price escalation clause can be agreed on, it is important that the price escalation clause be carefully drafted. The clause should identify the specific materials that are considered to be volatile and the unit prices for such materials at the date the contract is executed. The clause should further provide that the owner will become liable for any price increases in those materials that cause the total contract price to be increased by an agreed upon percentage. Further, a well-written clause will set out notice periods for identification of price increases and identify the type of documentation that will be required to evidence the increase as well as what events trigger an increase in contract price, what is the appropriate measure of market price, how many times the contract price can be increased and what are the time periods covered. These clauses will typically involve a series of notice and documentation protocols which must be followed strictly to be effective. Such safeguards are essential to protect the contractor from accusations that bad purchasing practices are simply to blame for the price differences.

Drafting and implementing an effective escalation clause is of benefit to everyone, the contractor, the subcontractor and the owners. Consult with a construction attorney familiar with your industry and the local economy and regulations. A little clause can go a long way towards protecting your company’s bottom line.