Following the Trump Administration’s move to impose tariffs on lumber, steel, and aluminum imports, the construction industry experienced notable material price increases and faces continuing uncertainty about how public policy will impact materials markets. This article (i) discusses legal avenues for contractors to seek recovery for tariff-based material cost overruns, and (ii) proposes how industry stakeholders can control material cost escalation risks.
In April 2017, the Trump Administration announced tariffs of approximately 20% on Canadian softwood lumber imports that were finalized by the U.S. Department of Commerce in November 2017. On March 1, 2018, the Trump Administration further announced tariffs of 10% on aluminum imports and 25% on steel imports. On May 31, 2018, these tariffs became effective against Canada, Mexico and the European Union. As U.S. trading partners move to impose retaliatory tariffs and U.S. policymakers consider further tariffs, future materials costs remain uncertain. Contractors should respond to these developments by evaluating their rights to recover for material cost overruns on current projects and ensuring that future contracts adequately address responsibility for such risks.
Grounds To Recover Tariff-Driven Material Cost Overruns
The question of whether material cost escalation is legally compensable or sufficient to excuse contractual performance generally depends on the terms of the applicable contract. Absent a contract provision permitting relief, the law has traditionally been reluctant to provide compensation or excuse contractual performance based on the grounds of normal material cost increases. Material price fluctuations have been viewed as a function of the market and an inherent risk of doing business. Consequently, the law generally views market-driven material price fluctuations as part of the bargained-for risk assumed under a fixed price contract.
Legal doctrines excusing performance in the face of unforeseen or changed circumstances impose a high bar for obtaining relief. For example, the legal doctrine of commercial impracticability only excuses contractual performance where a party’s performance is rendered commercially impracticable by the occurrence of unforeseen circumstances involving risks not assumed by either party, the non-occurrence of which was a basic assumption underlying the contract. As discussed in the Restatement of Contracts (Second) § 261:
A mere change in the degree of difficulty or expense due to such causes as increased wages, prices of raw materials, or costs of construction, unless well beyond the normal range, does not amount to impracticability since it is this sort of risk that a fixed-price contract is intended to cover.
Material price increases occasioned by the government’s adoption of tariffs as opposed to those caused by market-based forces may provide stronger grounds for invoking the doctrine of legal impracticability. The former type of price escalation is more difficult to anticipate and results from unique circumstances outside of the realm of the status quo. Regardless, doctrines such as commercial impracticality generally only serve as a defense for a contractor in the face of a contractual breach and do not typically provide affirmative grounds to seek recovery for increased costs of completion.
A contractor’s best grounds to seek recovery for tariff-driven material cost increases will likely be the terms of their contract. In assessing their rights, contractors should review all applicable contract documents for the project. Subcontractors should review all provisions incorporated through any flow down clause and government contractors should review all incorporated Federal Acquisition Regulation provisions. If the relevant contract contains a material cost escalation provision, the contractor should ensure that it adequately documents its claim and complies with any conditions precedent to its assertion. However, absent a material price escalation provision, contractors should examine the following types of provisions with care:
- Force Majeure Provision: A force majeure provision generally excuses contractual performance when events that the parties could not have anticipated or controlled render performance impossible or impracticable. Most contracts narrowly define what constitutes force majeure (French for “superior force”) and limit the definition to circumstances including wars, labor strikes, acts of God (i.e., hurricanes, earthquakes, droughts etc.), and specific unforeseen acts by government or regulatory authorities. However, some force majeure provisions embrace broader sets of commercial risks or include a catchall provision generically including “other circumstances outside the parties’ control” within the definition of force majeure. Although the contractual language is ultimately determinative, normal material price fluctuations have generally not been understood to constitute a force majeure Nevertheless, material price escalation triggered by the government’s implementation of trade barriers presents more favorable circumstances to argue for the existence of a force majeure event.
- Change in Law Provision: Some construction contracts include a provision allowing the contractor to recover costs resulting from changes in existing laws or judicial/ administrative interpretations of such laws. For example, where such costs are recovered from the owner, ConsensusDocs 750, § 3.27.1 (2016) permits the subcontract price to be “equitably adjusted for Changes in the Law enacted after the date of this Agreement…” Recovery under a change in law provision will largely depend on the language of the specific provision at issue and any conditions it imposes on recovery. Key issues include what is included within the term “law” (i.e., whether executive orders are included), what constitutes a “change” in law, and the applicable time-period during which the change must occur. Nevertheless, broader versions of change in law provisions may establish entitlement to recover tariff-driven material price increases.
