Over the last few years, the construction industry has witnessed unprecedented fluctuations in material costs, most notably during the COVID-19 pandemic. Pandemic-driven supply chain disruptions propelled prices of commodities like lumber and steel to record highs, leaving contractors, suppliers, and owners scrambling to absorb unanticipated costs. Further, design professionals were put at risk given how certain pricing models conflicted with commitments to “design to a budget.” As new tariffs now loom on the horizon, some industry experts fear we may face similar price volatility. Whether these tariffs will fully mirror the pandemic’s wave of cost escalation remains to be seen, but prudent construction professionals are once again dusting off their contingency plans—and their contracts—to proactively manage potential price spikes, shortages and disruptions to supply chains.
With the looming potential for increased tariffs on foreign products under the current U.S. presidential administration, construction professionals—including general contractors, design-builders, material suppliers, subcontractors, architects, and engineers—are closely watching the impacts on material costs. Price fluctuations in key materials such as steel, aluminum, lumber, and glass have already created challenges for project budgeting, procurement strategies, and contractual risk allocation.
As the industry grapples with these uncertainties, construction professionals must proactively address the potential financial burden of tariffs by structuring contracts that account for cost escalation. This article explores how to draft contracts that account for potential material price increases, examines recent industry trends, and provides practical strategies for mitigating risk.
Addressing Potential Material Price Increases in Contracts
One of the most pressing questions is how to address potential material price increases in construction contracts. While contractors have long dealt with fluctuations in labor and material costs, tariffs present a unique challenge—an external governmental action that can cause rapid and unpredictable spikes in pricing.
To mitigate this uncertainty, many contractors are turning to “material price escalation clauses.” These provisions allow for adjustments in the contract price when material costs exceed a predetermined percentage threshold. A well-drafted escalation clause should clearly define which materials are covered, specify how cost increases will be measured, and outline a mechanism for verifying and approving adjustments. Some contracts tie pricing to external indices such as the Producer Price Index for Construction Materials, ensuring that price increases are based on objective market data rather than supplier pricing alone.
Another emerging strategy is the use of “allowance provisions” for materials that are likely to be affected by tariffs. Instead of locking in a fixed price, the contract provides a flexible budget for these materials, allowing adjustments based on actual procurement costs. In some cases, contractors are also negotiating early procurement agreements, securing materials before tariffs take effect to avoid cost spikes altogether.
Who Bears the Burden of Tariff-Induced Price Escalations?
Contractors are often at risk of absorbing material price increases unless specific provisions are in place to shift or share the burden with project owners. The degree of exposure largely depends on the contract type:
- Fixed-Price Contracts (Lump Sum): The contractor assumes full responsibility for any price fluctuations, including those caused by tariffs. Unless an escalation clause is included, the contractor must absorb any cost increases, which can severely impact profit margins.
- Cost-Plus Contracts: Material price increases can generally be passed on to the owner, provided there is no Guaranteed Maximum Price (GMP) capping the total project cost.
- Guaranteed Pricing Agreements: Contractors may find themselves locked into fixed prices without protection against unexpected increases, making it essential to structure supplier agreements carefully to avoid one-sided exposure.
One critical issue is whether a tariff increase can trigger a force majeure or change-in-law provision, allowing contractors to seek relief. Some contracts define new tariffs as a material change in the law, entitling the contractor to additional compensation or renegotiation. However, this is far from standard practice and depends heavily on the specific contract language.
Another potential risk lies in subcontractor and supplier agreements. General contractors must ensure that any escalation protections negotiated in their contracts with owners are mirrored in their agreements with suppliers and subcontractors. Otherwise, a general contractor could be on the hook for cost increases that cannot be passed down the chain.
Best Practices for Contract Provisions to Protect Against Tariffs
To safeguard against the financial risks posed by tariffs, contractors should incorporate specific contractual provisions that allow for cost adjustments. The most effective strategies include:
- Material Escalation Clauses, which should contain the following elements:
- Clearly define which materials are subject to price adjustments.
