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Practical advice to construction projects affected by COVID-19: Disruption and prolongation costs

  • United Kingdom
  • Construction and engineering
  • Litigation and dispute management

16-09-2020

This article follows on from our articles on the Top 5 COVID-19 issues affecting construction contracts; mitigation and acceleration; and Assessing claims for extensions of time.

Parties to a construction contract will likely be familiar with dealing with claims for delay as a result of sites closing as the UK locked down.

Although delay seemed to be the word on everybody’s lips once the full scale of the pandemic came to light, the true long term implications to projects are increases in costs, disruption and prolongation.

For example, contractors may be required to invest to comply with new health and safety requirements; staff and material costs may become more expensive due to travel restrictions and supply shortages; and delays and loss in productivity may extend the programme and increase the site costs.

This will come at a time when contractors are already under financial pressure. There are reports of an increase in insolvencies of SMEs, and any supply chain issues will only lead to further delays and additional costs.

We have seen considerable sympathy being shown by employers to their contractors - they are wary of the risk of insolvency, with many choosing not to take a hard line on contractual entitlement. Even though this attitude may harden in the future, it remains the case that a properly developed claim will have a greater chance of success in formal dispute resolution proceedings. Far more important for most contractors is to maximise their prospects of recovering costs in the short term which means persuading employers to engage with and resolve claims.

In practice, a contractor’s ability to recover these costs will largely fall on its ability to prepare its claims, and to demonstrate and substantiate that the losses have been properly incurred as a direct result of COVID-19.

We have set out in this short note some practical advice for employers and contractors who may be considering bringing or responding to claims for increased costs.

Legal basis for claims costs arising from COVID-19

The starting point for a contractor considering a claim for delay or increased costs is establishing a contractual basis. This poses a potential issue for claims arising as a result of Covid-19.

These are unprecedented times, and in most cases construction contracts do not expressly address the risk of a pandemic.

There may be a reference to pandemic in the force majeure clause, but these clauses often only provide a right to claim time, and then only for the period of time that performance was rendered impossible. Whilst time is important because an extension can mitigate a liability for liquidated damages in due course, the priority or necessity for many contractors is money.

Contractors may try to argue that the circumstances affecting the works amounts to a material adverse change; or that there has been a change in law (for example, due to the imposition of health and safety legislation). The success of any argument will turn on the wording of those clauses; and whilst arguments may be met with some sympathy from tribunals, it seems likely that they will ultimately be challenging to pursue.

A contractor is likely to be better placed turning to the depths of the contract and its appendices, to look at the allocation of risk between the parties specific to a particular contract, rather than looking for a global right to raise a claim. Construction contracts are complicated documents, which often refer to a large number of supporting documents often containing detailed provisions governing the performance of the works. These confer rights and obligations on both parties, which if breached (or likely to be breached in the future) may give rise to a claim for time and money.

Demonstrating causation and substantiating loss

Despite the contractual challenges mentioned above, recent experience shows that many employers have been sympathetic to contractors who have genuinely suffered losses associated with COVID-19 through no fault of their own. In addition, many Employers have been (and should be) conscious of the risk of contractor insolvency.

However, it is one thing for Employers to take a generous view when it comes to contractual entitlement but quite another to expect generosity when it comes to handing over money. Employers will want to know costs have been incurred and caused as a direct result of Covid-19. As a result, global claims are likely to get short shrift.

In these circumstances, the success or failure of a claim for relief will fall on whether a contractor can demonstrate and substantiate that it has suffered loss as a direct result of COVID-19.

In any event, construction contracts will usually contain strict requirements requiring a contractor to substantiate its claims. For example:

  • JCT D&B 2016 – “such information as is reasonably necessary to enable the Employer to ascertain the loss and/or expense incurred” updated at monthly intervals until “all information reasonably necessary to allow ascertainment of the total amount of such loss and expense has been supplied.
  • NEC4 ECC Option A – a Contractor must submit a quotation when notifying of a Compensation Event, which “comprise proposed changes to the Prices and any delay to the Completion Date and Key Dates… [and] details of the assessment with each quotation… [and] alteration to the Accepted Programme in the quotation [if applicable].”
  • FIDIC – For a “fully detailed Claim” the Contractor must provide “all contemporary records on which the claiming Party relies” and “detailed supporting particulars of the amount of additional payment and/or EOT claimed.”

The SCL Protocol on Delay and Disruption also sets out detailed guidance for contractors as to record keeping under Appendix B.

