Last week, we presented the first half of Luke J. Farley Sr. and Dixie T. Wells’ article on construction in the age of COVID-19. Here is the second half, where the authors answer questions about recovering costs, if projects can be cancelled due to the outbreak, and how builders should deal with the virus on future projects.
If the COVID-19 outbreak causes an increase in the cost of labor and materials, can the contractor recover that increased cost from the owner?
It depends. With workers likely to be quarantined and supply chains disrupted, you can expect price increases for both labor and materials. Does the contractor have to bear the burden of those price escalations? It depends on the basis of payment on which the parties agreed in the contract.
If the contract price is a lump sum, then the contractor bears the risk of all price increases. If the contract price is cost of the work plus a fee, the owner will bear the risk. But true cost-plus contracts are exceedingly rare in the commercial context.
Lastly, if the contract price is the cost of the work plus a fee with a guaranteed maximum price (GMP), then the owner bears the risk of price increases but only to the GMP. After reaching the GMP, the contractor bears the risk of price increases. But what if the GMP contract allows for a contingency? Generally speaking, a contingency is a line item included in the GMP at the time of contracting to account for “unknown unknowns.”
It’s difficult to imagine something that better fits the definition of “unknown unknowns” than the current pandemic. Contingency clauses in GMP contracts vary widely — some are written to mitigate the owner’s risk while others favor the contractor; some treat the contingency as part of the GMP, while others don’t.
Regardless, if you have a GMP contract with a contingency, you should argue to the owner that all cost increases resulting from the pandemic must be paid from the contingency first before being counted as part of the other costs of the work. Paying from the contingency first can help prevent you from exceeding the GMP, which effectively means you won’t end up bearing all of the risk of COVID cost increases.
Can the project be terminated because of the outbreak?
Yes. Owners will naturally be skittish about moving ahead on big capital projects given the economic uncertainty that comes from the pandemic. Some will even want to pull the plug, especially if there’s a lag between the time of signing the contract and starting the work, and there’s still an opportunity to make a clean break, so to speak.
These days most commercial construction contracts include a so-called “termination for convenience” clause which allows owners to terminate contracts for their own “convenience.” In other words, under this type of clause, the owner can terminate the contract even if there hasn’t been a default by the contractor. If an owner determines that the pandemic will make it difficult to get financing or find a tenant for the finished project, then the owner is free to terminate for its own convenience.
A termination for convenience doesn’t mean the owner can leave the contractor empty-handed. These clauses give the owner the flexibility to terminate, not to avoid bills. Under most termination for convenience clauses, the contractor is paid for all work done until the date of termination, including overhead and profit. The contractor is also paid its reasonable expenses resulting from the termination, such as added costs for an early demobilization. The contractor won’t, however, get paid for any unperformed work or the profit on that work.
Your contract could be at special risk for termination if you’ve entered into a construction manager at-risk (CMAR) agreement. Under the AIA series of documents, for instance, the owner and the contractor first sign the CMAR agreement and then later execute an amendment to the agreement setting the guaranteed maximum price (GMP) for the project. The owner, however, is free to terminate for convenience before signing the GMP amendment.
If costs for labor and materials increase because of COVID and then you propose a high GMP or the likelihood of finding a tenant for the project goes down, the owner may decide to terminate even before the GMP amendment is signed. In that case, you would only receive compensation for the preconstruction services and the owner would be free to price the work on the street.
How should I deal with COVID-19 on future projects?
Plan ahead and revise your contracts. Understandably, most contractors are concerned with how COVID-19 will affect their ongoing projects. But, unfortunately, COVID-19 may be here to stay for the next several months. Some scientists even think we could be hit by several waves of COVID over the next few years. It’s critical that contractors plan as if COVID will be around for a while and that includes incorporating COVID into your contracts.
Obviously, the COVID risk should now be priced into the work to the extent you can, because, as mentioned above, the contractor is most likely to bear the cost of any COVID-related price escalations. All good estimators are probably already doing this. COVID should also be directly addressed in the terms of the contract itself.
The provisions that will require the most attention when negotiating construction contracts in the COVID era are the clauses pertaining to delays, extensions of time and liquidated damages. All these points should all be negotiated with effects of COVID-19 outbreak in the forefront of your mind. COVID-19 should be explicitly listed as an excusable delay.
The risk is too great not to directly address the issue and relying on old form language may now be inadequate. The essence of excusable delays is that the delay event was unexpected. At this point, no one can say they were caught off guard by future COVID outbreaks.
The best way to protect yourself is make clear that COVID remains a ground for extending the contract time. This is especially important if you’re using an AIA form contract, since it’s the only major industry form that doesn’t explicitly reference disease when addressing delays.
Luke J. Farley, Sr. is a construction lawyer at Ellis & Winters LLP in Raleigh, N.C. He can be reached at luke.farley@elliswinters.com. Dixie T. Wells is a partner in the Greensboro, N.C., office of Ellis & Winters. She is also a member of the Construction Law and Litigation Committee of the International Association of Defense Counsel (IADC). She can be reached at dixie.wells@elliswinters.com.
