Mitigating The Impacts Of Tariffs In Construction Contracts

The unprecedented expansion of new tariffs by the Trump administration through Executive Order 14257 issued on April 2, 2025, will undoubtedly affect thousands of existing construction projects and the negotiation and drafting of any contracts for new construction projects for the foreseeable future.

This significant escalation in U.S. trade policy, which was enacted under the International Emergency Economic Powers Act, was intended to address alleged disparities in tariff rates and trade deficits, includes two components:

• A 10% universal tariff on all imports; (effective April 5, 2025) and
• Reciprocal tariff rates that are specific to 57 countries with rates ranging from 11% to 50% (effective April 9, 2025). More specifically, the new reciprocal tariffs being imposed upon the two largest trade partners for the United States, China and the European Union, are respectively 34% and 20%.

The reciprocal tariffs are cumulative of previously imposed tariffs, which in some cases result in tariffs greater than 70% being imposed on some goods. As part of the new trade policy, significant reciprocal tariffs are being assessed against many allies of the United States, including Canada, Japan, Taiwan, Israel and India.

How Tariffs Impact Construction Contracts and Projects

The new tariffs are expected to significantly increase the costs of new construction projects by approximately 10% and delay projects because of supply chain disruptions across the globe, which could significantly decrease profit margins for contractors and cause project owners to scale back the scope of upcoming projects or suspend those projects altogether.

The impacts of the new tariffs will be significant for materials that are vital for most projects, including steel, aluminum, lumber, copper, concrete, dry wall, appliances and other electronic component parts, and is expected to cost the U.S. construction industry billions of dollars in the coming year. These materials are often crucial to the critical path systems for most commercial projects, including structural wall, foundation, floor, ceiling and roof systems.

The new tariffs are particularly problematic for contractors who have GMP contracts (e.g., AIA A101-2017) with owners who desire some degree of certainty about how much a project will ultimately cost, especially public or quasi-public projects that rely on bond financing or large private projects reliant on lenders. When material costs increase significantly for a project governed by a GMP contract, the contractor is typically obligated to incur those increases. On the other hand, owners are disproportionally impacted by projects governed by the cost of the work plus a fee contract (e.g., AIA A103-2017) because increased costs are passed along to the owner.

In both scenarios, these contracts generally lack effective mechanisms to address significantly increased material costs due to tariffs. Change Orders are generally ineffective at addressing significantly increased costs because they are reactive in nature, often require the agreement of both parties and do not provide the parties with a mechanism to terminate the project if agreement cannot be reached. If one party refuses to agree to an increase in project costs through a Change Order, a dispute will often follow, which can delay the project, erode the trust between the parties and increase litigation or arbitration costs.

Likewise, contingency and allowance clauses are not particularly effective in addressing significant price increases because the amounts typically budgeted into these clauses (less than 5%) is not enough to address significant increases in material costs that will be caused by the new tariffs that start at 10%.

Force Majeure clauses are also not necessarily effective to address significantly increased material costs because they are mostly intended to address unforeseen events, like acts of God or extreme weather events, that completely prevent the performance of one party.

Considering the extensive media coverage of the Trump administration's tariffs, both before and after the election, it is hard to imagine any dispute resolution process will consider the new tariffs as unforeseeable. Moreover, Courts have been reluctant to apply Force Majeure clauses for commercial impracticability that may make a project less profitable, or unprofitable for one party, because losing money on a project does not prevent performance.

Often left unaddressed in construction contracts, rising tariffs threaten to discourage parties from engaging in new projects, or worse, scuttle projects that are ongoing. Indeed, a recent construction contract negotiation that Bracewell was involved in shortly after the November election, but before any tariffs had been assessed, was significantly prolonged and complicated by protracted haggling over language in force majeure, contingency, change order and other contractual provisions that could be impacted by the new tariffs. Ultimately, the parties were only able to move forward because of an agreed price adjustment clause that was written in the construction contracts.

The Most Effective Mitigation Tool: Price Adjustment Clauses

The current circumstances beg the question: how can parties involved in construction projects adequately protect against cost overruns caused by the inflationary effect of the new tariffs? The most effective mechanism that can be used to address this issue is a detailed price adjustment clause, which are sometimes also referred to as price escalation clauses since they are mostly employed to address increases in costs.

Unlike 2018, the new tariffs issues under Executive Order 14257 are predictably going to be exponentially more expensive by affecting products and materials beyond just steel and aluminum, including all products and materials imported from all countries and higher more specific assessments against 57 other countries. Prior to the Trump tariffs in 2018, it was uncommon to find price adjustment clauses in typical construction contracts.

Surprisingly, even after the imposition of steel and aluminum tariffs in 2018, these types of adjustment clauses are still uncommon and are not included in standard forms from construction contract authorities like the AIA, which instead rely on the change order process, or other problematic provisions, to address inflation.

A price adjustment clause, where parties agree at the outset of a project to specific terms and mechanisms to address inflation (in this case imposed by tariffs), is the best solution. Parties are more likely to be able to agree on the parameters of how increased costs will be managed before the project begins and those increased costs occur, unlike the change order process where one party will generally have leverage over the other and disputes are more common. These clauses also provide the benefit of allowing for longer term contracts that do not have to be frequently renegotiated. And price adjustment clauses between sophisticated parties are generally enforced by the courts if they rely on objective standards; and are allowed by the Federal Acquisition Regulations.

