Tariffs, Contracts and Construction
by David B. Applefeld, Esquire
With ongoing changes in trade policy, businesses working in the construction industry need to be proactive when negotiating and drafting their contracts and evaluating their risks.
Construction services are typically delivered under either a fixed price or guaranteed maximum price (GMP) arrangement. Under a fixed price contract, the contractor agrees to perform a defined scope of work for a sum certain. Absent a change to the scope of the contractor’s work, the contract price is fixed, and the contractor bears the risk of unforeseen events impacting its cost to perform. Under a GMP contract, the contractor is paid for the cost of the work plus a stipulated fee, which in total cannot exceed an agreed maximum contract price. Absent a change to the work, the contractor similarly bears the risk of events impacting its cost to perform because there is a maximum contract price. The imposition of tariffs on imported construction materials can dramatically impact a contractor’s cost and ability to perform.
A tariff is a tax that is imposed by one country on goods imported from another country. Tariffs are paid to the country of destination by the party importing the foreign goods. Tariffs are often assessed at a percentage of the value of the imported product. For example, if a shipment of imported lumber is valued at $10 million dollars and a 25% tariff is imposed, the importer must pay a $2.5 million tariff on the imported goods. Because this increased cost is passed down through the supply chain, tariffs can significantly increase the cost of imported products used by the construction industry such as lumber, steel, aluminum and electrical components. In addition to increasing construction material costs, shifting tariff policies and associated supply chain disruption also lead to uncertainty when setting the contract pricing. Contractors and project owners facing these challenges can take immediate steps to protect themselves by reviewing their existing contracts and contract form templates. It is noteworthy that the standard American Institute of Architects (AIA) form contract documents do not specifically address tariffs, but do include provisions concerning taxes and potential force majeure events that may be relevant to analyzing the impact and allocation of risk associated with tariffs.
Because tariff policies can change rapidly and create uncertainty for business in the construction industry, a well drafted contract that anticipates and addresses the impact of tariffs is essential. The following contract provisions are among those that should be considered:
• Price Escalation Clause: A price escalation clause is a contractual provision which transfers the risk of price fluctuations from the contractor to the owner, by allowing the contractor to increase its agreed contract price upon the happening of certain events such as material cost increases, changes in labor rates or other market conditions. Price escalation clauses are designed to protect the contractor from unexpected and unanticipated increases in costs that might otherwise lead to financial hardship or project delays. Price escalation clauses should be negotiated at the contract drafting phase. A well drafted price escalation clause will clearly identify the triggering event and the adjustment mechanism, and will document the existing conditions at the time the contract is signed.
• Change-in-Law Clause: A change-in-law clause is a contractual provision that specifies how unforeseen legal changes will be addressed by the contracting parties. These clauses set forth the terms on which a party supplying goods or services can recover its increased cost to perform due to a change in the law. Absent such a clause, the cost of complying with both current and unforeseen legislation that is enacted after the contract is signed is deemed to be built into the contractor’s price, and the risk falls on the contractor.
• Force Majeure Clause: Taken from French law, the term force majeure literally translates to mean “superior force”. It refers to a contractual risk allocation provision which excuses performance when circumstances beyond the contracting parties’ control make performance commercially impracticable, illegal, or impossible. Such clauses have been successfully invoked to excuse performance, obtain time extensions, and justify changes to the contract price following natural disasters, acts of terrorism and changes to governmental regulations. By definition, a force majeure event must include three characteristics. First, the triggering event must have been unforeseeable. Second, the event must arise from an external cause outside the control of the party seeking relief. Finally, the event must be unavoidable such that the party seeking relief could not have avoided the adverse consequence by exercising due diligence.
Shapiro Sher’s construction law team has more than 30 years of experience counseling contractors, owners, design professionals and suppliers in all phases of the construction process. If you have questions about how tariffs may impact your business or navigating other construction law matters, contact David B. Applefeld at dba@shapirosher.com