What is an Escalation Clause in a Construction Contract?

Woman's hands holding red pen resting on table on top of contract, man's hands opposite pointing to line where signature is required, yellow hard hat in the background.

If you are planning on making improvements or adding on to your home, keep an eye out for the escalation clause in your contract. It can mean a huge difference in what you are quoted and what you actually pay, and protects you, particularly in times like these, from exorbitant costs.

What is an escalation clause?

The escalation clause is an addendum in a contract that allows for adjustments in fees, wages, and overhead costs based on price fluctuations in the market. It shifts the burden for increasing costs, such as material or labor shortages, from the general contractor (GC) to the homeowner.

Pros and Cons of Escalation Clauses

If a client is willing to accept an escalation clause as part of the contract, GCs can submit more competitive bids with the confidence that they will meet their required margins as a business. More contractors will be willing to bid on jobs with escalation clauses, and homeowners will benefit from this competitive process.

Without guaranteed pricing, homeowners may feel uneasy about not knowing what the final costs may be, but the clause usually allows for negotiation, clear communication, and opting out - more on that to come.

Costs Subject to Escalation Clauses

There are many costs associated with adding an addition or building a new home. Labor, materials, weather delays, and more. Here are some of the bigger ticket items:

Fuel

The recent ransomware attack on Colonial Pipeline is a prime example of how an escalation clause can be used. The price for gas rose dramatically in just a few days as availability fell and demand rose. If a contractor has to use generators or equipment in the project, the escalation clause would cover this increase.

Steel and Wood

Before the pandemic, a sheet of plywood could be purchased for under $20. Purchasing that same sheet today would be over $50 in most places. Overall, the price of lumber has increased 252% since the pandemic.

The price of steel increased 60% in 2020 and is expected to continue to escalate.

What to Look For In an Escalation Clause

1. A list of current pricing for materials to be used should be outlined in your contract, so you

clearly understand the bid and starting point. It should look something like this:

Specified Building Material / Current Price per (Unit of Measurement) / Date / Supplier

1)____________________/_________________________________/_______/______________

2)____________________/_________________________________/_______/______________

3)____________________/_________________________________/_______/______________

4)____________________/_________________________________/_______/______________

5)____________________/_________________________________/_______/______________

2. The escalation clause should also contain a statement that guarantees clear communication of

any claim a builder may make for a cost increase, such as:

Any claim by the Builder for payment of a cost increase, as provided above, shall require

written notice delivered by the Builder to the Owner stating the increased cost, the building

material or materials in question, and the source of supply, supported by invoices or bills of

sale.

3. The homeowner and CG should agree on a percentage increase notification the homeowner

can agree to before purchases are made. It would read like this:

Should there be a rise in the cost of any specified building material or materials, exclusive of

any other price changes, that would cause the total contract price to increase by more than

_____(%), the Builder shall, before making any additional purchases of specified material or

materials, provide to the Owner a written statement expressing the percentage increase of the

contract price, the building material or materials in question, and the dollar amount of the

price increase to be incurred.

4. A right of refusal/cancellation of the contract should the homeowner decide the price is

unsupportable is also necessary. You may want to see if a GC will accept a “delay” in building

should material costs get out of hand, assuming you can live with the delay?

For a full example of an escalation clause,

How Material Costs Impact Your Home Insurance

Mutual Assurance members pay an assessment based on their policy’s premium each year. The premium is primarily based on dwelling values which are adjusted annually to account for residential construction cost indexes across the state. When steel, wood, fuel, and labor costs increase, so does a property’s value, based on the replacement costs should a storm or fire damage the dwelling. Factoring these costs into our policies each year is necessary to protect the members and the Society.

Reputable GCs, homebuilders, and homeowners should be willing to include and agree to an escalation clause in their contracts for the protection of all parties. Reviewing your contract with an attorney is always advised, particularly with large expenditures like an addition or major remodeling.