June 28, 2004

Potential Relief from Material Price Squeeze?

Holland & Knight Alert
Deborah S. Griffin

It is not news to anyone who has priced or ordered steel in recent months that prices have shot through the roof. Increases of 100 percent over six months have been reported. Many attribute this spike in steel prices to China’s new, voracious appetite for scrap steel and a retraction of production by U.S. steel mills, which have driven down supply. For projects that were estimated, bid and financed before this price escalation began, those procuring steel face substantial losses or erosion of expected profits. Even as steel prices appear to be stabilizing, the prices of other materials, such as Portland cement, appear to be destabilizing. The climate of uncertainty about material prices presents formidable challenges to those estimating, bidding and financing new projects, as well. Is relief from these threats available?

Relief on Existing Contracts

Absent a contract provision that explicitly provides for an adjustment in the contract price in the event of an unexpected increase in the market price of essential materials, a party seeking relief will have a difficult, but not always impossible, task. In past episodes of dramatic price increase, some parties have found relief by showing that the increase was so unexpected that the parties never could have contemplated such an occurrence at the time of negotiation and execution of the agreement. The party harmed by the increase has argued that the contract should be voided or modified because, at the time of execution, both parties to the contract mistakenly believed that the price of the material or resource would be purchased at a certain dollar figure or that market fluctuations would be within a normal range, when in actuality at the time of purchase the price was far beyond what could have been reasonably contemplated.

Such an argument invokes the recognized legal principle that a mutual mistake of fact may justify rescission, or avoidance of a contract, or a modification of its terms. However, relief is not automatic or inevitable in the case of a mutual mistake of fact. In order to warrant rescission or modification, three conditions must be met: (1) the mistake must relate to “the basic assumption on which the contract was made;” (2) the party seeking to avoid the contract must show a material effect of the agreed exchange; and (3) the mistake must not be one as to which the party seeking relief bears the risk. Concerning the third element, a party bears the risk of mistake if (a) the risk is allocated by agreement, (b) the party was aware of the potential occurrence at the time the contract is made, and/or (c) the risk is allocated by the court.

The facts of a given situation, and the law of the governing jurisdiction, will determine whether an attempt to rescind or modify a contractual agreement based on a mutual mistake will succeed. Holland & Knight’s Construction Industry Group urges its clients and friends to consult their lawyers if they believe they may be entitled to relief in the case of the current steel price crisis.

Relief on Future Contracts

In response to the recent severe price volatility in the steel market, construction industry trade associations, including the Associated General Contractors of America (AGC), are seeking prospective relief through model price-adjustment contract language for private construction and utilization of Economic Price Adjustment (EPA) clauses for public construction.

Private Contracts

On May 6, 2004, the Executive Board of the AGC approved a model price-adjustment amendment that contractors and owners can execute when a specified material exceeds a percentage range above (or below) a mutually agreed baseline price.

Public Contracts

The Federal Acquisition Regulation (FAR), and many state procurement regulations, include procedures for addressing unexpected significant price escalation in materials or labor markets. FAR 14-408-4 and 16.203 are two existing federal regulations addressing EPA. During the past several months, many federal and state procuring agencies have been approached by contractors and industry organizations seeking EPA relief in connection with steel price escalation. Unfortunately, as reinforced by the above discussion, most procuring agencies have taken the position that EPA clauses and relief are only available if an EPA clause is included in the contract terms and conditions at the time of contract. Due to the unexpected nature of steel price escalation, such provisions have been absent from most if not all of the contracts that are currently experiencing severe price volatility.

Despite the position taken by most federal and state procuring entities that EPA relief is not available for existing contracts, these entities also have initiated efforts to include EPA clauses in bid documents for procurements on a going-forward basis. In this regard, contractors are advised to examine the bid documents carefully to determine whether an EPA clause is included in the contract documents for a procurement. If such a clause is not included, and a contractor is concerned that that project may be subject to unacceptable materials price volatility, it is advisable to raise this concern with the contracting officer prior to the bid or proposal due date and request that an EPA clause be included.

Holland & Knight’s Construction Industry Group continues to monitor the materials price volatility issue closely. Please do not hesitate to contact us if we can be of assistance in crafting a solution if you are faced with actual or potential liability as a result of unexpected materials market conditions.

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