Avoid disputes with a discussion, contract

Susan Linden McGreevy breaks it down for contractors looking for ways to protect themselves contractually against price and availability problems.

Although the recent economic downturn has left people scrambling for ways to increase sales and profit while avoiding risk, the construction industry has been vulnerable to price and availability fluctuations for decades. One of the many effects of globalization on construction, as well as just about everything else, is that a construction boom in Shanghai can result in a sheetrock/steel/you-name-it shortage in Shawnee, Kan., or Shannon, Ireland. And even if you can get goods, can you afford them?

This gets people talking about how to best protect themselves contractually against price and availability problems. Contractors have been trying for a long time to come up with solutions. In the 1950s and 1960s, ITT Arctic Services was providing monitoring of the Distant Early Warning System (the DEW Line) in Canada for the U.S. government. ITT Arctic Services was paid in U.S. dollars, but was incurring a lot of its expenses in Canada. This was fine until May 31, 1970, when the Canadian government removed the fixed par value of its currency, allowing the Canadian dollar to float in the International Money Market. For the first time in memory, the Canadian dollar fluctuated upward in value against the U.S. dollar.

The contractor sued the United States, claiming that it had not assumed this risk in signing the contract. The U.S. Court of Claims disagreed. In this case, it decided that the risk of currency fluctuation was squarely on the contractor. Nowhere in the contract was there language in which the government made any representations about exchange rates. Since ITT signed a firm, fixed-price contract, the court found that it had assumed the risk of unexpected costs.

ITT Arctic Services was not alone in its approach. Contractors, particularly those doing firm, fixed-price work, price their bids, and after the bids are accepted, scurry around for ways to improve the bottom line by finding less expensive ways to get the work done, including purchasing materials for less than the bid price. They fully expect that, if successful, this effort will go right to the bottom line. The last thing they expect is to have to turn over the savings that they have worked hard to realize to their customer. Even cost-reimbursement contractors frequently cut deals that allow them to share savings that they created for their customers.

Yet there is a dilemma. What goes up can also go down, and what is delayed in delivery can also arrive early. What is fair for a contractor to request of its customer? Let's break this down into the most common options.

Unavailability, delay and price: If the goods are unavailable anywhere, the cause usually is a natural disaster, war or other event that normally comes within a typical force majeure clause. In this world, however, there are very few things that are unavailable, period. Just as a ticket scalper can get you four front-row seats to a sold-out concert at $1,000 each, most construction commodities can be found, somewhere, if you are willing to pay the price. Unless you have specifically addressed the potential issue in the contract, however, the force majeure clause will not apply to these situations.

Extra time and money: What most contractors really want is to be paid the extra cost of purchases over what was included in their price/estimate, or the extra time to complete required by waiting on allocated goods. It is possible to draft a clause to do this, but when you plan your strategy of how to approach the customer, think through a couple important items.

Some owners may be persuaded that a one-way clause is in their interest because it avoids the inclusion of a contingency in the contractor's price for something that might never occur. In other situations, a clause that only benefits the contractor will be harder to sell than one that could also benefit the customer. If assumptions are built into the contract, such as X dollars per ton of steel, or Y weeks for delivery of chillers, the parties can quantify the adjustment up or down to the contract in the event of the specified potential problem.

Also define what “cost” means. Do you get a volume rebate? Are you eligible for a free trip or refrigerator if you buy enough goods from a manufacturer? Make sure that you take the time to consider all the factors that go into your representation to your customer of what your net price is. This is crucial on public contracts in particular, where there may be stiff penalties for overpricing, such as the U.S. False Claims Act.

Most customers understand that you can't control pricing, and that if you are going to take on that risk, the customer will pay more. An advance discussion and contract agreement on how it will be handled can avoid disputes later, but make sure you have done your homework and come up with a plan that is realistic and fair to both sides.

Susan McGreevy is a partner at Stinson, Morrison, Hecker LLP, Kansas City, Mo., 816/842-4800, e-mail to [email protected].