Compliance with these clauses and this guidance will in most cases require the contractor to maintain and present detailed documentary records, which separate out COVID-19 related costs (so far as possible).

Categories of costs arising from delays and disruption

The SCL Protocol defines:

  • disruption as “the loss of productivity and hence additional loss and expense over and above that which would have been occurred were it not for the disruption events for which the Employer is responsible.
  • prolongation as “work actually done, time actually taken up or loss and/or expense actually suffered [as a result of the delay].”

These definitions encompass a wide range of project costs which might be incurred in instances where the contractor is delayed as a result of COVID-19. For example:

  • additional time spent by personnel/out of hours working;
  • office overheads;
  • equipment costs;
  • additional accommodation and site welfare costs;
  • inflated cost of materials or additional costs for replacement materials; and
  • financial costs, such as bond or insurance extensions.

Quantification of claims

(a)    Disruption

Quantifying claims for disruption is challenging, particularly in evidencing that a loss of productivity, or inefficient use of plant or labour, has a direct causal link with an Employer delay event.

There are a number of different methods of analysing disruption claims, which can broadly be divided into: (i) analysis on a productivity basis; and (ii) analysis of planned as against actual expenditure.

Contractors should also be wary of any hypothetical or prospective analysis of productivity, as damages are awarded in court on the basis of losses actually incurred. This analysis may be useful when making a claim within the contractual mechanism, but will not stand up to scrutiny if the claim is progressed to formal dispute resolution.

(b)    Prolongation

On site costs usually comprise of two main ‘streams’ of losses:

(i) personnel and equipment costs (on site costs); and
(ii) other costs (head office overheads, financial costs such as insurances and bonds etc.) (off site costs).

Additional time spent by personnel is often expressed in claims by reference to the contract preliminaries, and is therefore calculated on the basis of the rates included in the contract multiplied by the length of the extension of time. The contractual rates are estimates.

Damages for breach of contract claims are awarded on the basis of losses actually incurred (rather than estimated). Therefore, it is difficult for a Contractor to evidence a claim for these costs, calculated on the basis of the contract preliminaries, without producing additional contemporaneous evidence such as detailed timesheets. This often creates its own practical issues, which will hinge on how thorough the Contractor’s historic record keeping has been.

Losses associated with equipment differ depending on whether the equipment is hired or owned. It is easier to evidence losses associated with hired equipment, as there will be a rate upon which it is hired, and this can be applied for the length of time of the delay. If it is owned equipment, this becomes more complex, and usually involves an assessment of either: (a) the depreciation in value of the asset; or (b) the value of lost opportunity.

Off site costs claims are usually claims for loss of opportunity or unabsorbed office overheads. This can be complex to calculate in the context of a large business, and often requires supporting evidence such as financial accounts showing a reduced turnover or, for lost opportunities, tenders which were never priced, for example. This exercise is often so complicated, input from quantum specialists adept at applying the relevant financial formulae can be required.

Advice to Employers and Contractors faced with claims

First and foremost, all parties to construction contracts need to keep detailed records of any changes which might result in an increase in project costs.

Contractors will need to make sure they take the time to evidence and quantify any claims as far as possible. There is a tendency for contractors to put in global claims to recover all additional project costs incurred, without proper supporting evidence or having undertaken a full quantum analysis. These types of claims are unlikely to be upheld in formal proceedings, and common sense dictates that these will be viewed with suspicion by an employer.

There may be advantages to an employer willing to consider these claims, even where the legal basis is uncertain. Settlement of claims can achieve greater budgetary certainty, particularly if the parties can agree to allocate the risk of COVID-19 going forward. Moreover, in the current economic climate, there is a heightened risk of contractor insolvency, which is a significant risk to any project.

If claims are not resolved, and costs continue to increase, contractors are more likely than not to resort to formal dispute resolution proceedings, such as adjudication, to unlock disputes where they will improve cash flow. Employers considering contractor claims should pay particular attention to payment notice provisions to ensure that they are not subject to any “smash and grab” adjudications. Employers should also be cognisant of potential insolvency risks associated with a flat rejection of claims, where a Contractor has genuinely incurred additional costs.

The best approach is often for the parties to have a discussion about the potential additional costs likely to be incurred as a result of site restrictions from Covid-19, and attempt to agree between them which of these costs should be borne by the employer and which by the contractor. This sort of discussion should help to stem the flow of such claims, in addition to providing some protections for contractors from the dangers of insolvency.