Problematic Construction Contract Clauses: Escalation

This is the eleventh blog post in a 12-part series that discusses clauses in construction contracts with the goal of providing awareness of contract terms that often cause difficulties and give rise to claims.

Previous blog posts have addressed problematic contract clauses involving differing site conditions, no damages for delay, changes, coordination, suspension of work, warranty and defects liability, variation in quantity, inspection, force majeure, flow down, compensation and payment, and weather. This post discusses escalation clauses, and the twelfth post will discuss oral modifications clauses.

Escalation Clauses
An escalation clause provides price or rate adjustments depending on changes in a specific index or factor, like the cost of living or the price of a particular good. It protects against inflation and ensures fair and reasonable prices or rates. It can also safeguard parties from losses due to inflation or market fluctuations and help to avoid disputes.

An escalation clause can be used as a risk management tool by both parties in the contract. It should specify the formula or index used to determine the adjusted price or rate, the frequency of adjustment, and the maximum amount to which the cost adjusts.

Certain contracts specifically state that the contractor’s compensation is not subject to escalation. An example of such language for a lump sum contract for engineering, procurement, and construction management services is as follows:

Compensation, Payment and Taxes
In consideration of the engineering, procurement and construction management services performed hereunder, Owner will pay to Contractor a lump sum amount of         (    ) (U.S. or Foreign) (“Lump Sum for Services”), not subject to escalation, subject to such additions and adjustments thereto or deductions therefrom as may be made pursuant to the Agreement.

However, if the contractor is delayed because of a scope change or an owner-caused delay, there is a possibility that the contractor may be entitled to escalation costs if it can prove these damages. Owners who use clauses prohibiting escalation may encourage higher bids from contractors where there is uncertainty regarding delays that may occur on the project.

A contractor may recover unanticipated escalation costs for labor and materials for a compensable delay. Such recovery requires a comparison of the schedule of planned expenditures to actual expenditures. An integrated cost and schedule activity relationship is the single most important tool in establishing a contractor’s right to claim escalation costs due to a delay. If the schedule is CPM-based, the effect of a delay on the critical path can first be analyzed to allocate the responsibility of the delay. As a second step, the as-planned cost can be directly compared to the as-built cost of the activities whose delay is compensable. In some cases, these costs can be substantiated by evidence of an increase in labor rates as detailed in a union agreement. Another method of proof available is the use of labor and/or material indices published by governments or various companies.

Another complication to recovery of escalation costs may be a “no damages for delay” clause in the contract. However, certain circumstances, such as the delay not being contemplated by the parties, may overcome this restriction. See Richard J. Long’s article “The ‘No Damages for Delay’ Clause.”