War-Fueled Rising Construction Costs May Warrant Force Majeure Review | Stoel Rives – Ahead of schedule
The Russian invasion of Ukraine and the economic sanctions imposed by countries around the world in response have cut off the supply of fuel, steel and other materials needed for construction. This has led to price escalation that threatens construction project budgets. Owners and contractors across the country are running to their contracts (and their lawyers) to figure out who bears the risk of these cost increases. Although contracts vary widely in allocating the risk of material price increases, there are a few common provisions to look out for.
Some contracts include express material price increase clauses or material allowances that distribute the shared risk between the contractor and the owner. Some contracts also have broadly enforceable amendment provisions that grant the contractor the ability to request an adjustment to the contract price. But in the absence of such provisions, the key contractual clause is often a “force majeure” clause, which deals with the allocation of the risk of unforeseeable events beyond the control of the parties.
An example of typical force majeure language is:
“The Contractor shall not be in default by reason of any failure to perform this Contract in accordance with its terms if the failure arises from causes beyond the reasonable control of the Contractor, including, but not limited to, cases of force majeure or public enemy; strikes or labor unrest; riots or civil unrest; acts of war; epidemic or pandemic disease; acts of governmental authorities; or exceptionally severe weather conditions.
Unfortunately, this type of language can raise more questions than it answers. When a military conflict directly affects the performance of the contract, the conflict will generally be qualified as an event of force majeure. But it is rare for a contract to specify what qualifies as “war”. Is a foreign war away from the project site an “act of war” affecting performance? What about material price increases caused by the economic ripple effects of war?
Courts have dealt with similar issues before, albeit rarely. The basic rule laid down in various cases is that the contractor generally bears the risk of price increases due to shortages of labor or material resulting from war, but that such shortages may excuse delays in ‘execution. Definition issues have been discussed in the context of insurance policies. For example, “war” does not necessarily have to refer only to formal and declared war.
In the 1993 case TRT/FTC Communications, Inc. v. Pennsylvania State Insurance Company, a federal appeals court even determined that a theft that occurred during the 1989 Operation Just Cause conflict in Panama was caused by the war to the extent that it was “enabled by military hostilities.” But cases like these only provide a rough guide: every contract is different and should be assessed on its particular terms.
Some construction contracts, notably the American Institute of Architects model contracts, do not include force majeure clauses regarding cost increases. In such cases, the risk of price escalation generally rests with the contractor unless he can demonstrate that the increase fundamentally altered the project in a way not intended by the parties or made the execution genuinely impossible. These positions are generally difficult to defend and tend to lead to costly and time-consuming dispute resolution procedures.
If a contract contains a force majeure clause which appears to cover the indirect price impacts of a foreign war, it is imperative that the contractor strictly adheres to all notice and complaint procedures specified in the contract. A contractor may waive its rights to request a price or time adjustment by failing to comply with the procedures. Procedures often require advance notice of the event within a certain number of days. But this poses another difficult question: is the relevant “event” the outbreak of war or rising downstream prices? This ambiguity can again lead to disputes, so a contractor should provide notice as soon as possible.
For those entering into contracts, how should the parties deal with this kind of conflict-driven price escalation? Contractors should consider the possibility of extensive military conflicts impacting prices and availability of materials and take this risk into account when preparing bids or estimates. Owners may be incentivized to agree to material allowances or price increase clauses, assuming some of the risk, rather than paying contingency prices. For negotiated contracts, it is advisable to negotiate specific and well-defined force majeure clauses and to specify price thresholds or percentage increases over defined periods for key materials beyond which price increases constitute a compensable change. This can provide some degree of certainty to the parties and reduce the risk of disputes based on competing interpretations.
Like it or not, in the wake of the war in Ukraine and the escalation of international tensions, it is harder to say that the war and the resulting price hikes are truly unpredictable events. Although force majeure clauses are often boilerplate and easily ignored, it is important that owners and contractors pay careful attention to the allocation of risk in their contracts for these types of increases.
Originally published as an editorial by the Oregon Daily Journal of Commerce on May 19, 2022.