Explosion of construction costs – will we now see a huge wave of bankruptcies?

 2.0 Update of our guide on dealing with material cost increases and delivery delays

The current development in construction costs and material deliveries

In June of last year, we published a guide on how to deal with material cost increases and delivery delays. This was in response to exploding construction costs and delays in material deliveries already severely affecting the construction industry in 2021.

Instead of the expected easing of the situation, the problems have actually worsened in the meantime. The ongoing COVID-19 pandemic as well as the war of aggression in Ukraine and the associated sanctions against Russia have led to further price increases. For example, a significant share of construction materials comes from Ukraine, Russia and Belarus: about 30% of construction steel, 40% of raw iron, 25% nickel and 75% titanium. This has also been accompanied by a considerable rise in the cost of fuel and energy.

Due to the increased breakdown of supply chains, shortages of raw materials and materials continue to rise rapidly and with them prices. The cost of steel, concrete, timber and much more varies daily, if not hourly. These unpredictable price fluctuations now lead to an almost incalculable price risk. Contractors can often only acquire certain building materials at high prices, which sometimes causes problems that threaten their very existence. To combat these, construction companies try to pass on price increases and procurement problems to the clients. Due to the difficult calculation variables, many contractors limit their offer period to only a few days or submit their offers without obligation.

Above all this, the question arises as to how to deal with these further problems legally.

What are the consequences of such price increases and supply bottlenecks for builders and construction companies? What should be considered now?

Public sector contracts

As of 25 March 2022, the new Federal Ministry of Housing, Building and Urban Affairs (BMWSB) issued a decree that makes the inclusion of material price escalator clauses in new and existing contracts mandatory and regulates them. The decree was issued in response to the current supply bottlenecks and price increases of certain construction materials as a result of the Ukraine war and is binding for the award of public contracts. The special regulations it contains are intended to counteract the effects for current and upcoming federal construction measures for product groups such as steel and steel alloys, aluminium, copper, petroleum products, epoxy resins, wood and others. The regulations are initially limited until 30 June 2022.

Accordingly, in ongoing award procedures in which the bids have not yet been opened, material price escalator clauses must be included retrospectively, execution deadlines must be adjusted to the current situation and the bid deadline must be extended if necessary. After the opening of bids, the procedure must be reset to the status prior to the submission of bids in order to be able to subsequently include material price escalator clauses and, if necessary, extend the execution deadlines.

For existing contracts, the Federal Ministry has affirmed a case of force majeure or another unavoidable event within the meaning of Section 6 (2) no. 1c) VOB/B if the materials from the named product groups are demonstrably not or temporarily not procurable by the company, not even at higher purchase prices than calculated. As a legal consequence, the execution period will be extended by the duration of the non-deliverability of the materials plus a reasonable surcharge for the resumption of the work. This will not give rise to any claims for damages or compensation against the company, nor shall the client be in default of acceptance vis-à-vis subsequent assignments for work if their performance has to be postponed as a result.

In addition, the Federal Ministry for Public Projects has recognised in principle the disturbance of the basis of the transaction pursuant to Section 313 of the German Civil Code (BGB) on the following grounds:

• The contracting parties concluded the contract on the assumption that the necessary materials could in principle be procured and that their prices were only subject to the general variables of economic life. They would not have concluded the contract with this content if they had known that the events of the war in Ukraine would have such an unforeseeable influence on the price development.
• The risk of material procurement is in principle in the sphere of the company, but not in cases of force majeure.
• The reasonableness of adhering to the unchanged contract is a case-by-case decision, whereby there is no fixed limit beyond which unreasonableness is to be assumed. In case-law and literature, unreasonableness is assumed at values between 10-29% or 15-25% increases in quantity or price. However, this depends on an overall view of the contract and not on the individual item.

If, in an individual case, a disturbance of the basis of the contract (Section 313 BGB) can be affirmed, the company is entitled to an adjustment of the prices for the affected items, which in turn are to be determined “according to the circumstances of the individual case”. According to the statutory provisions, an obligation to pay more than half of the additional costs by the client is regularly considered unreasonable.

Private sector contracts:

1. Transfer of the principles of the BMWSB decree of 25 March 2022 also to the private sector

First, the question arises as to whether the BMWSB decree described above for public construction projects can also be transferred to those in the private sector.
This must be answered in the negative, as the decree is expressly only binding for the award of public contracts.

A separate claim to price adjustment does not arise for contracts in the private sector.

2. Statutory risk distribution

The decisive factor for possible price adjustments in contracts between private parties is rather the legal and contractual distribution of risk. In our June Newsletter 2021 we already pointed out that the price calculation for building materials generally falls within the contractor’s area of risk. The contractor also regularly bears the procurement risk, i.e. the risk of procuring the building materials required for the construction of the work in good time. In this context, the contractor must take all measures necessary to fulfil its performance obligations under the contract. In case of doubt, the contractor must also enquire with other suppliers. Any considerable additional costs that may arise as a result shall be borne by the contractor.

