Escalation clauses: When and why you should use them
The bottom line is escalation clauses protect your bottom line – but that’s not their only benefit. We’re outlining why they’re needed in residential construction contracts.
The COVID-19 pandemic brought a host of change to the United States. One major shift no one expected: a red-hot housing market.
With Americans forced to spend more time in their homes, homeowners developed a renewed interest in living space and home functionality. As a result, the demand for new home construction began to explode amid a global pandemic.
Manufacturers and supply chains were poorly equipped to meet demand. Multiple government-imposed lockdowns slowed—or entirely halted— the flow of goods and materials across the globe. As the demand for new homes drastically rose and unforeseen weather events compounded supply chain constraints, we saw a shortage of raw building materials lead to sharp price increases. Several raw material prices escalated to new heights: iron and steel prices grew 62.8%, lumber prices shot up 154% and the price for crude petroleum rose 186.7% … all within twelve months.
Catapulting prices in the middle of jobs left fixed-price builders in difficult situations, unsure whether to absorb the cost of rising materials or ask the purchaser for more money.
Luckily, a certain residential construction contract clause in fixed-price agreements can offer you protection: escalation clauses.
What is an escalation clause? This is a contract modification provision, working hand-in-hand with force majeure clauses, that allows builders to control the otherwise uncontrollable. Escalation clauses lay out when a specific force majeure event triggers a price increase (in either all materials or a specific one such as steel), the builder is entitled to adjust the contractually agreed-upon price.
For example, Builder B agrees to build a house for Purchaser P using a fixed-price agreement. In the middle of building the home, supply chain interruptions cause lumber prices to increase 30%.
Instead of absorbing the cost, Builder B has included an escalation clause in his residential construction contract which states that he is entitled to equitably adjust the price should a force majeure event occur. The force majeure section defined supply chain disruptions as a type of force majeure event, thereby triggering the escalation clause. Thus, Builder B’s job profit margins are protected from soaring material prices.
Including escalation clauses in your building contracts has several benefits:
1) Protect your profits
First, escalation clauses allow you to protect your businesses in a world of extreme demand, volatile prices and inconsistent supply chains. When prices rise, builders with escalation clauses can worry less about the detrimental impacts to their job profit margins.
2) Reduce job delays
Second, escalation clauses reduce potential job delays. Disputes often arise when the builder raises the total cost of the home, which can lead to job delays and scheduling conflicts. But, by including an escalation clause within the initial contract, you have a contractual provision you can point to as justification for rising prices.
3) Improve client relations
Finally, escalation clauses create transparency between you and the client. As we’ve mentioned before, the key to a good contract is transparency. Escalation clauses assist in setting the expectations between both parties from the start. The clearer you can be up front, particularly on matters concerning costs, the better the business relationship with your client.
When communicating a price increase to your client, be sure to: (1) contact the clients directly, either by phone or email; (2) explain the reason behind the price increase as many homeowners may not be aware of the disruptions your business is facing; (3) let the client be aware of the specific provisions within the contract that justify you in raising the price; and (4) be understanding of their position as rising costs can be one of the most difficult conversations to have with them.
To include your own escalation clause relating to a force majeure provision, be sure to contact your attorney*.
*The materials available in this blog are for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem.
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Sam Garrett serves as an internal law clerk for Buildertrend, previously holding roles as a Customer Success intern and legal affairs analyst. Throughout his time at the company, Sam has become well versed in the issues facing today’s builders and spends time researching ways to help pros overcome those challenges. He is currently pursuing his doctor of law from the University of Oregon.
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