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Tarriffs, A Pandemic And War: Construction Contracts Must Withstand The Unforeseeable – Operational Impacts and Strategy



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Since the tariffs on steel and the first wave of the COVID-19
pandemic, the construction industry has been reeling from the
impact of material shortages and price increases, labor shortages,
breakdowns in the supply chain and the inflationary effect of these
issues. Unfortunately, the war in Ukraine has only exacerbated the
situation.

International conflicts can constrain supply, resulting in
delays and price increases for contractors, subcontractors and
suppliers. The disruption caused by the war is expected to be
particularly acute due to the role that Russia and Ukraine play in
the world economy and the effect of the economic sanctions that
have been imposed on Russia by the United States and other
countries. Russia controls approximately 10% of the global copper
reserves and is estimated to produce about 10% of the world’s
nickel supply. It also provides at least 30% of Europe’s oil
and natural gas. Ukraine is a significant source of raw materials,
such as iron. Thus, the war will cause significant shortages and
price increases to the global construction industry. There are
already reports of delays and cost increases for commodities such
as nickel, aluminum, copper and—most importantly—steel,
which have resulted in impacts to construction costs and schedules.
Suppliers are especially sensitive to the volatile markets caused
by these conditions. Some are insisting on automatic price
increases in their purchase orders.

All of this, not to mention the anticipation of what may come
next, points to the necessity for a new paradigm to achieve a
successful project. It is more important today than ever that
owners, contractors, subcontractors and suppliers reasonably
address the economic and time impacts of these unforeseeable events
in preparing contracts for future work and in administering
existing contracts. Otherwise, the risk of a default on more than
one level may put projects in jeopardy, to no one’s
benefit.

During periods of economic stability, fixed price contracts
without clauses providing relief for escalation and delay may work
fine. The contractor can protect itself against unanticipated
events through a reasonable contingency in its price. However,
during periods of extreme unanticipated escalation and delays
resulting from events for which neither party to the contract are
at fault, such as the time and cost impacts of the tariffs on
steel, the pandemic and the Russian invasion of Ukraine, it is
important for the parties to have explicitly dealt with the
problems in their contracts through price escalation, time
extension (i.e., force majeure) and delay damage clauses.

A price escalation clause in the contract, which allows the
contractor, subcontractors and suppliers to recover some
compensation from the owner for unanticipated increased material
costs is often advisable, particularly in the current volatile
conditions. An escalation clause can take many forms, from a
dollar-to-dollar increase in price based on actual purchase orders
and invoices to an objective formula based on a cost index. The
owner can absorb the entire escalation cost, or the escalation cost
can be shared between the owner, contractor, subcontractors and
suppliers. The escalation clause can be limited to substantial
increases in cost and/or certain listed materials. Another way to
reduce or limit escalation costs is to provide for the purchase of
materials upfront by subcontractors, with a provision for early
payment for stored materials and storage costs. The key is to
negotiate clauses that spread the risk of unanticipated escalation
between the parties in a fair manner.

Most construction contracts contain force majeure clauses that
provide a time extension for unanticipated delays that are beyond
the control and without the fault or negligence of the contractor.
However, some owners argue that delays resulting from tariffs,
COVID-19 and the Russian invasion should have been anticipated in
contracts entered into after the commencement of these events. To
avoid these arguments, the contract should include provisions
specifically allowing schedule relief for these events to the
extent the impact of the events is not known or possible to predict
and price at the time of contracting.

Finally, the parties should consider clauses that address delay
damages resulting from the tariffs, the pandemic, the war in
Ukraine or other similar unanticipated events, particularly if the
owner caused or contributed to the cost impacts of those
events.

So, what do the parties do about cost impacts that the owner,
contractor, subcontractors and/or suppliers incur on existing
contracts due to tariffs, COVID-19, the war or other similar events
if the contracts do not include a clause providing compensation for
escalation or delay damages resulting from unanticipated events
that occur through no fault of a party? Foremost, it is imperative
that the parties develop and maintain an open dialogue with
everyone on the construction team. Efforts should be made to
minimize and mitigate the cost and time impact of the unanticipated
events regardless of which party bears responsibility.

The contractor then needs to examine its contract to identify
provisions that will allow it to recover a time extension or
additional costs for the events. Most contracts provide schedule
relief, but no damages, for acts of war, a pandemic or, more
generally, for events beyond the contractor’s control and
without its fault or negligence via a force majeure provision. If
the owner refuses to grant a time extension to which the contractor
is entitled, the contractor may be able to recover for constructive
acceleration to overcome the delay. To reduce or eliminate a
contingency in the contract price, sophisticated owners may have
included a price escalation clause that provides complete or
partial relief for escalation costs. Finally, the contractor should
examine clauses relating to contingencies, allowances, changes in
law, suspensions of work, differing site conditions or unknown or
concealed conditions, changes and termination to see if they might
allow some recovery. To recover damages from the owner, the
contractor must find a clause that provides a basis for relief. The
owner, subcontractors and suppliers should perform the same review
of their contracts as the contractor to find clauses that provide
them a basis for relief or a defense.

In any event, it is important for the contractor to issue the
appropriate notices and claim letters promptly to the owner to
preserve all rights and remedies. Since many contracts have strict
notification deadlines, it is not advisable to wait to send the
letters until the full impact is known. It is best, at least, to
immediately send preliminary notices and provide further details as
new information on the impacts is discovered or obtained. It is
important for the owner to know that a claim is coming so it can
protect itself and possibly mitigate damages. Likewise, the
subcontractors and suppliers should meet the notice and claim
requirements in their contracts.

In addition to sending notices upstream, particular attention
should be given by the contractor to the impact of these problems
on its subcontractors and suppliers, particularly those who may not
be able to weather the impacts of the tariffs, COVID-19 and the war
in Ukraine. And the impact is not limited to this specific project
but includes the ripple effect of financial and cash flow problems
the subcontractors and suppliers may have on other projects. If a
subcontractor or supplier fails to perform or goes into bankruptcy,
the impact can be tremendous, and a lawsuit seldom provides the
contractor with full recovery.

On a management level, it is even more essential than normal for
the entire team to review each party’s performance to make sure
its work is on schedule and long-lead items have been ordered and
are in production. If a party sees schedule slippage, reduced
manpower levels or delayed material deliveries, it should take
immediate action to mitigate damages and overcome the impacts. In
addition, the parties need to meet the notice and claim
requirements of their contracts.

CONCLUSION

Reducing and fairly allocating the impacts of events like the
tariffs, COVID-19 and the war in Ukraine starts with negotiation of
contract clauses that provide at least some protection to the
contractor, subcontractors and suppliers from increased costs and
delay. A bad contract will make recovery very difficult, if not
impossible, and may leave the contractor, subcontractors and
suppliers at the mercy of the owner and put the project in
peril.

To assure successful completion of a project when unanticipated
events occur, collaboration and cooperation are key. Notice letters
(up and down) are only the first step to ensure the preservation of
rights, but they are not the end of the story. Everyone on the
project should be part of a broader team working together to
overcome these challenges. Without waiving any rights, reaching out
to subcontractors and suppliers to determine what can be done
together to ease the burden could help mitigate the impacts. At the
same time, working with the owner and its team will make them aware
of the difficulties and may lead them to participate and be part of
the solution. It is more important than ever for all project
participants to collaborate and coordinate in this effort.

Originally Published by Construction Executive, 10 May
2022

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.



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