3. Consequences for existing contracts:

For existing contracts, the question arises whether the contractor may be entitled to (a) a claim for price adjustment and/or (b) a claim for extension of time on the basis of this distribution of risk

(a) Claim to price adjustments?
If the parties have not provided for an adjustment of the contract prices in already existing contracts, e.g. a material price escalator clause, the contractor is basically left to bear the rising costs due to the legal distribution of risk described above; the contractor therefore usually has no possibility to receive compensation for the price increase from the client. In principle, there is no entitlement to a price adjustment.

If, on the other hand, the contract contains a corresponding provision for price adjustment, this does not happen automatically either. Instead, the contractor must present and prove the existence of the contractually agreed prerequisites for this adjustment and, on this basis, assert the price adjustment vis-à-vis the client.

Special case of lapse of the basis of the contract, Section 313 BGB??
As already mentioned in our Newsletter of last year, the application of the principles of the lapse of the basis of the contract (Section 313 BGB) is to be considered in case of the occurrence of unforeseeable events in connection with contracts already concluded. This would have the consequence that the contractor would be entitled to adjust an already concluded contract with regard to the agreed prices

A lapse of the basis of the contract according to Section 313 BGB is to be assumed,

• if certain circumstances which have become the basis of the contract have changed so seriously after the conclusion of the contract due to unforeseeable events that the parties would not have concluded the contract under these conditions or would have concluded it only in a modified form.
• In addition, it must be the case that at least one of the contracting parties, taking into account all circumstances of the individual case, in particular the contractual or statutory distribution of risk, cannot reasonably be expected to adhere to the unchanged contract.
  
  

It is true that the war in Ukraine may indeed represent such an unforeseeable event as the cause of the existing price and supply problem, which is in principle suitable to disturb the business basis of a contract.
However, whether this exceeds the limit of unreasonableness for one of the contracting parties has not yet been clarified by the highest courts.

In connection with the Corona pandemic, the courts affirmed the assumption of an unforeseen event within the meaning of Section 313. Nevertheless, with regard to the question of a resulting price adjustment claim, explicit reference was made to the reasonableness and the weighing up of interests in the individual case.

For the assumption of a case of Section 313 BGB, it therefore decisively depends on whether the contractor can be expected to adhere to the unchanged contract or not, taking into account all circumstances of the individual case, in particular the above-mentioned legal risk distribution for price calculation and procurement of building materials.

In this context, however, the situation of the contractor must also be taken into account, who has calculated with the agreed prices in its financing and cannot finance higher construction costs in case of doubt.

This will have to be assessed separately for each individual case, so that no prognosis can be made at this point.

(b) Entitlement to an extension of the time limit?
A claim for an extension of the contractual periods can also only arise from a corresponding agreement already made in the contract.

The VOB/B contains such an agreement which the contracting parties may invoke if it has been validly incorporated into the contract. According to this, the following applies:

Pursuant to Section 6 (2) no. 1 c) VOB/B, execution deadlines may be extended if an impediment is caused by “force majeure” or other circumstances unavoidable for the contractor. Whether the Corona pandemic or the war in Ukraine justify the assumption of a case of force majeure must be clarified on a case-by-case basis. Force majeure can at most be assumed if the respective material is actually not available.

However, the shortage of materials must not be due to defective planning or insufficient ordering. Furthermore, the missing materials should also not be procurable at a higher price - which would be reasonable for the contractor due to its allocation of risk. According to case-law of the higher courts, even exorbitant price increases for the timely procurement of materials fall within the contractor’s sphere of risk.

Even if a case of force majeure exists, the contractor must notify the customer of the hindrance in accordance with Section 6(1) VOB/B and provide concrete evidence of the effect on the construction process.

4. Consequences for new contracts:

For contracts to be concluded in the future, the inclusion of corresponding price escalator clauses should be appropriate and in the interests of the parties. In this respect, it seems sensible to at least take into account the above-mentioned principles of the BMWSB decree of 25 March 2022. Against this background, the following should be taken into account when drafting such a clause:

• The clauses should be formulated in a balanced manner and be oriented towards the basic distribution of risk outlined above
• Both parties should not only bear a corresponding share of rising costs, but also benefit from falling costs. Therefore, the possibility of price reductions should also be taken into account.
• In addition, price escalator clauses should refer to certain fixed materials and allow an objective assessment of actual price increases by containing objective and comprehensible reference points to be proven by the contractor or the claimant respectively.
• The definition of a limit beyond which unreasonableness is to be assumed also appears sensible from the point of view of practicability.
• Furthermore, such clauses could in return be linked to an obligation of the contractor to order the building materials directly after the conclusion of the contract so that they are available in time for the construction of the building. Against this background, at least a delay in delivery could be counteracted.
  
  

Creativity is therefore required in the individual drafting of price escalator clauses in order to do justice to the different interests on the one hand and the legal distribution of risk on the other.

Such clauses must also be formulated in such a way that they do not fall at the the hurdles of the general terms and conditions test, in particular Section 309 No.1 of the German Civil Code (BGB) for consumer contracts and Section 307 of the German Civil Code (BGB) for business contracts.

It is therefore advisable to have appropriate clauses drafted within the context of detailed legal advice relating to the individual case.

We would be happy to assist you.