Inflation: The Elephant in a Construction Dispute or Contract Negotiation

Originally published as an Op-Ed by the Oregon Daily Journal of Commerce on June 16, 2022.

Inflation is hitting the country hard. Consider this: $1 million in January 2020 has the same buying power as over $1.7 million today, according to the Consumer Price Index inflation calculator. How much weaker the dollar will get is anyone’s guess.

As the economy—the construction market in particular—continues to experience inflationary challenges, it is critical that owners, contractors, and design professionals beware of the risks presented by inflation and understand the options to mitigate those risks. Following are answers to questions that industry professionals may have regarding such issues.

Where does my contract address inflation?

Odds are likely that your contract does not directly address inflation. But that does not mean that the impact of inflation is not embedded in your contract (or should be embedded in contracts you sign in the future). Review these contract provisions closely, with an inflation lens:

• Escalation clause: If a contract includes a specific provision dealing with material price increases, then that provision is a good place to start. Escalation clauses handle price increases in a variety of ways and often entitle the contractor or design professional to additional compensation (or a credit) if the price of material “x” deviates by some fixed percentage from a baseline figure for the expected cost of that material.
• Impossibility of performance: Depending on applicable law, this doctrine may provide a defense to a claim of breach of contract where the impact of inflation made it impossible to perform the duties of the contract. Whether performance is “impossible” will vary depending on the circumstances, and many jurisdictions will require objective impossibility—meaning that it must be impossible for any similarly situated owner, contractor or design professional to perform. This legal doctrine may also apply even if the contract does not have a specific provision addressing this issue.
• Impracticability of performance: A cousin to the preceding provision, if performance is impracticable, but not impossible, there may still be a defense (or at least a mitigating effect) of a failure to perform.
• Force majeure: Read the force majeure clause carefully to see if the impact of inflation could be captured, and if the relief available is merely more time to perform (which may not be helpful when dealing with inflation), or an adjustment to the cost of performance.

Such provisions are the tip of the iceberg but a good starting point. Other relevant clauses include constructive change provisions or extensions of time clauses. Creative parties may even draft a provision specifically addressing the risk of inflation.

Can I recover damages specifically for inflation?

There are limited decisions analyzing whether courts or arbitrators should take inflation into account when awarding damages. In specific circumstances, such as bad faith claims against insurers, there is precedent in some courts for taking into account the effects of inflation. For example, in this specific context the Court of Appeals for the Ninth Circuit (analyzing California law) upheld the use of inflation as an element of damages where, among other factors, “there was a steady rate of inflation during the compensable period.” (See Leslie Salt Co. v. St. Paul Mercury Ins. Co., 1981.)

Several years later the Ninth Circuit (this time analyzing Arizona law) held that “the factfinder may take inflation into account in measuring damages for breach of contract where doing so will put the damaged party in as good a position as if the contract had been fully performed and will avoid an otherwise unjust result.” (See Safeco Ins. Co. of Am. v. Duckett, 1988.)

How these decisions or related opinions will impact a non-insurer dispute under Oregon law appears to be an open question. There is dictum from a recent Oregon Supreme Court decision that appears to acknowledge the relevance of inflation when evaluating certain types of damages (see Busch v. McInnis Waste Systems, Inc., 2020), but whether the court’s reasoning in Busch will translate to a commercial construction dispute remains to be seen.

Does prejudgment interest compensate for inflation?

The objective of compensatory damages is to put a plaintiff in a position the plaintiff would have occupied if no wrongful conduct had occurred. As many disputes are resolved years after the fact, prejudgment interest is one way to compensate a party for the time value of money. But whether prejudgment interest will also account for the effects of inflation will depend on the time period at issue.

In times of high inflation, prejudgment interest may be insufficient to fully compensate a party as most prejudgment interest statutes are not indexed to account for inflation. Parties to construction disputes, in particular, are cautioned not to assume the award of prejudgment interest is a foregone conclusion—even putting inflation aside. Construction disputes often involve damages for additional work, delayed work or changed work that are heavily contested in quantum, and often subject to expert disputes. Depending on the jurisdiction of a dispute, even successful claims may not generate an award of prejudgment interest (or may only produce a limited award of prejudgment interest), which during times of inflation can be particularly damaging to a company’s bottom line.

During volatile times like these, it is critical to stay informed and plan accordingly. Tools for monitoring construction cost trends (like the one at www.mortenson.com/cost-index) are great resources. It’s important for all construction project parties to keep inflation top of mind when evaluating their next dispute or negotiating their next contract.