Material Cost Escalation, Delays and COVID-19: Managing Risk in Challenging Times

Spikes in building material costs and unforeseen delays in delivery are some of the unexpected consequences of the COVID-19 pandemic. The true impact of these consequences in the construction industry are just beginning to be felt, and the effects of such additional costs will likely continue for some time. 

Unlike the economic disruptions from the 2008-2009 recession, the economy has rebounded quickly from the pandemic. New orders for raw materials and component parts were strong in March and April of 2021, suggesting a strong construction economy outlook for the foreseeable future. However, there is inflationary pressure tied to this rebound — and it has a profound impact on construction project cost and financing. As inflation rises, the Federal Reserve is expected to begin to nudge interest rates up. Current inflationary drivers include commodities (such as oil, steel and other metals) all of which are critical construction materials. 

What Do High Material Costs Mean for the Construction Industry?

Although non-residential construction spending is still lower today than this time last year, there are signs that commercial construction is reviving. That being said, non-residential projects in 2021 and into 2022 will face some historic challenges, including the following:

• Increased Steel Costs. Steel, joist and deck costs are critical in many vertical construction projects, and recent costs of such materials have dramatically risen in price — in some instances, up 250-300% year over year. In addition, delivery lead times have endured significant delays, with regular delivery ranging from 12 weeks to as many as 40 weeks.
• Gypsum and Acoustic Insulation Materials. These materials are essential in commercial construction and include ceiling grids, insulation, drywall and joint compound. In 2021, costs increased by 5% to 20% per month in some markets.
• Increased Lumber Costs. Lumber costs have risen and continue to rise dramatically. Perhaps the most ubiquitous raw material in construction now — 2x4 studs — are up more than 400% in price, with extremely limited availability in many markets.
• Commercial Plumbing Supplies. Global markets in copper were disrupted by COVID-19 and other supply chain stressors, which caused prices to soar up 175% year over year in mid-April 2021. Similarly, finished carbon and stainless steel experienced increases up to 10% since January 2021 as supply chains became strained. In addition, lead times for delivery of these materials continue to increase and are not expected to stabilize any time soon.
• Commercial Electrical Materials. Like other industry segments, stainless steel, copper, PVC and resin — all of which are critical to electrical contracting — are spiking. Domestic manufacturing of PVC pipes has been down 40% because of unforeseen climate events in the South and Southeast regions of the U.S.

All of the foregoing challenges are compounded by an economy-wide shortage of available transportation and drivers to deliver these materials, which further delays use of the products that are already in short supply.

Additionally, the cost impacts and delays in delivery are worsening in real time — and during the bidding, award and construction of projects. Triggered by these dynamics, project cost and timing overruns are beginning to occur on a much larger scale. Absent some reaction by construction partners, delays and significant cost exceptions will plague projects well into 2022.

Recognizing and Assigning Risk

From a legal standpoint, the issue clients are confronting on an economy-wide basis is how to address these risks? More particularly, how can parties to construction contracts mitigate the threat of unexpected cost overruns and material delivery delays in the midst of a project?

Historically, owners, contractors, subcontractors, and suppliers have approached allocation of risk arising from material price increases on construction projects differently.

Owners often contend that prices are fixed during the course of the work, and any increase must be agreed in a change order. Downstream contractors, subcontractors and suppliers contend that any unplanned event or condition that results in increased costs is a basis for an adjustment to the contract sum and contract time. Until recently, however, the risk of such unexpected material price increases was not significant on an industry-wide basis. So, under normal circumstances, construction contracts did not directly contemplate this kind of contingency. This all changed in 2021. Volatile material prices have forced parties to a construction contract to address and account for unexpected price increases and delivery delays.

To date, parties have been forced to deal with these issues in a clumsy manner, especially when these contingencies are not carefully considered during the contracting process. Contractors, subcontractors and suppliers faced with increased material supply costs and delivery times that were not contemplated during contract negotiation are now resorting to force majeure or cardinal change arguments. Owners have often rejected these claims unless addressed in the contract. Force majeure and cardinal change have not historically been used to address product price increase; recently however, parties have resorted to these legal theories because the pandemic continues to influence the economy, current material prices and delivery delays. By identifying and embracing these issues during contract negotiations, parties can avoid murky legal arguments — and the prospect of future litigation — over such unexpected conditions.

What’s Next?

Looking forward, it is crucial for owners, contractors and other downstream construction partners to contemplate and address these concerns from the beginning. With respect to material price increases, it may be as simple as the parties recognizing potential volatility and negotiate a mutually acceptable price escalation clause. This approach should include the following actions:

• Identifying specific materials or material categories that may be at risk for significant volatility.
• If possible, identifying suppliers for these “at-risk” materials that will provide fixed pricing for a fixed period of time.
• Defining volatile pricing. For example, parties could create triggers like 5% over 30 days or 30% over 180 days.
• Pre-ordering materials when feasible (and accounting for storage costs).
• Anticipating the potential impact for future projects under current conditions.
• Discussing use of a contingency line item for raw materials.
• Considering bilateral flexibility: if the owner shares the risk of price increases, then the owner should also share the benefit if prices come down unexpectedly.

Unanticipated material delivery delays and product shortages will require similar flexibility. A shortage of material transportation resources may be a long-lasting outcome in the post-pandemic construction economy.

Prudent owners, contractors, subcontractors and suppliers need to carefully consider these issues when negotiating agreements in wake of COVID-19 and other unanticipated events that have occurred over the last year. Price volatility and related delivery delays of construction materials will likely remain for the foreseeable future. As with many issues, open and honest communication during contract negotiations surrounding issues that may arise on a project not only fosters a good working relationship, it can also avoid unnecessary costs, delays and disputes on the back end of a project.