One serious implication of the pandemic is its impact on Chinese production, as mass public quarantines, curfews, and travel restrictions implemented to help fight the spread of the disease have crippled manufacturing and shipping sectors, among others.
Thus, the question surrounding construction supply-chain problems reverberating from China’s efforts to fight the coronavirus epidemic is not a matter of if, but when, the effects will hit the U.S. construction industry, how extensive they will be, and how long they will last.
Among the ramifications U.S. companies can expect to begin feeling, if they haven’t already, include higher costs and price fluctuations, material shortages, logistics breakdowns, order cancellations and extended delays in product fulfillment and shipping, ultimately leading to slower project completion times and potential legal squabbles with both suppliers and project owners down the road.
Contractors are urged to begin preparing for these effects now by evaluating their own supply chains from end to end to identify vulnerabilities, identifying potential alternative supply sources, preparing for costs to soar, and making sure they have adequate provisions in their contracts to protect themselves from the increased costs and supply chain delays and interruptions that are threatening the construction industry due to the ongoing coronavirus epidemic.
Force majeure clauses
One of the ways contractors can seek to protect themselves is by including a “force majeure” clause in their contracts. A force majeure clause is a contractual provision that allocates the risk of performance if performance is delayed indefinitely or stopped completely due to circumstances outside of a party’s control which make performance impossible, inadvisable, commercially impractical or illegal and provides notice to the parties of the types of events that would cause a project to be suspended or that would excuse performance.
The purpose of the provision is to relieve a party impacted by the force majeure by extending, temporarily suspending or terminating the contract due to unexpected and unavoidable events such as “acts of God,” including hurricanes, tornadoes, floods, earthquakes, landslides, and wildfires, and certain man-made events like riots, wars, terrorism, explosions, labor strikes, and scarcity of energy supplies. To be classified as a force majeure event, the event must be beyond the control of the contracting parties, it cannot be anticipated, foreseeable, or expected, and the event must be unavoidable (irresistibility).
Without a force majeure clause in place, in some jurisdictions both the owner and contractor would share the risk, but in many others, the risk falls on the shoulders of the contractor for the increased costs caused by material shortages and higher prices and project completion delays due to these unexpected and unavoidable events outside of their control. Thus, anything that cannot be anticipated while drafting the contract and factors that could impede progress should be negotiated between the parties and addressed via a force majeure clause added into the contract.
When seeking to limit exposure, contractors must be specific and clear in their contract language when defining the scope and effect of a force majeure clause to protect themselves from unexpected liabilities. The following elements should be addressed in a force majeure clause:
- What events are considered force majeure?
- Who is responsible for suspending performance?
- Who is allowed to invoke the clause?
- Which contractual obligations are covered by the clause?
- How should the parties determine whether the event creates an inability to perform?
- What happens if the force majeure event continues for more than a specified period of time?
For companies that already have force majeure clauses in their standard contracts, it would still be wise to review those provisions to make sure they provide clear, comprehensive, and adequate protections for the company and consider whether terms such as “widespread epidemic,” “pandemic,” and/or “public health emergency” should be added to their force majeure clauses in light of the threat posed by the current coronavirus outbreak, as often courts will interpret the clause based on what is specifically listed in the contract.
Contractors should also review the terms of their existing force majeure clauses in preparation for potentially needing to invoke them for coronavirus-related issues, as many times force majeure clauses contain requirements that must be met to invoke and rely on the clause such as providing written notice within a certain time frame and mitigating some of the damages caused by non-performance.
Price acceleration provisions
In light of the wide-ranging and potentially long-lasting effects posed by the coronavirus epidemic on construction supply chains worldwide, contractors should also consider adding terms to their contracts to protect themselves from labor and material price increases in the form of a price acceleration provision. A price acceleration provision generally provides that the contractor may adjust the contract price to reflect the revised actual cost of the labor and materials. Assuming the contractor is using its own labor force, there may not be a significant enough increase in labor costs to warrant an adjustment of the contract. As a result, the price acceleration clause is usually limited to increases in materials over the course of a project.
Price acceleration provisions typically require the contractor to provide the prime contractor or owner with evidence supporting the claim for additional compensation through documentation of the increase in actual cost. Price acceleration clauses also sometimes contain a termination for convenience provision that may allow the contractor to escape a contract if the cost of materials has increased exponentially or the materials themselves have become difficult or impossible to fin
This last component is generally disfavored and often removed from the contract by prime contractors and owners because of the uneasiness they have with the idea of a termination for convenience. Nevertheless, it is still a worthwhile option to propose in order to provide the contractor with the utmost protection caused by substantial unexpected increases in the price and availability of materials. Below is an example of a standard price acceleration provision that contractors should consider adding to their contracts:
If there is an increase in the actual cost of the labor or materials charged to the Contractor in excess of 5% subsequent to making this Agreement, the price set forth in this Agreement shall be increased without the need for a written change order or amendment to the contract to reflect the price increase and additional direct cost to the Contractor. Contractor will submit written documentation of the increased charges to the Prime Contractor/Owner upon request. As an additional remedy, if the actual cost of any line item increases more than 10% subsequent to the making of this Agreement, Contractor, at its sole discretion, may terminate the contract for convenience.
A subcontractor may find it difficult to include a price acceleration clause in its contract with a prime contractor because both the owner and the prime contractor are looking for fixed prices prior to the start of the construction. In that situation, subcontractors may want to consider buying and storing materials prior to the start of construction to avoid the increases in prices that are expected to occur once the full force of the coronavirus-related disruption to China’s construction industry supply chains begins to be felt in earnest in the U.S. and elsewhere around the world.
Subcontractors may also want to request a deposit to purchase the requested materials depending on the nature of the job. To the extent that a subcontractor adds a price acceleration provision to their contract, the subcontractor should consider requesting that the prime contractor also add a similar provision in its contract to allow the prime contractor to seek additional funds from the owner for any labor or price acceleration that occurs.
Construction companies and contractors should also be cautious and use common sense when providing firm bids for contracts for projects that may not begin construction for several months from the time the proposal is submitted. Under these circumstances, the contractor faces additional exposure for any increases in the costs of labor and materials caused by the negative impacts of the coronavirus on the construction industry following the bid process.
Therefore, estimating those jobs thoughtfully, appropriately, and perhaps more conservatively can potentially make or break a contractor, at least for the time being while the extent of the repercussions of the coronavirus on the market are not yet known, and for many months to come until the epidemic is under control and global supply chains and economies begin to normalize.
Since there is no current vaccine for the coronavirus and the number of infected individuals continues to rise every day, no one can say how long it will take for the virus to be contained and the economy to normalize. Thus, the time is now for contractors to take steps to mitigate their risks and protect themselves from the wide-ranging and potentially calamitous effects that are expected to hit the U.S. construction industry once the aftershocks from the virus’s impact on China’s construction manufacturing and supply lines make their way here in full force.