By Michael F. McKenna and Jennifer R. Budd of Cohen Seglias
Published December 28, 2021
For contractors trying to navigate the construction industry’s current supply-chain battles, President Dwight D. Eisenhower once articulated advice that, although not about the industry’s problem, is still right on point: “In preparing for battle I have always found that plans are useless, but planning is indispensable.” Due to unprecedented supply-chain disruptions, many highway and transportation contractors are finding that they must quickly abandon any plan developed for subcontracting work or delivering material and the time to complete such tasks. Without such plans, however, projects can quickly go underwater.
Supply-chain disruptions are causing both materials shortages and significantly longer lead times, meaning that materials are not onsite when needed for construction to continue. Additionally, some subcontractors and suppliers are unwilling to hold prices for more than a few days. These conditions impact not only the construction schedule but also project finances. Yet, many owners, especially public owners, may be willing to grant time extensions but are not keen to compensate for such costs.
In a moment like this, the second part of President Eisenhower’s quote is key: planning. There are steps and strategies that contractors can implement to help weather these conditions and put them in the best position to prevent and recover cost overruns caused by supply chain woes.
Ask Questions Pre-Bid
Before bid opening, contractors should take advantage of the pre-bid opportunity to ask the owner questions focusing on the supply-chain challenges facing the industry:
- Will the owner consider alternate or substitution requests on an expedited basis?
- Will the owner also accept a substitute manufacturer in lieu of the agreed-upon manufacturer?
- Will the owner consider copper or cast-iron pipes instead of PVC (or whichever reasonable substitute exists for the impacted material)?
- Will the owner pay expediting charges for material?
The most important questions that a contractor should ask pre-bid may be along the lines of:
- Will the owner add a price escalation clause for material?
- Will the owner issue a lump sum line item or an allowance to compensate the contractor for cost increases due to supply-chain delays and impacts?
By contractors asking these questions, all bidders will better understand the owner’s view and the potential risks when entering into a contract with that owner. If the owner’s answers reveal that it is operating in a “business as usual” manner, then contractors will need to increase their prices to account for the added risk.
Ask for Alternates or Substitutions Early and Often
As soon as a project manager learns of a longer-than-usual lead time for a material, or a significant cost increase, the contract or project manager should promptly request a substitution, if possible. If the cost has increased, the substitution should document the cost increase of the originally specified item. If the alternate is denied, the contractor will be in a much better position to make a claim based on the unavailability.
Further, if a contract includes a price escalation clause, a contractor should submit change order requests for all price increases and provide documentation of the price on which the bid was based. Even if the contract does not, submitting change order requests will be necessary so that the contractor has a chance for recovery, including ensuring compliance with notice requirements.
Review Time Extension and Force Majeure Clauses
Many highway and transportation contracts expressly identify supply-chain disruptions as excusable time impact events, but not necessarily compensable. While contractors should request a time extension to avoid liquidated damages being assessed, how can they recover cost impacts from extended performance due to supply-chain hurdles? While these conditions are too recent to have generated relevant legal cases, more courts and arbitration panels will look to determine who bears the risk for the current supply-chain problems. If the specifications include a clause that provides for change orders when there is a “change in the character” of the work, this type of clause may provide a good argument for additional payment. Indeed, the supply-chain issues have completely altered the character of the work.
Crucial to recovering supply-chain costs, contractors must document all impacts and their consequences and submit change order requests to the owner. If supply-chain issues are delaying progress, contractors should show the time impact in schedule updates submitted upstream with the time impacts described in the narratives. And, as always, give the contractually-required notice of any potential time or cost increase.
There may also be the rare instance when time impacts push a contractor into a period of time where these issues become more likely.
Possible Avenues for Recovery of Extreme Cost Increase
Faced with such an unprecedented situation, contractors have several legal theories they may use to recover extreme costs increases that plague many parts of the project.
- Breach of the Covenant of Good Faith and Fair Dealing: Implied in all contracts, this covenant prevents parties from acting in “bad faith,” which typically involves dishonesty or bad motives. This doctrine will not relieve a party from performing contractual obligations because the contract is no longer profitable. A higher showing is required, and this type of claim is highly fact-sensitive.
- Commercial Impracticability: A contractor can use this theory when “a contract is commercially impracticable [because] performance would cause extreme and unreasonable difficulty, expense, injury, or loss to one of the parties.” (Raytheon Co. v. White)). If a contractor proves that it was commercially impracticable to perform the work, the contractor is relieved of performance. If the contractor was compelled to perform despite the impracticability, it can recover the costs incurred in attempting to perform the contract.
- Frustration of Purpose: Using this theory, a court can excuse an obligation to perform under a contract if the contractor can no longer achieve its purpose for the transaction, both parties knew of the purpose, and the contractor did not cause the frustration. Essentially, the frustration must be so severe that completing the transaction makes little sense. If the contractor was compelled to perform in the face of frustration, it can recover the costs incurred in attempting to perform the contract.
These doctrines will only provide relief for monumental cost increases, and a contractor will face a high burden. Contractors can help improve their likelihood of success with such claims by taking these measures:
- To ensure the significant documentation needed to show the unavailability or cost increase of the material, the causes, and other cost impacts, contractors should begin tracking and compiling all documentation as soon as they encounter an impact.
- Contractors should pursue all alternatives (substitutions for material or manufacturers).
- To support a commercial impracticability argument, contractors should submit any and all change order requests for any increased costs.
- For denied change order requests, contractors should request to be relieved of performance by asking that an item be removed from the contractor’s scope, or if the cost impacts are project-wide, asking for a negotiated termination for convenience.