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Escalation Clause: Protect Your Bottom Line

Oct 21, 2022

Before the onset of the Covid-19 pandemic, an escalation clause was not something at the forefront of people’s minds. Cost increases typically arose from natural disasters, including hurricanes, floods, and fire, with materials like oil, asphalt, concrete, and plywood seeing the most significant cost increases. Since the pandemic, supply chain disruptions have led to increased costs associated with construction projects. Between April 2020 and April 2021, input costs, including materials and labor for construction projects, increased 26.1%. Those increased costs have remained in place without an end in sight, resulting in the escalation clause becoming something an increased number of contractors are seeking as part of the way they do business.

Because of the pricing structure of most commercial construction contracts, the contractor bears the risk of any unexpected increase in the cost of materials. As such, the risk of rising material costs lies squarely at the feet of the contractor. A price escalation clause becomes a critical tool for any contractor seeking to do business during these rocky times as it entitles a contractor to change an order should the price of certain types of materials increase between the time of bid submission and the time the contract is effective. In addition, it allows the contractor to confer any assumed price increase in materials to the owner after a contract is signed, reallocating some or all the risk back to the owner, who absorbs the price increases.

While cost escalation clauses can take many forms, a good escalation clause shares the risk of cost increases between the owner and the contractor and protects both their interests during this unprecedented time of supply chain issues and construction cost increases.

What to Consider When Deciding on an Escalation Clause?

There are many factors to consider when evaluating whether an escalation clause makes sense in your contract. Among the questions to ask are:

· Does the clause allow adjustments for price increases and decreases, thus creating parity in price volatility, or are the adjustments limited to increasing or decreasing prices?

· Will all materials be included within the clause or only certain ones? And will materials not expected to increase in price be excluded from the clause?

· Are there markups for overhead or profit included within the clause?

· Will there be a maximum limit to the amount that can be adjusted?

· What method is used to determine how the escalating prices will be measured and to notify the other party of the basis for a price adjustment?

· Will any time extensions be granted for the contractor to provide materials due to potential delivery delays or material unavailability?

· What supporting documentation will be required to justify the price adjustment?

Types of Escalation Clauses

It is important for owners and contractors to consider the escalation clause type and its effect once triggered. Depending on the type of project and its participants, any of these available clauses may be preferable.

Any-Increase Clause: This clause specifies that a contractor or supplier could be entitled to reimbursement or change order for any price increases occurring between bidding or signing the contract and construction.

Threshold Clause: Only entitles the contractor to additional compensation for price escalations that exceed a certain percentage or dollar amount.

Delay Escalation Clause: Freezes a fixed price for a limited period, allowing the contractor additional compensation if the project is delayed beyond a given number of days or a specified date.

Escalation clauses are intended to protect contractors from steep increases that are beyond the normal fluctuation of market prices. Not having one in place puts you and your company at risk for insurmountable income loss. Protect yourself by contacting the CRI team with questions about adding a price escalation clause to your construction contract. It could make all the difference to the success of your future contracts.

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