One of the major headlines in 2020, in construction, that did not directly involve the coronavirus, was the dramatic increase of lumber prices across the country. From April to September 2020 alone, general construction lumber prices increased 130%. Specific types of dimensional lumber increased as much as 158%. And while prices corrected slightly in the beginning of the fourth quarter of 2020, at the end of the year, prices were back on the move upward.

There are dozens of articles that discuss the economics behind the price increases, corrections and rebounds, but using those to predict where material prices are going or to change estimating or budgeting metrics is only half the battle. Most construction projects take longer than couple of days to estimate, sell and perform. Where that process takes months or even a year, contractors and subcontractors need a mechanism to seek compensation for cost increases.

Enter the price escalation clause. A price escalation clause is a provision that can be inserted into any contract to provide a way for subcontractors or contractors to recover some or all of the cost increases that occur over the course of a project under certain circumstances. While there are several variations and options for language to include in a price escalation clause, at a high level, there are two main types:

1. delay/event price escalation clauses; and
2. percent-change price escalation clauses.

The delay/event price escalation clause is triggered by a specific event happening or a delay and allows the affected party to seek reimbursement for the increased costs. Over the course of a multi-month or multi-year project, the event could be passage of certain milestone, a change of the calendar year or a critical supplier issuing a price increase. The event could also be a default by another party or a change of a specific contractor or supplier. Where any of these events could impact the cost of a project, the affected party should consider adding a provision that shares the risk of the increased cost.

More common is a price escalation clause that is triggered by certain delays that are not caused by the party trying to enforce the clause. The delays can be natural disasters, acts or omissions caused by other contractors or the project owner, pandemics, etc. Provisions can require the delay to last for a certain amount of time or can simply allow a party to recover increases no matter how long the delay lasts so long as the delay causes the increase.

Finally, percent-change price escalation clauses allow for a party to recover costs once their budgeted cost has increased by a certain percentage. These types of provisions are much rarer, but can be very useful where the parties are attempting to equitably distribute the risk of cost increases. This type of provision also is more likely to allow a contractor to recover for increased costs like the recent spike in lumber prices. If a spike in material costs occurs, but is not caused by a delay or does not occur during a delay, then a delay/event price escalation clause likely will not be triggered.

While the benefits of a price escalation clause are obvious, they can carry an unintended consequence. Most provisions limit the amount of the increase to the difference between the budgeted cost and the actual cost. This can require a contractor to open up more of its books or processes than it prefers in order to obtain the increase. It also requires contractors to be diligent in their estimating and budgeting to have a firm baseline against which to compare any increases.

Like with many contract provisions, price escalation clauses can be very nuanced and may even be regulated by statutes. Exercise caution when implementing them and consider consulting with an attorney when drafting or negotiating them.