Tariffs of up to 25% have been proposed as an economic and fund raising tool for the Federal government in 2025. Those tariffs may be applied to the two largest U.S. trading partners, Canada and Mexico, as well as China and other countries. By example, Canada exports most of its lumber to the United States.
The impact of the tariffs will affect not only building materials, but also building tools and equipment. If your company is a supplier, subcontractor, general contractor, or owner involved in construction, what should you do to address this risk? There are two main considerations if tariffs are imposed.
1. The increase in the price of the materials or equipment. Consider that some materials may already be subject to a smaller tariff.
2. The availability of the materials and equipment.
Who should or can bear the cost impact of the tariffs on pre-existing contacts? What can be done to address tariffs in future contracts?
GENERAL CONTRACT RULE
The general rule is one must first look at the new statute / regulation and your contract. There is no statute or regulation yet, but you should look at your purchase order or contract. However, it is the rare contract that has an escalation clause or force majeure clause regarding supply chain issues. I’ve not seen a “tariff” clause in my many years in the industry. Covid-19 driven escalation and prior periods of escalation have proven that there is usually no relief for a seller in most purchase orders or contracts. A detailed review of your purchase order or contract should be performed. Historically, most owners reject escalation type claims, which in turn flows down to subcontractors and suppliers. Arguments such as impracticability are rarely viable as an excuse to performance. Again, your purchase order or contract may have terms that anticipate price increases and escalation.
SOURCE OF THE MATERIAL
Although no statute or regulation has yet been issued, certainly everyone in the chain needs to know the source of the materials and equipment. Often specifications require materials or equipment that can only be obtained from another country. If you are lucky, you’ll find out the source is in the United States and the fear has no basis. However, if you are buying a tractor made in Iowa, made with steel from outside the U.S., the issue returns.
The issue may be price, but the inability to obtain a single computer chip may hold up delivery of a large piece of equipment. Researching these issues now will be important to addressing challenges.
If the material or equipment is critical, but is impacted by price or late delivery, there should be some prompt consideration of value engineering. Value engineering in this instance should focus on both availability and price.
DOES FORCE MAJEURE APPLY?
The issue is not only price, but whether the materials will be available at all or only on a delayed basis. While one can suggest that any such issues may fall under a force majeure clause, those clauses typically only address finite delay issues. The obligations to deliver are suspended, not eliminated. Also, if “supply chain”, “tariff” or “escalation” are not specifically listed in the force majeure clause, they may not fall within the scope of a force majeure clause.
FINANCIAL CONSIDERATIONS
You should keep in mind that a vendor or subcontractor that has to pay a 25% tariff may not be able to afford the losses that will occur if it has to pay the 25% out of its own pocket. Some companies faced with a substantial loss on every item will simply refuse to deliver, notwithstanding contract obligations. Given the potential impact on all of the project participants, some consideration of cost sharing as a compromise to allow the parties to move forward with the project may be necessary. What is the impact on the project of a substantial delay, who is in the best position to pay for some, or all of the tariffs and what are available alternative approaches are key questions.
While a vendor or subcontractor may not be entitled to reimbursement of a 25% tariff, the owner and contractors should question the impact on the overall project. If a supplier can justify a price increase under its purchase order for tariffs, it may also be entitled to overhead and profit on the 25%, likely increasing the impact closer to 30%. I suspect that even if the material item is available locally, the vendors are likely to increase their prices by 25% or slightly less, to take advantage of the market. You have to ask yourself where else can you go to get the material or equipment. We learned during Covid-19 that the supply chain is fragile.
ACT SOON; KEY ISSUES
Regardless, acting fast on all of the issues will likely be critical. These issues should be anticipated. Should you be pre-purchasing materials and storing them? Typically, a subcontract will allow such pre-purchases with permission from the owner and the general contractor.
Even if you have not signed the purchase order or contract yet, consider adding clauses that cover:
A. Documentation of what materials or equipment will be subject to the tariff.
B. When are you entitled to recover a tariff? What happens where the purchase was previously funded, but the materials were not timely ordered?
C. Address whether overhead and profit can be recovered on the increased cost.
D. What documentation is required from the vendor or subcontractor?
E. What kind of mitigation is required by the vendor / material supplier? Do you require documentation of alternate sources and prices?
F. Who is responsible for the schedule impact? Should the force majeure clause be redrafted / expanded?
G. Make sure you have a termination for convenience clause.
H. Consider risk / reward of not paying the tariff amount.
CONCLUSION
A 25% tariff has the potential to severely disrupt individual businesses and projects of any size. You should act quickly and get ahead of the issue.
Laurence P. Lubka is Senior Counsel at Hunt Ortmann Palffy Nieves Darling & Mah, Inc. He represents California clients throughout the world, ranging from local payment disputes to drafting contracts for projects overseas. Mr. Lubka represents public entities, general contractors, engineering firms, major subcontractors and suppliers. Mr. Lubka’s over forty years of representing clients on a wide variety of projects allows him to provide a complete range of support to clients of the Firm.
