Trump tariffs: mitigating construction cost claims

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Publication March 15, 2018

The Trump tariffs have arrived, and with them come several pertinent questions regarding development and construction in the United States. How will the Trump tariffs affect current construction projects and future negotiations, and how should in-house counsel and project management teams evaluate a contractor’s right to recover increased raw material steel and/or fabricated steel component costs? Most importantly, how do owners and contractors mitigate the potentially devastating effects of the tariffs on an otherwise strong and growing construction sector?

Depending on the contracting strategy and specific contract terms, most construction and development contracts will anticipate changes in applicable law (and will typically define “laws” or “government regulations” or both), and may include specific provisions allowing for increases to the contract sum for changes in law. All construction contracts, even industry templates (i.e. American Institute of Architects (“AIA”), ConsensusDocs, DBIA, and the EJCDC), vary from project to project and based on the rights and obligations of the parties; however, understanding the key terms to identify and highlighting and appropriately negotiating important concepts are vital to mitigate the risk of increased cost claims.

This article provides practical advice how the typical construction contracts in the energy, infrastructure, and commercial sectors will govern contractor claims for an increase in the contract sum resulting from increased material costs due to the Trump tariffs.

Tariff changes in typical EPC contracts

For typical engineering, procurement and construction (“EPC”) projects, most owners will discover that the EPC contract grants the contractor a change order for increased costs due to changes in tariffs, such as the recent tariffs promulgated by the Trump administration. However, the effect(s) of the applicable language will depend on how the EPC agreement defines changes in laws, change orders, force majeure, and other important provisions, as well as the thoroughness of those definitions. Here are some questions that an EPC owner should consider and some direction to the various provisions in the EPC agreement which will affect the outcome:

  • Does the EPC contract contain a provision for “changes in laws?” Some provisions will define what constitutes a “change” and what is included in the definition of “laws.” However, some EPC provisions will purposely (or naively) fail to define what constitutes a “change,” the time period within which a change must occur (e.g., following execution of the contract, following notice to proceed, etc.), or the breadth and scope of “laws.” For these reasons, the analysis does not typically cease at the definition of changes in laws alone.
  • Does the contract appropriately define “laws,” or is it left for interpretation whether laws include treaties, executive orders, etc? During pre-construction contract negotiations, owners and contractors may not appreciate that a specific definition of “laws” will be crucial at a later juncture in the project, while others intentionally leave the term vague and wholly undefined for the time-being in order to avoid confronting the issue during a contentious negotiation, valuing it less than other issues. But, overlooking or ignoring the definition leaves open several questions: does “laws” include every local licensing and permitting requirement? Does “laws” include only that which is statutorily imposed by a legislature with jurisdiction over the project? Or, does the definition of “laws” extend to issues such as treaties or tariffs which, in the case of the Trump steel tariffs, were manifested through executive order? Most likely, if the parties attempt to enumerate the types of laws included in the definition and do not specifically include tariffs, treaties or executive orders, the definition of laws likely does not include changes in tariff structures. If the parties do not attempt to further define “laws” or enumerate the types of “laws,” the parties will subject themselves to an interpretation based on the applicable state law jurisdiction.
  • Does the contract’s change order provision reference change in laws as grounds for an increased cost? Even if the EPC agreement lacks a provision calling for a potential increase in the contract sum for “change of laws,” the contract’s change order provision(s) may otherwise grant the contractor the right to request an increase in the contract sum for changes in conditions. And, sometimes those changes in conditions may specifically reference “changes in laws” as a condition entitling the contractor to an increase to the contract sum through a change order. In this regard, change order provisions specifically referencing changes in laws directly implicate the analysis above regarding change in law provisions. However, some EPC agreements contain a change order provision entitling a contractor to a change order for “changes in conditions” but does not specifically reference changes in laws as a “change in conditions.” Further, sometimes these EPC agreements entitle a contractor to a change order for “changes in conditions” but do not define what “conditions” constitute entitlement to a change order. The owner’s likelihood of success in defending a claim for a change order for an increase in material prices due to tariff changes increases if the parties attempt to define or enumerate what constitutes a “change in conditions” and if that definition or enumeration does not include changes in laws. However, beware of the “catch all” language often found in the EPC agreement. For example, if the change order provision references “conditions not reasonably foreseeable to contractor”, or conditions not reasonably inferable from the “contract documents” or “conditions or circumstances beyond the reasonable control of the contractor (the worst case scenario for the owner), the contractor’s likelihood of success on a claim for an increase in the contract sum increases.
  • Does the change order provision otherwise reference force majeure events as a ground for increase in contract price? Even if the change order provision does not specifically reference change in laws or change in conditions, the change order provision may reference a right to increase in contract sum caused by increased costs resulting from a force majeure event, which begs the next question.
  • How does the contract define force majeure? The literal definition of “force majeure” derives from French language and means superior force. In the EPC and construction contract context, typically, the parties intend the force majeure provisions to define when and how the parties may excuse or suspend performance because of conditions outside the control. However, some owners mistakenly allow contractors to not only negotiate definitions of force majeure to include circumstances rising to the level of “force majeure” (e.g., hurricanes, fires, labor strikes, war, etc.), but also to include language enumerating the specific types causes, along with a “catchall” phrase, such as “anything else outside the reasonable control of contractor.” Although this type of provision may seem innocuous during pre-construction negotiations, this open-ended and vague concession by an owner could have a significant impact on the project, as it may entitle the contractor to an increase in the contract sum even if the definition of force majeure does not otherwise specifically enumerate tariffs, treaties, or executive orders.
  • What else should the parties to an EPC contract consider when analyzing the effects of new tariffs?
    • Can a “change in laws” result in entitlement to an extension of time for completion of the project?
    • If the owner denies an increase in the contract sum, what are the contractor’s rights and requirements to assert a claim? What are the timing provisions for asserting a claim? Must the parties consult a third party for an initial opinion regarding the claim and how quickly must the parties resolve the claim before reverting to the dispute resolution provision?
    • What are the contractor’s rights to suspend or terminate performance for the cost increases even if the tariffs do not amount to a force majeure event? What are the owner’s rights to recover damages against a contractor who suspends work or terminates for material cost increases that do not entitle the contractor to an increase in the contract sum under the EPC agreement?

