By: Alex Daley, Student-at-Law and Andrew Wood, Partner
Dooley Lucenti LLP
For an industry that relies on certainty, cost escalation in the construction industry has become daunting and nerve racking for owners, contractors and subcontractors. Although increases in construction costs for materials and labour is not novel to the industry, the drastic jumps we have seen due to inflation and COVID-19 are. According to data from Statistics Canada, construction costs for residential buildings in the first quarter of 2022 increased by 25% compared to the same time last year.
Our firm has been witnessing two popular questions coming from our construction clients: 1) who must bear the brunt of the increased costs for particular material?; and 2) who is responsible for government caused delays in construction projects? The answers to these two questions start with a review of the contract’s relevant provisions. Unfortunately, this becomes a larger issue for fixed-price contracts which rely heavily on certainty. Although construction contracts are often lengthy, detailed and all-encompassing, many of them did not prepare for what the industry has gone through in the past two-three years. If there is no price escalation clause in the contract, the analysis then turns the common law (the courts decisions) to determine who bears the brunt of the cost escalation and delayed caused costs.
We have not yet come across a decision that directly comments on this issue in the construction industry, however, there have been multiple decisions that comment on the issue in the landlord-tenant industry that could provide guidance.
In the case of Braebury Development Corporation v Gap (Canada) Inc., 2021 ONSC 6210, a commercial tenant, Gap (Canada) Inc. (“Gap”), did not pay rent as required under the lease in April or May, 2020, when it was required to shut down its store, and only made partial payments from June to September 2020. Gap then unilaterally vacated the premise in September 2020. Gap argued that it was relieved of its obligation to pay the arrears of $208,211.85 because the purpose of the lease was frustrated by the COVID-19 pandemic, and the resulting public health restrictions, which significantly impeded its ability to operate its business to the point where it was no longer reasonable, practical, or commercially viable for it to do so. The court ruled that “a tenant is unable to rely on the force majeure clause to excuse its failure to pay rent during the government-ordered lockdown.” The Gap then tried to state that the legal doctrine of frustration applies because “(1) the government’s COVID-19 restrictions “made the Lease radically different from that which was undertaken under the Lease when it was signed”, and (2) performance of the lease, by ordinary operation of Gap’s retail store at the premises pursuant to the lease’s “use” clause became impossible as a result of the government’s COVID-19 restrictions.” To this the court said “the question is whether the COVID-19 restrictions radically altered the terms of the lease. While this event did prohibit Gap from operating its retail store temporarily between March 2020 and May 2020, and then at reduced capacity until September 2020, it is not clear that this would be sufficient to engage the doctrine of frustration.”
Accordingly, summary judgment was granted in favour of the Braebury for the amount of arrears of rent owing. If we analogize this case to a fixed-price construction contract scenario, it would be the contractor who would bear the brunt of the cost increase in materials and be responsible for performing its duties under the contract at the agreed upon price – regardless of how drastic the materials have increased.
It is therefore paramount that contractors work with their legal teams to negotiate a fair and reasonable price escalation clause into their contracts to avoid being held liable for the drastic increases in material. If drafted well, the clause will protect both the contractor’s interest and the owner’s when prices escalate and unforeseeable amount.