As the impacts of the COVID-19 pandemic on the design and construction industry have demonstrated, unpredictable material and labour cost increases can cause significant hardships on consultants and contractors in fulfilling their obligations through fixed price contracts for their clients.

In today’s setting, two trends in the construction industry are on a potential collision course:

• The desire for clients to transfer all possible risks to either or both the consultant team and contractor, by insisting on fixed price contracts with no labour or material cost escalation clauses; and
• The unpredictable price fluctuations resulting from supply chain issues, notably those resulting from the COVID-19 pandemic.

While the client’s desire for price certainty is understandable, disregarding potential price surges will likely result in situations that are unfavourable to both the client and the contractor; this will undeniably affect the consultant in a direct or indirect manner.

Considering their role as contract administrators, how should OAA members bridge this type of conversation with their client? What should architects keep in mind for their own professional services contract between the client and their practice?

Forcing a contractor to absorb unpredictable material and labour cost increases could push a contractor to cut corners, walk off the project, or declare bankruptcy, assuming they are willing to take on the contract in the first place. This can lead to disputes resulting in unexpected legal costs and a requirement to replace a contractor midway through a project at a significant premium. These additional costs and lost time may easily exceed the costs of including a price escalation clause.

It will therefore benefit all parties (i.e. the client, contractor, and consultant team) to formulate a reasonable, project-specific escalation clause. The clause should specify the following:

• material and labour applicable to the clause;
• date, base quantity, and value that will be subject to adjustment;
• price index to be used to quantity the escalation; and
• method of price adjustment, including how the change in the price index will be used to escalate the base price, including any thresholds and which parties will bear the risk of any increase. (For example, one option is for the contractor to absorb a price increase up to a certain percentage, and then the client be responsible for any increases above that percentage. Alternately, the parties can opt to share the risk, by splitting the difference in the price increase.)

Note, a client may be more willing to accept a price escalation clause if there is a reasonable and fair allocation of risk. For example, the risk can be offset by creating the opportunity for the client to benefit from a decrease in the contract price, if prices decrease below a certain threshold.

What about the impact on the architectural services agreement?

Unexpected price escalations and material shortages will no doubt have a ripple effect on architectural services, with regard to the management of practices (e.g. staffing needs, project timelines, and product substitutions and the subsequent changes to details).

Practices should continuously assess impacts on the original parameters of their service contract as it pertains to the construction value, schedule, etc. This becomes especially important if client decides to make materials substitutions to manage costs or scheduling considerations.

Architects should consider having conversations with their clients about possible impacts to service agreement. When using the OAA Standard Form Contracts, you may want to consider adding clauses in anticipation of these issues. In consultation with legal advice, the addition of clauses to anticipate any potential Extra Services, as a result of price escalation, can be included under Schedule 5–Other Terms and Conditions. Once this framework is in place in the contract, Extra Services can be submitted per the terms of the contract.

Addressing this issue before a contract is finalized, by identifying and sharing the risks of increases in material and labour prices, may avoid unnecessary conflicts, delays, and claims.

Resources

For further information regarding the use of price indexes, refer to Statistics Canada’s Price Adjustment Guide for Contract Escalation.

Previous news articles published by the Ontario General Contractors Association (OGCA) related to this topic include “Practical Methods to Reduce Supply Chain Risks” and “OGCA Meeting with Hon. Kinga Surma, Minister of Infrastructure.”