CONSTRUCTION Accounting ARTICLE -
Price adjustment clauses can help curtail unforeseen costs
Target Audience: Construction Industry Professionals, Home Owners, General Contractors, Construction Accountants
From 2004 until late 2008, construction materials prices took contractors on a wild roller coaster ride, with many months and years bringing double-digit price percentage increases for steel and asphalt. Although prices for many materials have dropped or held steady in the last couple of years, some are climbing again.
The moral of the story? Construction materials prices are erratic and largely unpredictable — particularly in a shaky economy — and you can never be too careful when it comes to protecting yourself.
Rock, meet hard place
As construction materials prices skyrocketed, many contractors padded their bids to include room for increased materials costs over the life of their projects. The recent recession, however, has made it difficult for these cushioned bids to win jobs, so you may feel pressured to submit unrealistically low-priced bids.
To compound the financial stress of this situation, in many areas tensions are rising between owners and contractors: Owners feel taken advantage of when prices fall, and contractors feel forced to eat additional costs if bids leave no wiggle room for price increases. This conflict can lead to costly litigation, contract losses, defaults, project delays, and damaged reputations and relationships.
A good clause
One way to prevent, or at least mitigate, such sticky situations is to add a price adjustment clause to the contract. These clauses identify specific materials at risk for price increases and set an effective date from which to measure price changes that trigger an adjustment to the contract amount for materials. This date might be the date a contract is signed or the date a supplier provides initial quotes.
The clause must also identify the indexes used to gauge price fluctuations — for example, invoices from suppliers. Owners may insist, however, that a regularly published and credible index, such as the Producer Price Index, be used to support suppliers’ price increases. More than one index may be used if materials or currencies differ greatly. You can also include stipulations that specify the exact percentage a price must fluctuate to activate the clause.
Last, the contract must stipulate when and how often price adjustments will be considered and the process through which an owner will be notified of a price change. For instance, a clause might stipulate that adjustments be considered each time a materials shipment or purchase is made.
A win-win . . . generally
Price adjustment clauses can be helpful to contractors, but they go both ways. Clauses also protect owners in the event that prices drop from the original agreed-on numbers. Regardless of which way prices go, solidly drafted price adjustment clauses are generally a win-win — saving both parties time, money and risk.
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