On March 23, 2018, the U.S. began imposing a 25 percent tariff on steel imports and a 10 percent tariff on aluminum imports. As a result, owners, contractors and subcontractors — especially those performing under fixed or lump-sum arrangements — are bracing for a potential rise in the price of these commodities and turning to their contracts to understand the price risks and determine ways to minimize project disruption. Likewise, given the White House’s announcement that it would temporarily suspend the tariffs for goods from certain countries, including Canada, Mexico and the EU, project stakeholders are inquiring into the origin of the goods to demand, for example, that any steel or aluminum not yet purchased be sourced from favored nations that are not subject to the tariffs.
This article provides practical advice on contractual terms that may be used to evaluate and address these concerns, and provides recommendations that may be adopted to minimize the impact of other tariffs that may arise in the future.
Tariffs and Key Contractual Provisions
Along with the arrival of the tariffs came a number of questions for project stakeholders currently locked into fixed price contracts, such as whether the contract allows for an equitable adjustment or an opportunity for contract price negotiations, whether the tariffs constitute a “force majeure event” that could extend time for performance or allow contract price adjustments, and whether the tariffs will trigger the application of a material escalation or changed conditions clause that may entitle a contractor to a change order.
The key to assessing the scope of potential exposure and ascertaining possible avenues to mitigate or avoid the resultant financial consequences will likely lie in contract provisions relating to changes in law, force majeure, changed conditions and material escalation.
Most major form documents are silent on the issue of subsequent changes in the applicable laws. One exception appears to be ConsensusDocs 200 Owner/Constructor Agreement and General Conditions, which does contain a change in law provision in Section 3.21.1, which states: “The Contract Price or Contract Time shall be equitably adjusted by Change Order for additional costs or time needed resulting from any change in Law, including increased taxes, enacted after the date of this Agreement.” In considering whether the tariffs are sufficient to trigger the clause, stakeholders should review how “laws” are defined in the agreement and assess whether the definition encompasses tariffs, treaties or executive orders. This is a timely issue. The legal basis cited in support of the tariffs is Section 232 of the Trade Expansion Act of 1962, which act grants the president authority to impose tariffs if an article is being imported into the United States in such quantities or under such circumstances as to threaten or impair the national security. As such, there remains question such as whether the new tariffs are a product of a change to the law or an enforcement of existing law.
Absent a change in law provision, parties should fully analyze the specific language used in other potentially applicable contract provisions, such as those dealing with changes in work and cost of work. Markedly, major form documents are vague as to whether changed circumstances not related to scope can amount to a “change in work” and do not typically distinguish between the anticipated cost of the work at the time of execution of the contract and the actual cost of the work at the time the contractor purchases the materials.
Force majeure clauses typically contemplate contractor relief only for “unanticipated” or “unforeseeable” circumstances. For example, DBIA Document No. 535 defines “Force Majeure Event” in Section 1.2.8 as “those events that are beyond the control of both Design-Builder and Owner, including the events of war, floods, labor disputes, earthquakes, epidemics, adverse weather conditions not reasonably anticipated, and other acts of God.” In today’s construction world, and absent some modification to the standard force majeure clause, it may be difficult to demonstrate that material price escalation was “unforeseeable.”
Furthermore, even if the new tariffs work to trigger a force majeure provision, it is critical to note that some force majeure provisions entitle the party invoking the clause to additional time – not money. Still, other provisions may provide stronger opportunities to recover costs resulting from price escalations induced by the tariffs. Although some changed conditions or unanticipated conditions clauses are designed to address unanticipated physical conditions at the project site, other clauses may be less limiting in their definition of what “unanticipated conditions” qualify for price relief. Given the potential severity of the impact of these tariffs on certain projects, parties to a construction project may want to anticipate the potential impact of tariffs by specifically defining certain contract terms such as “laws,” “regulations,” “changes” and “force majeure” in order to avoid conflict and disputes down the road.
Material escalation clauses work to alleviate the actual cost impacts to the parties by allowing adjustments once a particular factor beyond the control of either party raises or decreases the costs of materials above or below a negotiated baseline, with entitlements based either on the delta between the as-bid and as-delivered prices or existing material price indexes. In reviewing the feasibility of obtaining an increase based on a material escalation provision, stakeholders are advised to review whether conditions precedent to its enforcement have been satisfied, understand the effect of any “risk-sharing” provisions that might be present, comply with all notice requirements, and determine what form of proof is necessary to obtain the privileges afforded by the provision.
Because most construction contracts are tailored to fit the parameters, limitations and constraints of a given project and are customized to reflect the parties’ priorities and tolerance to risk, it is inevitable that answers to the foregoing questions will vary. Consequently, the success of an increased cost claim can hinge on how an agreement defines changes in laws, force majeure, and other important provisions, as well as the thoroughness of those definitions. Project stakeholders should therefore pay particular attention to the definitions in their contract, especially as considerable differences and omissions exist in the major form documents on these issues, including the lack of definitions for changes in laws and force majeure.
“Country of Origin” Implications
Importers should be aware that the tariffs apply only to materials originating from certain countries (the “country of origin” requirement). If the product is manufactured and assembled primarily in one country, the country of origin should be easy to determine. If, however, the product’s components originate from country X, is shaped in country Y and flows through country Z before entering the U.S., determining the point of origin could be very complex.
Determining the point of origin of imported products for tariff purposes has long been a difficult task. Subject to any future clarifications or tariff amendments, there are two primary tests that may apply to this determination: the “wholly obtained” and “substantial transformation” tests. “An article is a product of a country or instrumentality only if (1) it is wholly the growth, product, or manufacture of that country or instrumentality, or (2) in the case of an article which consists in whole or in part of materials from another country or instrumentality, it has been substantially transformed into a new and different article of commerce with a name, character, or use distinct from that of the article or articles from which it was so transformed.” The point of origin for products affected by the tariffs will need to be determined on a case by case basis. Importers may need to take case law, U.S. Custom and Border Protection regulations and agency interpretations into account when determining the point of origin of the product.
Owners, contractors and subcontractors should keep these principles in mind while exploring ways to possibly mitigate, shift or recoup the resultant financial consequences of the new steel and aluminum tariffs.