- Establish a baseline price and specify the threshold for escalation (e.g., a 5% increase triggers a renegotiation).
- Require documentation from suppliers to verify cost increases.
- Outline a structured process for submitting and approving adjustments.
- Change-in-Law Provisions, which should:
- Define tariffs as a change in governmental regulation that entitles the contractor to additional compensation.
- Provide a clear process for requesting price adjustments due to new tariffs.
- Allowances for Volatile Materials
- Rather than fixing prices at contract execution, structure the agreement so that certain materials will be re-evaluated at the time of purchase.
- Procurement & Buy-Out Strategies
- Consider negotiating early procurement agreements or stockpiling critical materials to hedge against future price increases.
- Supplier & Subcontractor Alignment
- Ensure that subcontract agreements include the same escalation protections as the prime contract to avoid gaps in coverage.
How Owners Respond to Tariff Protection Requests
The reaction of project owners to escalation clauses and other protections against tariff-driven price increases varies based on project type, market conditions, and the owner’s risk tolerance. Large Developers and Institutional Owners often resist escalation clauses, preferring fixed-cost certainty. However, in times of extreme market volatility, some owners recognize that sharing the risk is necessary to ensure contractor participation and project viability. Public Sector Projects often impose strict fixed-price contracts with little room for price renegotiation. Private owners, particularly in negotiated contracts, may be more flexible in allowing escalation provisions. Design-Build and CM-at-Risk Arrangements provide more room for risk-sharing, as they involve collaboration between owners and contractors in setting budgets and contingencies.
While some owners are reluctant to accept escalation clauses outright, contractors have found alternative ways to negotiate shared risk, such as allowances for price fluctuations or indexing material costs to third-party benchmarks. In certain cases, owners opt to procure high-risk materials directly, removing cost uncertainty from the contractor’s scope. Project contingencies should be evaluated and adjusted to meet the likely price increases. Further, design professionals should be wary of allowing preliminary design drawings to form the basis of formulation of a GMP commitment, as the pricing could change, and the claims will be substantial as the design evolves over time.
Emerging Industry Trends and Strategic Considerations
Beyond contractual solutions, the construction industry is adapting in other ways to address tariff uncertainty. Some notable trends include:
- Material Stockpiling and Advanced Procurement: Many contractors are purchasing materials in bulk before tariffs take effect, ensuring stable pricing.
- Diversification of Supply Chains: Companies are exploring alternative suppliers, including domestic sources and non-tariff-affected markets, to mitigate exposure.
- Alternative Material Usage: With steel and aluminum often at the center of tariff disputes, some projects are exploring composite materials or other substitutes.
- Financial Hedging and Insurance Strategies: Certain firms are examining financial instruments to lock in material pricing or mitigate cost volatility.
- Industry Advocacy and Policy Engagement: Trade associations are lobbying for tariff exemptions and urging government entities to incorporate escalation relief into public contracts.
Conclusion: Preparing for the Uncertain Road Ahead
With the potential for tariffs to significantly impact material costs, construction professionals must adopt proactive strategies to mitigate financial risks. Contracts should be carefully drafted to allocate risk appropriately, using escalation clauses, change-in-law provisions, and procurement strategies to protect against unpredictable price increases. Owners, contractors, and suppliers alike must navigate these challenges collaboratively, balancing the need for price certainty with the reality of volatile material markets.
As tariff policies continue to evolve, staying ahead of these trends and implementing sound contract strategies will be critical to maintaining financial stability in construction projects. By taking a strategic approach to contract structuring and procurement planning, construction professionals can better position themselves to withstand economic uncertainty and deliver successful projects despite market fluctuations—no matter how similar or different they may be from the COVID-19 era. Get those contracts out and have them evaluated to make sure they will protect you when the prices inevitably and unexpectedly rise!
Here at GOT, our team of experienced attorneys can help guide you through your next contract negotiation. Give us a call to discuss your construction contract.