However, price adjustment clauses can be complex and must be fully thought out and sufficiently detailed to address as many contingencies as possible – the fewer variables the better. The main challenge to inserting a price adjustment clause into an existing or a new contract is convincing your existing or prospective contractual partner to agree to its terms. There must be some give and take, and it is important for the party with the most leverage during the negotiations to recognize that in the future, the shoe could be on the other foot.

Tariffs, Triggers and the Price Adjustment Clause

Perhaps the most important term in a price adjustment clause is the trigger, i.e., when is the clause activated? It does not make sense for a price adjustment mechanism to be triggered for trivial or nominal increases in product and material costs, and most parties, whether it is an owner in a cost-plus agreement or a contractor in a GMP contract, understand that it is customary for certain economic fluctuations to be absorbed by one side.

Therefore, a triggering mechanism that is activated beyond smaller price increases is important. The most effective triggering mechanisms relate to a specific percentage increase in the cost of a product or material measured from the time the contract is executed and tied to a reliable and accepted index, like the Producer Price Index published by the Bureau of Labor Statistics (PPI), the Construction Cost Index (CCI) or the Building Cost Index (BCI).

It is also important to specify the materials that are subject to the price adjustment clause to avoid any doubts amongst the parties to the contract. For example, a cost-sharing arrangement could be triggered when the cost of steel increases by 10 percent over and above the cost of steel at the beginning of the contract as reflected in the PPI.

Other provisions to consider in drafting the triggering mechanism for a price adjustment clause is to provide for not only price escalation, but also price reduction in the event of materials decreasing in costs. These clauses can also provide specific materials where the parties may agree to simply share costs. Drafting price adjustment clauses that are focused on mutuality and fairness will reduce the risk that a Court may decline to enforce such a clause due to a lack of consideration or unconscionability.

Another triggering mechanism that some parties utilize involves comparing the contractor's purchase orders at the beginning of a project to purchase orders issued later in the project. While this type of triggering mechanism may be more specific and more accurately capture local economic trends, it should be avoided because it is generally harder to enforce and may be subject to varied interpretations and manipulation.

It is important in any price adjustment clause to clarify that only the increased costs beyond the trigger price are subject to sharing, and not all of the underlying cost increases. Of course, both parties should have rights to review and/or audit all documents used to justify the implementation of a cost-sharing mechanism once it has allegedly been triggered. Rights and obligations to seek documentation and/or audit of a declaration of price adjustment is important because it further anchors the clause in fairness and accountability between the parties, which bolsters its enforceability.

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It is also imperative to specifically set forth the cost-sharing mechanism between the parties for all increases (or decreases) relative to the trigger price. A customary way to document that mechanism is through percentages, i.e., the owner pays 30% and contractor pays 70% of all increased costs for the product or material at issue, and vice versa. Other ways to handle the cost-sharing arrangement are through an express right of the contractor to draw off a contingency fund or through an allowance that is funded by the owner prior to the beginning of the project.

To avoid complications and conflicts, any price adjustment clause that is included in a construction contract should specifically reference any other contractual clauses in the contract documents that it may be interpreted in conjunction with and provide that that it governs to the extent of any conflict between those clauses. Specific severability language for the price adjustment clause should also be strongly considered if any part of the clause is determined to be unenforceable. It may also be prudent to require any other agreements for the same project with subcontractors, consultants or other parties to include reference to and/or subordination to the price adjustment clause or include the same price adjustment clause for consistency.

Finally, price adjustment clauses should contain a ceiling that when reached allows the parties to either suspend or terminate the project. The protection of a ceiling provision is important because even with a cost-sharing mechanism in place, there is usually a point at which cost increases become so substantial that it is not economically feasible for one or both parties to continue the project. The ceiling should be negotiated up front by the parties and should use the same mechanism as the trigger component of the clause, i.e., a percentage above a certain price index.

The price adjustment clause should contain language providing options to the parties once the ceiling has been reached. The options may include suspension of the project, a termination for convenience, a declaration of a force majeure or other forms of agreed procedures. A project termination under these circumstances would normally allow the parties to recover their reasonable costs and overhead and would not give rise to a default or a claim for breach. This allows either party to move on from the project without having to incur an extremely prohibitive increase in material costs or be subject to litigation.

Again, it is important to negotiate and draft a ceiling provision before the project begins, otherwise, there will not be a mutuality of interest and equivalent bargaining leverage between the parties.

Conclusion

Price adjustment clauses are a valuable tool for both owners and contractors that should be strongly considered considering the expansive and material tariff program instituted by the Trump administration to provide at least some level of control against rising product and material costs.

It is important that care is taken to make sure price adjustment clauses are fair to both parties and contain objective criteria for when they are triggered, and how they are applied, to ensure they are enforceable. These clauses can be tedious to draft and negotiate, but the time spent doing so before the project begins will pay dividends during the project by decreasing the risks of delays and disputes, which only serve to damage the relationship between an owner and its contractor and increase costs and legal expenses.