9.3 Escalation Clauses

• Library: Virginia Construction Law Deskbook (Virginia CLE) (2019 Ed.)

9.3 ESCALATION CLAUSES

9.301 Adjustments for Changes in Costs. There is a risk inherent in any contract that the assumptions on which it is based may prove false. When parties enter into a construction contract, their agreement is generally based on assumptions regarding the price and availability of labor and materials. Changes in the price and availability of labor and materials may dramatically alter the cost of performance. To address this risk, a contract may provide for price adjustment, cost reimbursement, or equitable adjustment.

Absent contract language to the contrary, the contractor bears the risk of any unforeseen change in circumstances. ³⁶ When such changes affect performance, contractors have sought relief under traditional doctrines of impossibility and impracticability of performance, mutual mistake, frustration of purpose, and force majeure. For the most part, these efforts have not been successful.

A price escalation clause typically provides for price adjustment based on changes in costs. That change may be calculated as the difference between the costs expected at the time of contracting and the actual costs paid. Another method of calculating cost changes is by reference to recognized price indexes.

9.302 Using Price Indexes to Calculate Cost Changes. The producer price indexes calculated by the United States Department of Labor, Bureau of Labor Statistics, are commonly used because they provide an objective measure of change. These indexes are organized in three major structures: Final Demand-Intermediate Demand (FD-ID) System, ³⁷ Commodity

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Type, and Industries. The Bureau publishes indexes by product groups, such as for electronic components, or for particular items, such as diesel fuel.

The Bureau of Labor Statistics provides detailed guidance for using these indexes for drafting an escalation clause. ³⁸ In sum, the Bureau suggests:

1. Establish the Base Price. The base price subject to escalation must be specified. It should be clear what quantity or volume of products the price refers to, and the date the price was in effect. This date will also establish the base value of the index. An escalation clause should cite the month and year and not the particular value of the index because the particular value may change.

2. Select the Appropriate Index or Indexes. The contract must specify the relevant price index. The parties should choose an index that reflects the cost of performing the contract. However, more specific...