Mitigating Contract Risk

The New Commodities Market

As the lingering impacts of the COVID-19 pandemic continue to challenge the construction and manufacturing industries, material and labor costs continue to rise. Project budgets are increasing, and commodity costs are changing daily based on availability and transportation.

On top of disruptions from pandemic shutdowns, tariffs implemented by the federal government have created uncertainty for managing performance contract costs. Allocations on raw materials and volatility in transportation are generating ripple effects across the industry.

For project and building owners, architects, general contractors, and suppliers entering project contracts, unstable markets and supply chain issues have created uncertainty in the marketplace, significantly impacting the cost of construction and project schedules. The duration of these conditions continues to be volatile, making project planning difficult at best. These daily market increases mean long-term budget implications that must be carefully accounted for during the planning process.

Put another way, fixed costs are no longer fixed as expectations from the market remain unclear. Flexibility and transparency amongst stakeholders is vital as we navigate the current construction conditions.

Necessities of a Contract

Under current market conditions, all stakeholders need to share the risk on a construction project and understand the following:

Commodities and raw materials are in short supply.
Unpredictability in terms of availability can cause prices to fluctuate.

Finalizing a contract for a construction project should include an agreement that operates on three separate levels:

Owner + Architect: This contract establishes the Design Intent of the building/project.
Owner + General Contractor: This contract is established to execute the Design Intent.
General Contractors + Subcontractors/Suppliers: These contracts are established for materials and specific services required to complete the project. This is also where complications and risk are more likely to arise, and should include a clause for cost escalation.

All contracts should incorporate escalation clauses that allow suppliers to establish the base price for materials as quoted, and an adjustment if necessary when it is time to produce the job. This ensures that if the price of metal rises dramatically from when the contract is inked to when the job is delivered, suppliers are not left with a cost impact out of their control.

Additionally, contracts should include Damages for Delay clause due to pandemic shutdowns, shipping interruptions, etc. Delay damages arise out of delayed completion, suspension, or disrupted construction, and allow the contracting party to recover costs when a project takes longer than the contract specified.

Including a Damages for Delay clause in the contract provides a mechanism that allows the contractor the ability to anticipate and control the construction risk from a cost and schedule impact. Subcontractors and suppliers would also be entitled to recover their impact by an extension of time and/or cost to complete the job. This creates a financial incentive to complete the job on time.

Cards on the Table

The best way to mitigate risk for all parties involved is to be transparent and have clear communications at the outset of contract formation. Cost escalations are impacting every stretch of the construction and manufacturing industry. When material commodities become volatile, it is best practice for the parties to agree on a common source of objective and publicly available resources to document material cost fluctuations. In the US Metals industry, the London Metals Exchange (“LME”) prices or Midwest Spot commodities indexes can be used confidently to document fluctuation trends over any specific period. More importantly, it is important to establish a benchmark value at the time of the contract formation to be compared to the fluctuations experienced during the period to be examined.

Establishing relationships with manufacturers and procuring materials early in the process can help to minimize risk by securing lower prices through forward buying. Forward buying allows materials and commodities to be purchased at a known price and secured for fabrication and delivery at a later date. Forward buying should be considered to lock in material procurement if there is a belief that commodity prices are likely to increase.

Moreover, including the manufacturer in the design team through a design-assist relationship improves budget and project success. A design-assist contract ensures all parties agree on the parameters early. The team reviews project sketches and selects materials and finishes early on. This approach has the propensity to lower costs, mitigate risk, and meet expectations for the project.

Whether the project involves a plans and specs procurement, design-assist or design-build contract, if an escalation event is identified the critical action item is to provide adequate notice to the contract parties as early in the discovery period as possible. During the contract execution stages, notice is critical to identify if the commodities markets movements could affect the contract price for the goods and services to be provided so that mitigation activities can be pursued. During these review points, there are opportunities to identify potential risk and resolve it but early notice is important to protect the interests of all project stakeholders. Legally, contract notice can take several forms:

Constructive Notice – At contract formation, the parties agree to peg the cost of performance to published material costs as in LME or Midwest Spot cited above. These values are published daily so constructive notice is accomplished in the publishing of those values to the public. The parties are assuming that all participants are aware of the publicly available information and are considered to be informed. This is the weakest and least compelling form of notice in the event of a contractual dispute.
Actual Notice – Continuously during the design process, the manufacturer will monitor material procurement and market movements and notify the contract participants in a timely fashion if there are price or procurement issues to manage expectations and allow those on the project team to adjust accordingly. The manufacturer will also provide product cost sheets and commodity cost sheets that include comparisons. This is the most compelling form of notice in the event of a contractual dispute. Even if specific values cannot be determined, at least the parties have received notice of a pending impact.
Specific Notice – After having provided actual notice of a pending price fluctuation event, the supplier/manufacturer can perform a re-estimate for the work based on the more current cost information based on current market conditions. This is a final opportunity to review proposals and for the manufacturers to provide information about material cost escalation.

Third-party validation is used to back up these proposals and rising costs are documented as a matter of mutual trust. As the commodities listing and published data are public, objective market information is available to show customers the factors impacting price swings. Additionally, actual metal costs can be shared at the time of contract formation for comparison to when the actual procurement process begins. To bring awareness to market volatility, especially with metals, Metalwërks has included a price-in-effect clause in its price proposals in addition to the boilerplate language in all proposals.

Case in Point: National Museum of the Army

The National Museum of the Army in Fort Belvoir, Virginia, showcases over 240 years of history in its 185,000-square-foot facility. The three-story building is designed as five pavilions connected by glass thresholds. Metal fins at the corners of each pavilion are incorporated over more glass to add texture and a dynamic sense of movement to the façade.

Metalwërks fabricated 100,000 square feet of stainless steel Arcwall™ Spline for most of the museum’s exterior. The conventional rainscreen wall system is installed over structural metal studs and exterior grade sheathing covered with a weather-resistant barrier.

The museum design team partnered with Metalwërks in a design-assist contract early in the process and mitigated potential risk by forward buying one million pounds of stainless steel when the material decision was made. The forward buy decision allowed the team to purchase raw materials at a lower rate and work collaboratively with Metalwërks to save time and money. By working collaboratively across the separate teams – design and manufacturing – smart planning through collaboration resulted in overall savings while meeting the design intent of the project.

Mitigating Project Risk

When it comes to executing construction contracts, the key is to make informed decisions from the beginning, ensure all parties are collaborating and acknowledging the uncertainty of our current market conditions.

Contracts that provide full visibility to all stakeholders – including recognition of the potential for changes in procurement costs from the beginning – protects everyone involved.

Fewer surprises translate into better partnerships and successful projects.