Sunday, March 21, 2021

What Modular Factories, Builders and Developers Need to Know About Escalation Clauses

No matter where you look today, lumber and building material costs are rising at historic rates for modular home factories who must pass on these costs to builders and developers.

Add in higher fuel costs, higher wages and COGS is spiraling out of control.

A price adjustment clause—also called an escalation or escalator clause—can be a powerful tool in a modular construction factory’s contract with builders and developers. 

Builders and developers are caught in the middle of today’s unprecedented price increases because they are under contract with their customers.

For modular builders or developers, their problems start at the factory level. But it doesn't end there. They have customers who signed good faith contracts for their new home or project. Now what happens when rising costs makes your contract a death notice for your business? 

Enter the escalator clause.

An escalator clause provides important protection for factories and builders when it comes to pricing. This contract provision allows for an increase in the agreement price due to factors beyond the control of either party that affect the value of the product or service. Commodity prices fall under that category.

Without an escalator clause, your business could get stuck covering costs that cannot be collected from your builders—or risk losing the customer who is not willing to foot the higher expense you are forced to charge. 

Escalator clauses are enforceable in most states and are commonly used in commercial contracts. Of course, they’re only good if the buyer is willing to accept them, but they set the stage for an important “what if” and should be included in your contracts as a financial safeguard.

Another protection against your customer’s pushback or claim of “breach of contract” is to include a disclaimer in all your sales materials and customer sales agreements that the “price is subject to change” or is good for a limited period of time. This could be for any number of market conditions that may arise—supply not meeting demand, higher shipping costs due to rising fuel prices, and of course, lumber. It’s a good time to review your sales agreements to see where you can place a disclaimer to prevent a slew of issues in the future you cannot anticipate or control.

What about force majeure?

A force majeure clause in a contract, which is meant to protect against unforeseen circumstances, does not serve the same function in terms of protecting against price increases or fluctuations. Force majeure clauses will not enable a factory or builder to modify or cancel a contract due to price increases generated by tariffs. These are generally for protection against significant natural disasters or other catastrophes.

Show me the money!

While adding an escalator cause in a contract is a valuable measure, it does not guarantee you’ll get the higher price. For example, the builder, developer and even the builder's customer may ask you to provide proof of:

  • The product cost at the time the contract was signed
  • The cost increase after the contract was signed
  • Reasons for the cost increase after the parties signed the contract—was it due to increases in labor or overhead costs (which are more controllable) or due to higher material costs, tariffs, production delays, or another factor outside the factory’s or builder’s control?

An effective escalator clause clearly specifies how the price increase will be calculated and when the price increase is triggered, and bases the price adjustment on an objective or verifiable standard. It may also be drafted in such a way as to permit cancellation of the contract altogether, depending on the situation. However, without the contract explicitly spelled out, the factory or builder is more likely to be held to the original sales contract.

Bear in mind that there can be extenuating circumstances that lead to litigation, if modification or cancellation of the contract cannot be negotiated. For example, a cost increase so high that performance under the contract will create significant financial hardship, but one party or both cannot agree to terminate or modify the agreement.

Contract rescission and reformation

In cases where litigation ensues, there are two legal tools available: rescission, which terminates a contract, and reformation, which allows for contract modification. In the event your contract lacks a well-crafted escalator clause, these remedies may be available to you through the courts.

In the case of an unforeseen event like lumber prices doubling, a court may rescind the contract or reform its terms to allow for the price increase. Given that these remedies are difficult to obtain and require litigation, it is far more expeditious and cost efficient to review your existing sales contracts and make sure to include an escalator clause—especially in light of today’s unwelcome price increases.

Working with a business attorney to review your present escalator clause or write one if you don’t have an escalator clause in your contract can be beneficial to both the modular factory and their builders. It protects against litigation, a default, or the unexpected termination of a contract. Business relationships should be built up and solidified, not destroyed by unforeseen circumstances that could have been planned for in advance. Escalator clauses and pricing disclaimers are tools every factory and builder should implement, especially today.

The Modcoach writes the Modcoach News, Modular Home Coach and Off-Site Construction News blogs. Modcoach Connects matches Consultants with Clients. 

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