OCA urges buyers to implement US-based hyperinflation escalation clause

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Inflation by Nick Youngson CC BY-SA 3.0 Pix4free

Ottawa Construction News staff writer

The Ottawa Construction Association (OCA) has published a notice encouraging construction services purchasers to implement a hyperinflation price escalation clause in new contracts, which would also allow for savings if prices decline.

“The association strongly urges buyers to consider adopting our recommended escalation clause based on the American ConsensusDocs 200.1 Amendment ‘Potentially Time & Price Impacted Materials’, as amended here, be adopted in all upcoming construction procurements,” the OCA said in a statement published in July on its website.

“Obviously, the tender documents, including the contract drafted by your organization and in particular its payment terms, are used as a means to allocate the burden of delivery risk and incentivise the contractor to deliver to time and quality,” the statement says.

“The form of contract (fixed price vs. cost plus for example) and its payment terms and the approach to risk allocation go hand-in-hand. The aim of the payment terms and pricing structure is to reflect the optimum balance between risk and return in the contract for you as owner/buyer. As a general principle, the approach should be to link payment to the delivery of service outputs and the performance of the contractor.

“Where a risk is transferred to the contractor, such as one relating to price and thus hyperinflation, the price paid by the owner reflects this and there is no adjustment mechanism if the event (hyperinflation/price escalation) does occur and impacts the contractor’s cost base (because it has already priced in the risk of the event occurring).

“Where a risk (e.g. hyperinflation risk) is not transferred (or not wholly transferred) to the contractor, contractual mechanisms can exist to adjust the price paid to the contractor by the owner by adjusting the price, or elements of the price, linked to a specified index.”

The OCA says without an inflation clause, contractors manage the risk of hyperinflation by:

  1. Carrying a contingency in their bid prices (negative impact on owner/buyer);
  2. Pre-purchase of material (neutral impact – but not overly available);
  3. Qualifying bid submissions (negative impact on owner/buyer);
  4. Making claims for price increase after contract award (negative impact on owner/buyer).

“Generally, a material price adjustment clause will entitle a contractor to a change order where the price of certain types of materials increases either between the time of bid submission or the time the contract is effective and when the contractor orders the material,” the OCA writes. “The amount of additional compensation the contractor can seek or the owner may claim (if a commodity price has gone down) may be based on either the actual price of the material versus the amount included in the bid or by using a commodity index to calculate the increased amount.”

But what about the possibility of price declines?

The association suggests the solution may lie in purchasers using standard contract form documents developed in the US under the name “ConsensusDocs”.

“The contract documents this group has developed are called ConsensusDocs because a series of trade organizations representing general contractors, sub-contractors and other construction professionals, came together and reached a consensus on what should be included in these standard form contracts in a way that will overcome some of the shortcomings that they saw in other standard form contracts,” the OCA writes.

Specifically, ConsensusDocs 200.1 Amendment No. 1- Potentially Time and Price-Impacted Materials and Schedule A, “is a good resource for drafting price escalation clauses,” the association asserts.

“Under this document, parties identify potentially time and price-impacted materials and establish a method for establishing a baseline price based upon market or catalog prices, actual material costs, material cost indices or some other mutually agreed upon method.

“This document provides for an agreed upon percentage adjustment to the contract price for increases or decreases in the baseline price, excluding overhead and profit, provided the contractor provides written notice and appropriate documentation substantiating such adjustmentIt also provides that the contractor shall be entitled to an equitable extension of contract price and an equitable adjustment of the contract price for the delay in the delivery of, or unavailability of, a potentially time and price-impacted material beyond the control of and without the fault of the contractor or downstream party.”

The OCA says it recommends referencing the United States Department of Labour Producer Price Index Table 9 (https://www.bls.gov/web/ppi/ppitable09.pdf) for any construction material. “This index was selected due to its superiority to any Canadian index as to its extensive list of materials and the monthly tracking of cost changes,” the statement says.

In its statement, the association provides and example of how the escalation clause would be implemented.

In the example, drywall is identified in the bidding stage as a material experiencing hyperinflation and is agreed upon between the buyer and prime contractor to be addressed with this price escalation clause.

“The baseline amount for drywall at time of contract is $400,000. Contract signed January 2022 and it agreed that the date of adjustment will be when the drywall is purchased five months later in May 2022.

The calculations then involve these considerations:

  • Baseline Price = $400,000
  • PPI Commodity Code for Gypsum is #13-7101 of US Dept of Labour PPI
  • PPI Index as of January 2022 is 417.482
  • PPI Index as of May, 2022 is 450.113
  • Difference is 450.113 – 417.482 = 32.631  which in percentage terms 32.631 divided by 417.482 = 7.81 %
  • Price Adjustment = $400,000 x 7.81 % = $31,240

Adjustment provision

With this model, the risk is shared. If prices go up, the contractor is protected from hyperinflation, but if they decline, the contractor returns the savings to the purchaser.

“We believe the attached is relatively balanced in that credits can be claimed by the owner/buyer if there is a decrease in certain commodity items identified by the contractor at time of bid,” the OCA writes

“We urge you to consider including a price adjustment provision in your upcoming tender documents which will benefit you in obtaining more competitive pricing given that contingencies will not be required or if required will be greatly reduced in a corresponding reduction in claims.”

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