Cost plus, GMP and other Non-EPC/lump sum contracting strategies

 

Whether or not a contractor in a cost-plus, GMP, or other non-EPC/lump sum contracting strategy may succeed on an increased cost claim depends on many of the same definitions as an EPC agreement; however, there are some substantial differences and omissions in the industry templates on these issues, including the lack of definitions of changes in laws and force majeure. Instead, the contractor’s right to an increase in the contract sum often depends on the following terms and conditions:

    • Guaranteed Maximum Price. In a Guaranteed Maximum Price (“GMP”) contract, the parties typically agree that the owner will reimburse the contractor for the cost of the work, plus the contractor’s general conditions and a contractor’s fee (usually on a percentage of the anticipated or actual cost of the work), but the contractor will agree to accept the risk that the total costs of the cost of the work plus the general conditions and the contractor’s fee will not exceed a guaranteed maximum price. In this regard, when tariffs promulgated after the contract execution date increase the contractor’s cost of the work for the project, the contractor likely accepts the risk unless the change order and other provisions permit the contractor to an increase in the GMP.
    • Cost of the work. As stated above, the typical cost reimbursable contracts, whether with a GMP or not, typically define the cost of the work the owner agrees to pay, and the cost of the work does not typically distinguish between the anticipated cost of the work (a) at the time of execution of the contract and (b) at the time the contractor actually purchases the materials or executes subcontracts for the scopes of work including those materials. However, some shrewd contractors will attempt to modify the cost of the work provisions to include clauses that acknowledge the owner’s understanding of the risk that material prices may increase, and the contractor’s subsequent right to an increase in the GMP should material prices increase beyond assumptions in the schedule of values attached to the contract.
    • Changes in the work. If the definition of cost of the work does not include an acknowledgement of the contractor’s entitlement to an increase in the GMP when material prices exceed certain assumptions in the schedule of values attached to the contract, then the contractor will likely rely on the change order provisions in the contract. Typical industry template forms vaguely entitle the contractor to an increase in the contract sum or GMP as a result of “changes in the work” or “changes in scope.” These same industry forms fail to specifically enumerate whether material cost increases resulting from changes in laws, treaties, tariffs, or government policies, constitute a “change in the work” or a “change in scope” entitling the contractor to an increase in the GMP or contract sum. However, properly modified industry forms and properly negotiated bespoke agreements should anticipate these types of claims.
    • Material changes. In addition to provisions regarding “changes in the work” and “changes in scope,” some of the various construction contract forms include a definition of material change. The best “material change” definitions make clear that the contractor must anticipate minor modifications in the scope of work and the contractor must perform the work for the GMP or contract sum pursuant to: a) all of the designs, materials, and documents provided to the contractor; b) the definition of the scope of the work contained in the construction contract; and c) any additional work “reasonably inferable” from the designs, materials and documents provided to the contractor prior to execution of the contract. Further, if used properly, the material change definitions should also make clear contractor may not recover for an increased cost of work or for increased general conditions unless the material change actually results in increased costs and/or a critical path delay to the project.
    • Unforeseen conditions. Most contractors attempt to shift the risk for unforeseen conditions to the owner. In doing so, some contractors modify contract forms to include a broad enough definition of unforeseen conditions, which may potentially include unforeseen changes in material costs resulting from changes in laws, regulations, tariffs, treaties, polices, etc.
