The business of construction is a roller-coaster ride at the best of times. But few things challenge the industry more than the fierce cost escalation that construction is currently experiencing. Unfortunately, with escalation, someone in the process often must lose.
Cost escalation is uniquely challenging because it breaks the bonds and expectations that the industry depends on. Owners rely on the price certainty that contractors and suppliers are usually able to deliver. Without that certainty, the entire construction process breaks down. Escalation, however, cannot simply be managed by passing the financial risk onto contractors and suppliers with tighter contract terms. It also cannot simply be passed on to the owner – the owner has usually not planned for it and may have no capacity to absorb it.
What can be done to navigate the escalation storm?
For owners and developers, the key is engagement with their contractors and suppliers. It is not as simple as having the right contractual terms. While an owner can legally limit its exposure to escalation through contract language, it will not help that owner if the contractor is unable to fulfil the terms of the contract or fails to complete the contract due to insolvency. An owner’s engagement with contractors and suppliers includes understanding what the contractors and suppliers are up against and working towards a contractual understanding that effectively manages the risk. While escalation will continue to be unpredictable, understanding and managing the risk in the project procurement process is the best means of ensuring a successful outcome.
Owners and developers should also limit their expectations of contractors and suppliers.
In a normal market, it might be reasonable to expect prices to be held for several years. That expectation is likely not reasonable in an escalating market, and the owner must adjust expectations accordingly. In a rapidly escalating market, organizing the project around reasonable expectations can become critical to the project’s success.
For contractors and suppliers, there are at least five things that can be done to navigate the escalation storm.
First, be transparent. Transparency with your customer will build the trust that is necessary to navigate escalation successfully.
Second, watch your contract language. Your customer will have little sympathy for you if you sign a fixed-price contract and then simply expect to be relieved of its requirements.
Third, understand your risk. While it may be hard to predict where escalation will go with your product or service, you are likely in the best position to understand the risk. So, assess your risk proactively and share that assessment with your customers.
Fourth, be creative. Escalation risk can be managed in a wide range of ways; it is up to you to come up with solutions that will work for your customers.
Five, be prepared. If you need to bring a claim for escalation, you will want to have documented in detail exactly how and when you were impacted by it. Organize your evidence in advance to establish a strong escalation claim.
The construction business is rarely dull, and the current environment is no exception. But through careful planning, open communication and patience, the industry will navigate the escalation storm successfully. •
Norm Streu has served the B.C. construction industry for 25 years as a leading business executive and lawyer and is a past chair of the Vancouver Regional Construction Association. Christopher Hirst is the managing partner at Alexander Holburn LLP.