Recently, several clients have contacted the firm after suffering cost impacts caused by President Trump’s unexpected changes to America’s tariff schedules (“Trump Tariffs”). In one case, a sprinkler subcontractor claimed that the Trump Tariffs caused pricing for sprinkler piping to increase by 36%.
The issue is who bears the risk of unforeseeable increases in material pricing caused by sudden unpredictable changes in international trade policies?
The Expectation of Predictability in Multi-year Material Prices
For decades, contractors pricing multi-year projects have expected, and relied upon, relative stability and predictability in material pricing. This well-established expectation was not formed overnight, or by accident.
On January 1, 1948, the United States of America and 22 other nation-states executed the General Agreement on Tariffs and Trade (the “GATT”). The GATT is an international trade treaty formed in the aftermath of World War II, which has a stated goal to reduce or eliminate tariffs, quotas, and to promote free trade. The implementation of the GATT eventually led to the creation of the World Trade Organization (the “WTO”). The WTO, founded on the principles established by the GATT, has a stated ideological purpose: to ensure that international trade is both “free” and predictable.
From a legal realist perspective, international trade is anything but “free,” as all nation-states enforce complex “Tariff Schedules.” Nevertheless, the WTO has established a global economic order, which has to a large extent achieved its main goal to reduce tariffs and establish predictability in the trade of goods and services. The expansion of the WTO, which now includes 164 nation-states, and the promulgation of its global policies, has resulted in a general expectation in the construction industry of predictability in material pricing.
Past Compliance With Tariff Schedules Reinforces Expectations of Predictability
At President Ronald Reagan’s request, the United States Congress created the Harmonized Tariff Schedule United States of America (“HTSUS”), which is a system used to classify goods imported into the country based on the International Harmonized Commodity Description and Coding System and classifies goods via their name, use, and material used for construction. On August 23, 1988, HTSUS replaced the Tariff Schedules of the United States under subtitle B of Title I of the Omnibus Trade and Competitiveness Act of 1988.
For over 30 years, the Executive Branch has generally complied with America’s commitments under the HTSUS, guided by the ideology that “free” trade is in America’s best interest. But the facts tell a different story. Since 2001—the year China joined the WTO—the United States has lost 60,076 manufacturing establishments. The Trump Administration has identified America’s commitments in international trade as a major causal factor in this loss, and the revolution of America’s economy.
It has become clear that President Trump is not an ideologue; he’s a realist. And from a realist perspective, sure, international trade may be guided by the philosophy that “free” trade is better and preferable, but the fact is that it is a competitive game, in which there are winners and losers. President Trump’s “America First” agenda is based upon the belief that the world’s nation-states are engaged in a global competition, in which sovereign nation-states are in control, not international organization such as the WTO. This has led the Trump Administration to make a number of unexpected strategic moves.
The Trump Administration’s Unforeseeable Tariff Changes
In January 2017, the Trump Administration immediately followed through on its stated intent to change America’s strategy in the chess game that is international trade. In one move after the other, the Trump Administration has challenged its trade relationships, from its relationships with Canada and Mexico under NAFTA, to Japan and other Asia Pacific nation-states in negotiations under the prospective Trans Pacific Partnership, to, most importantly, China and its role in the WTO.
In China, many see President Trump’s tariff threats as part of a package of hostile moves aimed at isolating and punishing China. These include what some have argued is harsh language in the Trump Administration’s new National Security Strategy. The effect of the Trump Administration’s unexpected acts to rebalance America’s economic relationships has resulted in actual cost impacts for contractors executing existing contracts in the construction industry.
Existing Contracts are Likely Protected by Certain Force Majeure Clauses
Typically, the builder bears the risk of cost impacts resulting from labor and material escalation. A prudent contractor prices this risk. But if a contractor’s plan for labor and material is affected by an event that is outside of its control, then the contractor may be entitled to recover the cost impacts resulting from that event. But only if the other contracting party is responsible for the risk associated with the event’s cause.
It is unreasonable to conclude that domestic contractors operating under existing contracts could have foreseen the unpredictable cost impacts caused by changes to the HTSUS, resulting from sudden shifts in America’s international trade strategy. And it cannot be disputed that these sudden shifts are outside of domestic contractors’ control. Therefore, existing contracts that include a force majeure clause likely governs the allocation of risk caused by unpredictable and unforeseeable changes to American international trade policy.
Force majeure, which originally derives from France’s Code Napoléon, is an internationally recognized legal doctrine covering events that are unforeseeable, unavoidable, and which materially affects contractual execution. Force majeure clauses encompass risks that lie beyond the control of contracting parties, and which may prevent the parties from fulfilling their duties and obligations.
Generally, “force majeure” means what the contract says it means. And if a contractor can demonstrate that there is a cause-and-effect relationship between the Trump Tariffs and material escalation, then a force majeure clause likely provides protection if the contract defines force majeure as any: (1) hostile acts; or, (2) civil disturbances; or, (3) unforeseeable circumstances. It could be argued that language similar to the following governs costs impacts caused by the Trump Tariffs:
Force Majeure means any unforeseeable circumstances beyond the control of the Parties against which it would have been unreasonable for the affected party to take precautions and which the affected party cannot avoid even by using its best efforts.
If a contract contains a force majeure clause that includes this language, then the contractor affected by the Trump Tariffs could be entitled to recover damages that result.
Additional Protection through Political Risk Insurance
To further mitigate these risks, American contractors engaged in multi-year major work should consider Political Risk Insurance (“PRI”) to protect their investments. While public entities have traditionally filled this need, private players are increasingly participating in the PRI industry.
An investor that values speed and does not wish to be monitored for compliance with social and environmental standards would likely prefer a private PRI policy, whereas an investor concerned particularly with national political policy risk who values the deterrent effect of the World Bank’s backing would likely opt for a Multilateral Investor Guaranteed Agency PRI policy.
Typically, contractors assume the risk of material escalation, and therefore, a prudent contractor prices it. But it is unreasonable to conclude that contractors could have foreseen the unpredictable cost impacts caused by strategic changes to America’s international trade policy. Considering this fact, contractors with obligations under existing contracts may be protected by contracts that include certain force majeure clauses.
For decades, contractors have relied upon well-established international trade norms promoting predictability in the trade of goods. But as President Trump continues to reassert American interests through unpredictable strategic acts in the international trade dimension, contractors are now on notice—expect the unexpected.
In future contracts, contracting parties should allocate the risk of time and cost impacts caused by sudden shifts international trade policy. Compartmentalizing unforeseeable political risk through force majeure provisions and managing risk through PRI is a fundamental strategy to handle the risks inherent to major works built in today’s uncertain political environment.