    • Allowances. Some of the various contractual arrangements will include certain variable and volatile materials as allowances, inside or outside of the GMP or contract sum. When the parties lock in the costs, the parties then execute a change order to either decrease the GMP or contract sum based on whether the actual costs are in excess of or less than the anticipated amount. This strategy allows the owner to ask the contractor to take greater risk on other contracting factors, but does not require the contractor to take a great amount of risk for investigating the material markets applicable to the project.
    • Contingency.  Other owners and contractors will agree to an amount of contingency, typically a percentage of the total anticipated cost of the work and often times owners and contractors will agree to enumerate certain factors for which the contractor can draw against the contingency line item of the schedule of values when the cost of work for another line item exceeds the budgeted or anticipated value. If the parties enumerate unexpected increases in market price for materials as a contingency item, the contractor may recover the increased costs if contractor has not previously depleted the contingency funds for other allowable costs.
    • What are the other considerations owners should analyze when negotiating construction contracts?
      • Is the contractor entitled to an increase in the GMP for the increased cost of work resulting from the increase in material prices, or can the contractor recover an increased contractor’s fee and general conditions? The answer will depend on specific provisions in the change order definition stating when, if ever, the contractor receives an increase in fee or general conditions. From an owner’s perspective, the contractor should not receive an increase in the general conditions unless the contractor suffered an excused delay to the project and the delay actually affected the project’s critical path to the extent the contractor must expend additional amounts to supervise the project for a longer duration or because the contractor increased the amounts of its supervision and management over the same duration to accelerate the project to overcome delays.
      • What are the termination provisions of the contract and is the contractor entitled to terminate because of materially changed conditions?
      • What are the suspension provisions?
      • Are there unit price provisions which would lock in the amounts allowed for increase costs resulting from tariffs?

What should you do next?

The Trump tariffs have already resulted in claims and notices of claims for our firm’s clients. Most importantly, the legal teams and project professionals charged with analyzing and determining the entitlement to these claims need to know what to do first and next. First, we recommend a full analysis of all applicable contract provisions, whether included in our summary above or otherwise. Parties often overlook exculpatory provisions or other acknowledgements modified into unsuspecting but somewhat related provisions. Next, we recommend gathering all key project documents related to the claims. For cost claims, our construction lawyers have prepared a Cost Claims Checklist and would be happy to share it with our client. Lastly, we highly recommend concurrent documentation as close to the time of the notice, even if the documentation of the dispute does not include final resolution.

Our construction lawyers resolve complex construction disputes for energy, infrastructure, and commercial construction clients through unparalleled, world class knowledge in the energy, infrastructure, commercial construction and real estate sectors coupled with an extensively deep bench in construction disputes. We routinely counsel owner, developer, and sponsor clients throughout all aspects of the construction process to avoid disputes when possible, manage risk, and recover damages necessary to maintain profitable projects.

Our lawyers know construction. We stand alongside our clients conducting critical path delay and liquidated damages analysis, reviewing change order and extra work claims, assessing design professional errors, mitigating defects, evaluating performance guaranty damages, and documenting all types of hurdles, pitfalls, and unexpected project anomalies.

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