Colorado Real Estate Journal - March 16, 2022
Two years into the global pandemic with supply chains fragmented, material shortages, shipping backlogs, skyrocketing material and oil prices, and labor shortages, projects running over budget and beyond target completion dates are significant risks for developers. Given these challenges, developers should begin projects by carefully analyzing the elements of the construction contract with the general contractor to address material cost overruns and delays, appropriately allocate these risks and formulate mitigation plans. Although fixed-price and guaranteed maximum price contracts make up most contracts utilized in private project delivery, the risk of increased costs and project delay is rarely, if ever, fully borne by the general contractor. With the confluence of so many headwinds, the risk of falling behind schedule and going over budget warrants careful examination of risk allocation in contracts, particularly in the force majeure, contract assumption and material escalation provisions. Analyzing these provisions is critical to understanding the allocation of risk between the developer and general contractor. Force majeure clauses, sometimes found under the heading “Delay and Extension of Time,” may permit the general contractor an extension of time and an increase in costs for broad categories of delay such as “unusual delay in deliveries” and “other causes beyond [general contractor’s] control.” Absent express limitations on these provisions, the contract may permit the general contractor to seek delay extensions and costs for unintended and possibly even anticipated causes. For example, while the impact of the ongoing COVID-19 pandemic may have been wholly unknown for projects delivered in 2020 and 2021, general contractors are likely now to have sufficient information to account for such impacts on both budget and schedule. Accordingly, such impacts may need to be carved out of or appropriately limited in contracts. Additionally, with the risk that material deliveries from myriad vendors may be delayed, what is deemed an “unusual delay in deliver[y]” should be addressed early and specifically in the contract. Much like COVID-19 impacts, general contractors are in the best position to advise developers of anticipated bottlenecks for materials and likely have built anticipated delays into their schedules and planned mitigation efforts. While force majeure provisions generally address schedule impacts and may even permit general contractor recovery of demobilization and mobilization costs, material price escalations are not commonly accounted for in such provisions. Rather, the risk that price escalations affect the total cost of project delivery to a general contractor often is reflected in the contract assumptions and price escalation clauses, which shift these risks back to the developer. Some contracts may itemize categories of materials and budgeted costs in the contract assumptions, requiring the developer to reimburse the general contractor for costs in excess of those budgeted. Allocating price escalation risk by category in the contract assumptions may limit a developer’s risk to the categories of materials identified, but this method often does not expressly identify whether such cost increases should be first allocated to the contingency or buyout savings, require notice and evidence that the general contractor has sought to enforce the applicable bids, or require early delivery of documentation evidencing the amounts of the price escalations. As a rule, contract assumptions should not be utilized to rewrite the terms of the contract. Developers should be wary of any provision in the assumptions that conflicts with or adds additional rights to the contract. Rather than placing material price escalations in the assumptions provisions, it may be prudent for developers to utilize price escalation clauses that address these issues and, where possible, limit increases in the contract amount to the categories of work subject to an identified risk of price escalation. It is equally important to consider whether the construction loan documents allow for similar extensions of construction completion dates and any pre-planned mitigation efforts, e.g., carrying and storage of preordered materials on or off project sites. Construction loan documents typically have an aggregate cap on the number of days a lender will permit the construction completion dates to extend beyond those initially provided for in the loan documents as a result of force majeure before the developer triggers a default there under. Understanding the risks of delays to the project schedule, what will be deemed a force majeure event under the loan documents, and how the contract seeks to mitigate these risks is essential to formulating reasonable construction completion dates for loan documents. Failing to negotiate timelines that account for present day realities, developers risk under budgeting interest reserves, triggering defaults for failure to timely complete, and triggering completion guarantees. Advance ordering and storage of materials to be incorporated into the work at a later date also may require consent in the loan documents. Understanding what items will need to be ordered in advance, how long these items could be sitting on site or in storage, and the maximum cost of planned early purchases will enable developers to ensure loan documents provision for such mitigation efforts. While current economic realities pose significant risks to project budgets and schedules, early communication and cooperation among developers and general contractors is essential to formulate mitigation plans, appropriately allocate risk among the parties, ensure that expectations are reasonable, and, as a result, prevent disputes from arising while the project is being built. ashley.arroyo@stinson.com andrew.gillespie@stinson.com