- Tax Provisions: Some standard industry contract forms contemplate potential adjustments to the contract price due to changes in tax law. ConsensusDocs 750, § 3.27.1 (2016) with AIA A201, § 3.6 (2017). Although tariffs are indirect taxes on imports, broad descriptions of the types of taxes covered may be required to establish an argument for recovery. In addition, FAR clause 52.229-3 which requires the contract price to include “all applicable Federal, State, and local taxes and duties…” also permits equitable adjustment for after-imposed federal taxes including “any new or increased Federal excise tax or duty….” 48 CFR 52.229-3(b), (c). Section 52.229-3 has been invoked by the Comptroller General in the context of a bid protest to support the position that a contractor was required to include import duties in its bid price. See Towmotor Corp., 65 Comp. Gen. 373, 375 (Mar. 4, 1986). Although 52.229-3(c) only allows recovery for a subset of the taxes and duties set forth in 52.229-3(b), an argument can be made based on Towmotor that 52.229-3(c) would permit recovery for increased import duties actually paid or directly passed through. Practically, there is little difference between such federally created costs and costs such as federal fuel tax increases for which 52.229-3(c) has been found to permit recovery. See Appeal of Consol. Const., Inc., ASBCA No. 46498, 99-1 B.C.A. ¶ 30148 (1998). Nevertheless, tax provisions including 52.229-3(c) may not provide recovery for increased costs paid to domestic suppliers or delays required to locate a more affordable domestic supplier.
- Change Order Provision: Typical change order provisions link entitlement to a change order to “changes in the work” or “changes in scope.” However, these provisions are frequently customized and should be scrutinized for potentially helpful language which may entitle the contractor to recover for material cost increases.
The above list of key provisions is not necessarily comprehensive, and contractors should examine the entirety of their contracts to locate all available grounds on which to seek recovery for tariff-driven material cost increases.
Strategies To Manage Material Cost Escalation On Future Projects
Contractors seeking to manage future risks associated with material price increases should consider adding a material price escalation provision to their contracts. A material cost escalation provision provides for the adjustment (upward or downward) of the contract price when key material costs exceed an established baseline. Much like the differing site condition clauses prevalent in the industry, material price escalation provisions can benefit both owners and contractors. Volatile materials markets force contractors, who traditionally bear the risk of cost fluctuations, to mark-up their pricing with contingencies to account for such uncertainty. The clause would allow the contractor to shed the material cost risk. Owner’s also would benefit from lower bid pricing absent the contingencies. Please note that for federal projects, the Federal Acquisition Regulation already permits inclusion of material price escalation clauses in fixed price contracts where “there is serious doubt concerning the stability of market or labor conditions.” 48 CFR 16.203-2.
In our view, an effective material price escalation clause must clearly establish a baseline for the price of the material(s) at issue and establish a methodology for how increases or decreases in material prices are determined and documented. Common methods include comparisons to an established baseline price based on: (i) catalog prices; (ii) actual costs; or (iii) material cost indices. The circumstances of every party and project differ. However, the following provision provides a starting point to draft an appropriate material escalation clause:
If during the performance of this contract, the price of ________ significantly increases, through no fault of contractor, the price of _____ under this agreement shall be equitably adjusted by an amount reasonably necessary to cover any such significant price increases. As used herein, a significant price increase shall mean any increase in price exceeding _____ percent (____%) experienced by contractor from the date of contract signing. Such price increase shall be documented through quotes, invoices, or receipts. Where the delivery of ___ under this agreement is delayed, through no fault of contractor, as a result of the shortage or unavailability of ____________, contractor shall not be liable for any additional costs or damages associated with such delay(s).
This provision can be further fine-tuned to provide for upward and downward adjustments, notice requirements, mark-up limitations, tipping points and caps, point of departure triggers, supporting documentation requirements and audit rights.
Recent tariffs on key construction materials have injected uncertainty into materials markets creating new risks for the construction industry. Affected stakeholders should respond by: (i) evaluating their rights under their current contracts, and (ii) incorporating an appropriate material cost escalation clause into their future contracts.