By Marc Pfleging, Scannell Properties
You may have recently seen the recent release from the AGC that outlines material inflation and supply chain issues that are having drastic impacts on general contractors.
The article includes a detailed explanation on the magnitude of issues that are impacting the construction industry. Since the article was prepared by the AGC, it appropriately focuses on the impacts that contractors are facing as they navigate current market conditions. Often times, developers are also stuck in difficult situations as they try to navigate the implications of current market conditions. This is especially true if the developer already has contractual obligations to deliver a building to an end-user or tenant by a firm delivery date. In some circumstances, a developer may have a legal position that supply chain issues (but typically not cost impacts) give rise to a force majeure event or excused delays under the contract. However, a contractual claim does not alleviate the importance of meeting the end-user/tenant’s expectations to meet the schedule, which is often critical from an operational standpoint for the tenant/end user. Accordingly, in some circumstances, a developer may not be able to unilaterally agree to an adjustment of dates with the contractor for business or legal reasons. However, the AGC article mentions that “parties may also want to discuss the best timing for ordering materials and components.” I wanted to expand on how our company has implemented this approach recently to help navigate issues arising from current market conditions.
If a developer is confident that a project is moving forward and the contractor has been selected, the developer may consider authorizing the contractor to order materials for long lead time items or items that may be subject to cost uncertainty prior to finalizing the construction contract with the contractor. This can be accomplished through an abbreviated contract or letter of authorization that directs the contractor to order necessary materials and lock in the pricing with the subcontractor or material supplier. Typically, these agreements include a cap on the costs that will be reimbursed by the developer to the contractor (i.e., it is limited to the materials or design work that is expressly set forth in the abbreviated contract without any further commitment or obligation to enter into a definitive construction contract).
Furthermore, if the contractor’s breakage fees will be less than the amount that is authorized in the abbreviated contract if it is terminated prior to (i) fabrication of materials, or (ii) an outside date, the developer will want to include a provision that limits its monetary exposure if the abbreviated contract is terminated prior to such fabrication or the applicable outside date. This approach can help secure long lead time items at a fixed price that will help alleviate some uncertainties with market conditions that could impact the developer’s ability to deliver a project in a timely manner. In turn, if the project is for an end-user/tenant, the developer should consider obtaining a corresponding reimbursement agreement with the end-user or tenant to cover some or all of the cost exposure that the developer is committing to under the abbreviated contract with the contractor.
In addition to providing comfort to the contractor and helping to meet the schedule for a tenant/end-user, construction lenders also gain comfort knowing that long lead time items or construction materials that are subject to significant price fluctuation have been locked in for the project. As noted in the AGC’s article, this approach may be unwise in certain circumstances and comes with other risks and considerations that need to be taken into account and evaluated on a case by case basis. However, our company has utilized this approach (and accepted the associated risks) to alleviate concerns that our contractor’s have raised from a schedule and cost perspective and to keep projects moving forward on schedule and in budget.
If you would like to submit content or write an article for the Real Estate & Land Use Section, please email Kara Sikorski at ksikorski@indybar.org.
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