Without question, the past three years presented unimaginable difficulties for the development and construction industries. In spite of these trying times, owners and developers still managed to find ways to convert attractive possibilities into impressive projects with the help of designers and contractors.
Global markets are adapting to the lessons learned from past years as time presses the wrinkles out of the global economy and supply chains continue to work around the dramatic constraints that constricted the availability of necessary materials and equipment. As the construction industry adjusts to these continuing challenges, new obstacles like inflation and restricted access to capital complicate the outlook for new construction projects across most industry segments.
Given the prevailing conditions in the global economy, owners and developers must be prepared to address the following issues for new and ongoing construction projects in early 2023.
Some pandemic-related issues including supply chain restrictions, price escalation, and attendant delays, are not going away any time soon.
Even though global supply chains are finally working out the kinks, contractors remain hesitant to let go of any leverage acquired after the events of the last several years. Increased contingency funds and creative price escalation provisions may have seemed like temporary patches needed to address extraordinary circumstances, but do not expect these terms to disappear from Guaranteed Maximum Price (GMP) contracts. Contractors will continue to attempt to shift exposure for risks associated with price and supply chain volatility from their plate and onto the plates of owners and developers as much as possible.
Owners and developers must be vigilant when negotiating contracts to ensure that the party who is in the best position to mitigate exposure for risks associated with price and supply chain volatility remains responsible for doing so. Efforts to shift price risk generally take three forms in the negotiation of contracts with a GMP: (1) inflated contingencies held within the GMP that are for the contractor’s sole use; (2) an increased number of allowances for large scopes of work; and (3) open-ended price escalation provisions. Owners and developers must address the challenges facing contractors and subcontractors while also providing reasonable assurance to equity investors and lenders that the GMP is indeed a "Guaranteed" Maximum Price, and not a cost plus agreement masquerading as one.
Expect contractors and subcontractors to be more litigious and to pursue claims vigorously.
A number of prognosticators expect access to capital to continue tightening in the first half of 2023. High interest rates and the associated economic contraction will postpone the commencement of many construction projects. Additionally, during challenging times like these, claims by contractors and subcontracts proliferate on ongoing and recently completed projects as those parties try to squeeze as much profit as possible from limited opportunities.
Owners and developers must also take steps to protect their projects from risks associated with the unexpected closure and bankruptcies of over-leveraged subcontractors and suppliers. To hedge against that risk, owners and developers should consider including provisions in construction contracts requiring payment and performance bonds or purchasing subcontractor default insurance.
Hopefully the headwinds encountered in early 2023 will be short-lived. Though unforeseen difficulties are inevitable, Morris, Manning & Martin’s Construction Law Practice Group is experienced in handling the curve balls that today’s market and economic conditions can throw the construction industry. If you need any assistance with these or other issues on existing or future development projects, please contact Bruce Smith, chair of MMM’s Construction Law Practice Group, Colby Nelson, or JD Howard.