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Bid Bonds, Performance Bonds and Price Escalations

March 11, 2022

 

The price of construction materials is soaring. Inflation is expected to remain high and oil prices are hitting record highs. Price Escalations are part of the current construction environment but how do these increases affect contractors and their contract bonds?

 

Bid Bonds and Price Escalations

 

Bid Bonds are used to pre-qualify bidders and ensure that they honor their bid price. So how do contractors protect themselves when their costs may change significantly between bid day and the time to build the project? 

 

Condition the Bid

 

One option is to condition the bid. The added condition(s) can be almost anything. However, in the case of rapidly changing prices, consider using an Escalation Clause. 

 

An Escalation clause ties material, fuel or other items to a specific price or index. Changes above or below the index create increases or decreases to the contract. 

 

Fuel Escalation Clauses are common on many state's DOT projects but Private Owners or General Contractors may be less receptive.

 

Conditioning a bid might get the bid thrown out and the bidder be considered "non-responsive". However, it's better to have your bid thrown out than take a project and lose money.

 

Pad the Bid

 

The more uncertain material prices are, the more extra money a contractor should be adding to their bid. The extra money acts as a cushion for price increases. Unfortunately, many contractors are worried about losing out on the project and do not add nearly enough extra money to cover their risk.

 

Performance Bonds and Price Escalations

 

Performance Bonds are required on projects to guarantee a price. Unfortunately, performance bonds could cause big problems for contractors when prices are rising quickly. Failure to honor the contract price could cause an Obligee to make a claim on the performance bond.

 

Fortunately, there are steps to prevent these claims and maintain profitable projects. 

 

Buy and Store Project Materials 

 

Contractors should consider purchasing and storing project material at the time of award if they can get it. This is especially true for items that are difficult to get such as roofing materials. 

 

Get Suppliers to Commit

 

Ask your suppliers to lock in prices. Some will and others will not, but you contractors should try. 

 

Purchase Futures

 

Contractors that use a lot of fuel such as heavy contractors should purchase fuel futures. There is a risk of being locked into higher prices as well, but having certainty for your contracts is worth the tradeoff.

 

Insert Price Escalation Clauses

 

When possible, include price Escalation clauses in your contracts as discussed above. Some obligees may be unfamiliar with these clauses, but will likely see them more.

 

Get Subcontractor and Supplier Bonds

 

One way to mitigate prices is to shift the risk downstream. This can be accomplished by getting performance bonds from your subcontractors and shifting the cost burden to them.

 

Supply Bonds from Suppliers would also be ideal. These bonds guarantee the delivery of material or equipment at a specified price. Unfortunately, many suppliers are unwilling to provide these in the current environment.

 

What About Price Escalations on Existing Contracts?

 

There are some things a contractor can do if they are already under contract and have performance and payment bonds outstanding.

 

Negotiate

 

The best case in these matters is almost always negotiating with the Obligee. Be ready to explain why they should agree to give you relief. They have the ultimate backing of the performance bond but making a claim could cause delays and project disruptions.

 

Force Majeure Clauses

 

Force Majeure clauses are common in contracts to protect parties from unpredictable events such as war, natural disasters, etc. These clauses could be widely interpreted to cover a variety of issues. 

 

However, the remedy for these clauses is often just more time. This may or may not help contractors deal with increasing prices.

 

Equitable Adjustment

 

If all else fails, you can ask for Equitable Adjustment. Some courts have held that significant material costs could trigger unfairness and contractors may be entitled to relief on Public contracts.

 

However, not all courts agree with this. Even if they do, Court costs and attorney fees may quickly deplete any relief that may be granted. This strategy should be considered a last effort and not done without consulting a qualified construction attorney.

 

Rapidly rising material and fuel prices pose a significant risk to contractors and their surety bond companies. Contractors should take all the precautions they can to reduce their risk. 

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