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Contractor Rights: Costs and Supply Chain Issues

Contractors are navigating the challenging problem of an increase in costs due to the supply chain. The costs of contracts have increased and problems have arisen due to the contractor’s inability to obtain items or their ability to pass on any increase in costs. This results in inevitable friction between the customer and the contractor. What are the contractor’s rights, and how can they address these issues?

A. Who bears the burden of an increase in costs?

Guaranteed maximum price (“GMP”) contracts provide a maximum amount that the contractor can bill the customer for the project, regardless of the actual costs incurred. The maximum price can be increased by change orders if the project’s scope changes; however, a change order is likely not appropriate for cost overruns or estimating errors by the contractor. The theory is that the contractor was in the best position to determine the price when bidding for the project and should bear the burden of an incorrect bid.

This is often memorialized in the contract itself, which is the first place that the contractor should look to resolve issues. For example, section 5.2 of AIA Document A133-2009 provides, “The Construction Manager guarantees that the Contract Sum shall not exceed the Guaranteed Maximum Price. . . To the extent the Cost of the Work exceeds the Guaranteed Maximum Price, the Construction Manager shall bear such costs in excess of the Guaranteed Maximum Price without reimbursement or additional compensation from the Owner.” Furthermore, Section 6.8 of A133-2009 (Costs Not To Be Reimbursed) provides, “The Cost of the Work shall not include the items listed below:. . . 7. Costs, other than costs included in Change Orders approved by the Owner, that would cause the Guaranteed Maximum Price to be exceeded[.]”

While the total contract sum may not change, the contractor may be able to draw from “contingencies” in a schedule of values in the contract. “Contingencies” address unknown risk factors that may arise throughout a project. Increasing the costs of contingencies in a schedule of values obviously is not beneficial to the contractor if contractor bears the costs. The dispute, however, arises if the owner bears the costs of an increase in the “contingency” category of a schedule of values.

B. Economic price adjustment/material escalation clause

The contractor can argue that an increase in costs due to a supply chain issue is not an estimating error since it could not have been anticipated. Therefore, if the issue is not addressed in the original contract, then the contractor can propose a means of allocating the new costs, such as splitting the increased costs in a manner that the parties see fit. The problem, however, is that the customer does not have to sign the proposed change order and is not incentivized to do so. To prevent these issues, the contractor would likely want an economic price adjustment/material escalation clause in the contract to address these issues. The clause would address how to allocate the risks and increase in costs if the price of goods increases.

C. Force majeure clause

Some contracts contain a force majeure (Act of God) clause that would address how to handle these issues. The escalation of prices is unlikely to fall within a force majeure clause since an increase in costs should have been anticipated. However, material shortages may fall within the clause, depending on the language. That said, some force majeure clauses only allow for more time to perform, not the termination of the contract. For example, AIA Document A201-2007 section 8.3 is labeled “Delays and Extensions of Time.” Section 8.3.3 provides:

Contractor may seek an adjustment to the Contract Time if Contractor experiences any delays to the schedule due to events that are attributable to either Weather Delay, Force Majeure Delay or delays that are within the control of Owner. Any Contractor request for an increase to the Contract Time must first be made within twenty one (21) days after occurrence of the event giving rise to such request or within twenty one (21) days after Contractor first recognizes or reasonably should have recognized the condition giving rise to the request, whichever is later.

The above force majeure clause does not allow the contractor to terminate the contract. Rather, the contractor can seek a delay in the contract, provided the contractor abides by the strict requirements therein. AIA Document A201-2007 requires a contractor to provide timely notice and substantiate the basis for the delay request. In other words, a contractor should not wait too long to make the request or the contractor will be deemed to have waived it.

AIA Document A201-2007 specifically addresses when delays are justified due to shortages in materials:

Delays caused by unusual shortages in materials may be considered a basis for delay only if each of the following is established: (a) Contractor made every effort to obtain such materials from all available sources; (b) such shortage is due to the fact that such materials are not physically available from a single or multiple sources or could have been obtained only at exorbitant prices entirely inconsistent with the rates indicates when the Guaranteed Maximum Price (“GMP”) was established taking into account the quantities involved and the unusual industry practices in obtaining such quantities; and (c) such shortages and the difficulties in obtaining alternate sources of materials could not have been known or anticipated as of the establishment of the GMP. AIA Document A201-2007, Section 8.3.12.

Again, AIA Document A201-2007 does not allow a contractor to increase the GMP due to a force majeure event; it only allows the contractor to increase the time of performance. AIA Document A201-2007, Section 8.3.9.

D. Change order/economic duress

A contractor may be tempted to leave the jobsite if the customer does not sign a change order to increase the GMP. This may constitute economic duress if the customer felt that he had no reasonable choice but to sign, which may ultimately permit the customer to rescind the change order(s) despite initially signing them.

E. Impossibility and/or Impracticality

The contractor may allege the doctrines of impossibility and/or impracticality for why it needs to increase the GMP through change order(s) or otherwise terminate the contract. That is, if a customer seeks to enforce the contract, the contractor can seek to prevent enforcement by arguing it was impossible or impractical to perform due to the increased costs. These arguments likely would fail if the contract itself addresses how to resolve these issues. These doctrines cannot supersede the contractual language.

Assuming that the contractual language does not bar the argument, the doctrine of impossibility likely would not apply solely because of the increased costs of goods, since the contract can technically still be fulfilled. Lloyd v. Murphy (1944) 25 Cal.2d 48, 54 (“The purpose of a contract is to place the risks of performance upon the promisor, and the relation of the parties, terms of the contract, and circumstances surrounding its formation must be examined to determine whether it can be fairly inferred that the risk of the event that has supervened to cause the alleged frustration was not reasonably foreseeable. If it was foreseeable there should have been provision for it in the contract, and the absence of such a provision gives rise to the inference that the risk was assumed.”).

Impracticability does not mean impossibility; the contractor can usually still perform the contract, albeit at a substantially higher price. Generally, the mere fact of increased cost or difficulty is insufficient to release a party from that party’s contractual obligations. Oosten v. Hay Haulers Dairy Emps. & Helpers Union (1955) 45 Cal.2d 784, 789 (“labor trouble” on part of milk farmer did not excuse milk processor from accepting deliveries of farmer’s milk). At some point, the increase in cost will rise to the level of impracticability. See City of Vernon v. City of L.A. (1955) 45 Cal.2d 710, 719 (defendant’s costs increased dramatically when it was required to handle plaintiff’s sewage in manner other than originally contemplated). Although that line is not clearly defined, the contractor can certainly make an impracticability argument to avoid enforcement.

F. Conclusion

The issues with the supply chain have created a host of problems for contractors, the resolution of which are far from simple. For assistance with these issues as they arise, please contact Joshua Borger, or 408.286.5800.