Dear Friend of Duval & Stachenfeld:
Getting right to it, something that just about every builder, developer, sponsor, lender, and investor is facing right now is the unprecedented super-fast rise in prices and/or supply chain disruptions.
D&S partner, Michael Kupin, leads our Construction Practice. He prides himself on being a business lawyer, thereby focusing on what is most important to our clients from a business perspective. Below is a brief article that hits this critical supply chain issue head-on:
Supply Chain Havoc in Pending Construction Projects; and
What You Can Do About It
Supply chain woes seem to be everywhere, affecting virtually every business these days. Construction projects are clearly no exception. Reports indicate that steel pipe costs have risen 78% in the last 12 months; plastic construction products up 35%. Lead time for roofing materials can be 8-10 months, with some window curtain walls taking 12 months for delivery. We at D&S get numerous calls from clients asking what, as a property owner, can they do in their construction documents to protect themselves. Fortunately, we have some answers.
First, a bit of background. Two very common approaches used for construction agreements are the Stipulated Sum and the Guaranteed Maximum Price ("GMP") models. In general, with a Stipulated Sum, the Contractor charges a fixed price for a project. With a GMP agreement, there is a cap on the cost to Owner with Contractor absorbing the excess costs and with savings (if any) inuring to the Owner, or sometimes shared with the Contractor. Usually, there is also an outside completion date, often coupled with a daily penalty for late delivery (so-called, 'liquidated damages').
That is how those models are intended to work generally. However, the forms of agreements used for these approaches regularly have exceptions allowing for increased costs or time, some obvious (an Owner-initiated Change Order) and others that are less so (if Contractor encounters unexpected subsurface or otherwise concealed conditions).
Where do issues resulting from supply chain disruptions fit in? Who bears the risk of delivery delays, shortages of materials, equipment or labor, or price spikes, all of which result from supply chain disruptions? That depends on what your agreements say or don't say about the topic. Depending on the parties' sophistication and the project's complexity, the resulting contract provisions can vary widely in level of detail, refinement, and Owner-protection.
We have often seen in construction agreements (initial drafts, that is) generally worded, poorly thought out 'exceptions' to the commitments made by the Contractor to bring the project in within a budget and on schedule. That is just what the Owner should avoid. Instead, we like to be more surgical and think about the issues falling into four buckets we have labeled - define, mitigate, align, and verify.
Define: Define carefully and with detail the materials and/or trades for which a Contractor claim for increase in price or schedule can be made. Should the area of potential claims be limited to just steel piping? Just roofing materials? As an Owner, don't accept the position that supply chain disruptions affect every aspect of the project. They won't.
Mitigate: Require contractors to start pre-construction activities early, including buying out trades or materials. Storage issues for materials should be addressed upfront. Contractors should outline plans to seek out and propose alternate suppliers and materials. Those and other best practices should be stated in the agreement as contractual obligations to be satisfied before a Contractor can make a valid claim for a price or time adjustment.
Align Interests: Allocating the risks of supply chain issues between Owner and Contractor need not be binary – i.e., it need not be either all Owner's risk or all Contractor's risk. As an Owner, consider sharing the risk rather than place it all on the Contractor. That way, the Contractor still remains financially incentivized to take proactive actions and nimble, reactive steps to address the problem but is not required to absorb all of the risk, which could compel it to raise its fee or, perhaps worse, force the project into becoming an adversarial relationship. Risk-sharing can be achieved in numerous ways, such as on a percentage basis (and it need not be 50/50) or on a time basis (Contractor absorbs any near-term price spike after which the risk of longer-term price spikes shift to Owner or gets shared). Cost savings sharing provisions can also be used. There are many other ways to address sharing the risk.
Verify: Require the Contractor to provide evidence of the cost increases or delays. For many materials, there are benchmarks and published pricing information to be referenced. Consider requiring submission of invoices, bills of sale, payroll reports, pricing sheets, and work orders to support a claim for an equitable price increase or extension.
In addition to focusing on the four buckets above – define, mitigate, align, and verify – other concepts to consider are: set out a detailed early value engineering process to be used when a problem is first encountered; require early and frequent notices to Owner; establish a collaboratively working model among Owner, Contractor, and Subcontractors; reserve and account for storage locations and costs; require open-book transparency; and maybe even split up the project into segments, some based on a cost-plus model, and others based on a GMP or a Stipulated Sum model. And keep in mind that many of these solutions could require lender approval or need to be baked into loan documentation. Comprehensive solutions often become a coordinated dance among a variety of stakeholders, requiring careful, up-front thinking and planning.
In the end, the problems of supply chain disruptions in construction projects are real and pervasive; and, unfortunately, not going away soon. However, with deliberative thinking and prospective planning upfront, there can be a myriad of approaches to mitigating the potential problems so that the end result is a successful construction project for all parties.
If you have a project where construction work is to be commenced or is ongoing, feel free to call Michael for guidance in these areas. His contact information is as follows:
Michael Kupin
mkupin@dsllp.com
212.692.7341
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