by Quenda Behler
The other night, my husband and I watched a television show
about contractors in California who are walking away from
But few contractors will walk away from an unfinished job
voluntarily. That's definitely not part of their business plan.
So why would it happen?
We think we know. My husband has been retired from the
construction business for several years, but both he and I will
never forget a period in the '80s when lumber prices were
skyrocketing. It got to the point where all of his contracts
were money-losers. For a while, staying in business literally
cost him money.
Today's Higher Level of Risk
If the construction business falls back into that situation, it
could be even worse this time around.
Just do the math. A 5 percent cost overrun on a $100,000 job is
$5,000. You could probably manage that without going out of
But a 5 percent cost overrun on a million dollars is $50,000
— not nearly as manageable. And some of those California
houses on the television show were multimillion-dollar
The fact is, costs are going up, no question about it.
Financing costs have already increased. Any increase in energy
prices will have an impact on the cost of materials everywhere,
as will any major hurricanes and floods.
So the critical question is this: Can you write your contract
to offset rising costs?
Yes, you can.
You could, for example, write a cost-plus contract, in which
the customers simply agree to pay whatever the cost of labor
and materials is, plus a fixed dollar amount or a percentage of
the costs as profit. If costs go up during the course of the
job, it's the customers' problem.
But customers aren't always willing to sign such an open-ended
contract. Before they sign on the dotted line, most of them
want to know exactly what the project will cost them.
Pad the Estimate
Another option would be to build enough money into your bid to
protect yourself if costs rise. The good part about that
approach is that if costs don't rise, you'll make more money
than you had expected to.
The bad part is that your bids will be high and you could lose
a lot of jobs.
Use an Escalation Clause
Perhaps the soundest solution would be to put an escalation
clause into your contract. That's a clause that allows you to
increase the contract price or bid if certain things happen.
What those certain things are depends on how you write the
Usually escalation clauses are triggered by increases in
material prices or labor costs that exceed by a certain
percentage what prices were when the contract or the bid was
I have heard of projects where the cost of the entire contract
was tied to something like the U.S. Consumer Price Index, but
odds are you won't get clients to agree to such an open-ended
arrangement. More likely, you'll have to limit the clause to
certain items — materials like concrete, steel beams, and
rebar, for example, or framing lumber and asphalt
In each case you will need to spell out a number of details.
First, you will need to state (in the contract or an addendum
to it) what the materials cost at the time of the estimate.
Those prices will be the basis for whatever happens later
Customers tend to be more comfortable when they
understand exactly what they're paying for; with an
escalation clause, they can see that an additional cost
is not a capricious increase.
Second, you will need to specify by how much the prices of
these materials need to increase for the escalation clause to
kick in. Since customers may feel that you are trying to cheat
them if you refuse to accept any risk for rising prices, it's
best to set a threshold below which you will pay the higher
cost — typically a 2 or 3 percent increase for a
Finally, you will need to specify where the new price will come
from. You could get a quote from a supplier, but if I were a
customer I'd be concerned that the contractor and supplier (who
work together all the time) might inflate the price.
A better approach might be to explain in the clause that the
contract price will be adjusted according to a published price
index. If the price index for lumber goes up 10 percent, for
instance, the contract cost for lumber will also go up 10
How to Sell the Clause To
There are several reasons an escalation clause is a good idea,
and you should use them when you explain to your customers why
the clause works to their advantage.
For one, an increased contract cost would be less expensive
than driving you out of business would be. Think those
homeowners in California are better off with their disappearing
contractors? Of course not.
However, you might be uncomfortable making such an argument;
some customers may prefer to do business with someone who
doesn't talk about such harsh realities.
A more acceptable explanation may be that your bid will be
lower if you don't have to build in extra money for unexpected
Also, customers tend to be more comfortable when they can see
exactly what they're paying for, even if it is a cost increase.
They can see that the additional cost is not a capricious
increase, or simply an attempt to make more money.
Price Jumps Aren't Unforeseen
You may believe that you're already protected from unforeseen
price increases because you have a clause in your contract that
allows you to charge more if you run into "unforeseen
But that kind of clause works only for genuinely unforeseen
conditions — for example, if you were to start excavating
and discovered the world's largest rock. (Okay, maybe just the
state's largest rock; either way, it's not a pleasant memory. I
won't even talk about the Indian burial mound that turned up on
The point is, no one could have foreseen while preparing his
bid that he would find a rock of massive proportions right
where he was trying to dig out a foundation.
However, the courts say that you can foresee rising prices,
because they're part of the ordinary risk of doing business. If
that risk isn't okay with you, then you will have to address it
— either by charging more or by using language that's
very specific about increased costs.
If you find yourself stuck because you don't have an escalation
clause, there are some legal arguments you might be able to
fall back on, depending on why the prices went up. The reason
for the increase would need to be something the parties to a
contract wouldn't ordinarily have considered at the time they
negotiated — war, an embargo, floods, forest fires.
To make such an argument fly, though, you'll need a lawyer
— and that will cost you a great deal more than it would
have cost to have hired one in the first place to write that
Quenda Behler Story, author of The
Contractor's Plain-English Legal Guide, has practiced and
taught law for more than 25 years.