Inflation: the elephant in a construction or contract negotiation dispute
Inflation is hitting the country hard. Consider this: $1 million in January 2020 has the same purchasing power as over $1.7 million today, according to the Consumer Price Index Inflation Calculator. No one can guess how much the dollar will weaken.
As the economy – the construction market in particular – continues to experience inflationary challenges, it is essential that homeowners, contractors and design professionals beware of the risks presented by inflation and understand the options for mitigate these risks. Below are answers to questions industry professionals may have regarding these issues.
Where does my contract deal with inflation?
Chances are your contract doesn’t deal directly with inflation. But that doesn’t mean the impact of inflation isn’t built into your contract (or should be built into contracts you sign in the future). Take a close look at these contractual terms, with an inflation lens:
- Escalation clause: If a contract includes a specific provision dealing with significant price increases, this provision is a good place to start. Escalation clauses handle price increases in a variety of ways and often entitle the contractor or design professional to additional compensation (or credit) if the price of material “x” deviates from some fixed percentage of a benchmark figure for the expected cost of that material. .
- Impossibility of Performance: Depending on applicable law, this doctrine may provide a defense to a claim for breach of contract where the impact of inflation has made it impossible to perform the obligations of the contract. Whether performance is “impossible” will vary depending on the circumstances, and many jurisdictions will require objective impossibility – meaning it must be impossible for any owner, contractor or design professional in a similar situation to run. This legal doctrine may also apply even if the contract does not contain a specific provision dealing with this issue.
- Impracticability of Performance: Related to the previous provision, if performance is impracticable, but not impossible, there may still be a defense (or at least a mitigating effect) of non-performance.
- Force majeure: Carefully read the force majeure clause to see if the impact of inflation can be taken into account, and if the relief available is simply more time to effect (which may not be helpful in the face of inflation), or a performance cost adjustment.
Such provisions are only the tip of the iceberg but a good starting point. Other relevant clauses include constructive change clauses or time extension clauses. Creators can even write a provision specifically addressing inflation risk.
Can I get damages specifically for inflation?
There are few decisions analyzing whether courts or arbitrators should take inflation into account when awarding damages. In specific circumstances, such as bad faith claims against insurers, there is precedent in some courts for considering the effects of inflation. For example, in this specific context, the Ninth Circuit Court of Appeals (analyzing California law) upheld the use of inflation as an element of damages where, among other factors, “there was a rate of ‘constant inflation during the compensation period’. (See Leslie Salt Co. v. St. Paul Mercury Ins. Co.nineteen eighty one.)
Several years later, the Ninth Circuit (this time analyzing Arizona law) ruled that “the investigator may take inflation into account in measuring damages for breach of contract, which will put the party aggrieved party in as good a position as if the contract had been fully performed and will avoid an otherwise unjust result.(See Safeco Ins. Co. of Am. c. Duckett1988.)
The impact of these decisions or related opinions on non-insurer litigation under Oregon law appears to be an open question. A saying taken from a recent Oregon Supreme Court decision seems to recognize the relevance of inflation when assessing certain types of damages (see Busch v. McInnis Waste Systems, Inc.2020), but if the court’s reasoning in Busch will result in a commercial build conflict remains to be seen.
Does prejudgment interest offset inflation??
The purpose of compensatory damages is to place a plaintiff in a position he would have occupied had there been no wrongful conduct. As many disputes are resolved years after the fact, prejudgment interest is a way to compensate a party for the time value of money. But whether prejudgment interest will also take into account the effects of inflation will depend on the time period in question.
In times of high inflation, prejudgment interest may be insufficient to fully indemnify a party, as most prejudgment interest statutes are not indexed for inflation. Parties to construction litigation, in particular, are cautioned not to assume that awarding prejudgment interest is a foregone conclusion – even setting inflation aside. Construction disputes often involve damages for additional work, delayed work, or changed work that is heavily disputed as to quantum, and often subject to expert disputes. Depending on the jurisdiction of a dispute, even successful claims may not generate prejudgment interest (or may only generate a limited award of prejudgment interest), which in times of inflation can be particularly damaging. to a company’s net income.
In these volatile times, it is essential to stay informed and plan accordingly. Construction cost trend tracking tools (like the one at www.mortenson.com/cost-index) are great resources. It is important for all parties to a construction project to keep inflation in mind when evaluating their next dispute or negotiating their next contract.
Mario Nicholas is a partner at Stoel Rives LLP and a member of its construction and design practice group.