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Given the significant risks associated with supply chain impacts to major construction contracts, a toolbox of legal and project risk mitigation strategies, presented here, should be considered to cover each major stage of a construction project: pre-construction/bidding/tender, contract negotiation, procurement and construction. In addition, when impacts do occur and disputes arise, the dispute resolution clause in contracts can become an important factor in resolving the disputes efficiently and effectively. This is especially important in construction contracts that have an international dimension and where oversight of the non-performing party may engage several legal systems.
Pre-construction phase: Key contractual provisions and planning
The preferred way to mitigate supply chain-related risks is to plan for them by allocating the risks in the construction contract. Often, a force majeure clause addresses such risks. Such clauses are commonly incorporated into turnkey-style engineering, procurement and construction (EPC) contracts that are widely used in international projects. However, force majeure clauses are absent from many industry-standard form building contracts in domestic or regional projects, such as the American Institute of Architects (AIA) and ConsensusDOCs templates widely used in the U.S. If a construction contract lacks a force majeure provision, construction contractors should consider adding one and clearly defining its scope to reflect the profile of the project. This process may include drafting express language describing events that would be considered force majeure where no universal judicial approach exists. For instance, the post-COVID contractual environment demonstrates parties specifically addressing risk in the context of a pandemic event. The absence of such a provision altogether would very likely be viewed as precluding relief. Owners cannot presume that mere silence in a construction contract is equivalent to a party’s reliance on force majeure provisions available under the operative law, thus limiting important protections for the owners. Further, owners should consider expressly allocating the contingent risk of supply chain impacts on major projects to avoid the risk of possible contractor cost claims based on the assertion that such risks were not contemplated at the time of contract formation, which could lead to claims of mutual mistake or commercial impracticability to seek recovery of additional costs.
When drafting such provisions in a construction agreement, careful consideration must be given to whether supply chain disruptions constitute a “force majeure event.” Drafters need to be careful about both the specific and general language used. For example, owners who unthinkingly agree to a definition of “force majeure event” that includes broad “catch-all” language such as “any other event outside the reasonable control of the contractor” may be unwittingly exposing themselves to potential additional cost claims.
Assuming that the definitions in a force majeure provision are appropriately drafted to address supply chain risk, the next issue to address is what relief will be available: Will the remedy for the force majeure event be limited to additional time for performance (and corresponding remission of liquidated damages risk that might be included in the contract for delayed performance) or will it result in an increase of the contract price? If it is the latter, then the parties must address the quantification of such price increases and the extent to which the increases will be compensable. Use of cost indices and material escalation clauses, such as “Day One,” “Threshold” or “Delay” clauses, might be considered, along with whether one party should bear the entire risk or the parties should establish a risk-sharing scheme.
Many commercial building contracts employ a cost-plus methodology, which is typically subject to a guaranteed maximum price (GMP) cap and includes an allocation of some level of financial contingency for unforeseen project impacts. On projects using this approach, the parties will normally enumerate unforeseen market price increases as an item of permissible contingency usage. Other contracts may classify materials subject to price volatility as contractual allowances, with negotiations then occurring over whether such items should be included in or should remain outside the GMP cap and/or any shared savings provisions. Contractors should be wary of any unit price provisions that would lock in amounts allowed for increased costs resulting from supply chain impacts. Finally, the parties should carefully consider the termination and suspension provisions of the contract. For example, the parties might consider whether a termination provision would allow a contractor to terminate an agreement because of materially changed conditions brought about by supply chain disruptions, as well as how these conditions are defined.
- Planning is key: Construction contracts should allocate risk of supply chain impacts through well-drafted force majeure or contingency clauses
- Procurement officials should minimize risk of supply chain impacts by securing key equipment and material supply contracts early
- Well-drafted dispute resolution clauses are essential for performance remedies and protective relief as they minimize impact and allow for proper enforcement