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Top 5 COVID-19 issues affecting construction contracts

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

28-07-2020

COVID-19 has delayed and disrupted (and will continue to disrupt) construction projects globally. For many projects that disruption is severe and construction contracts simply do not provide parties with all of the answers to questions posed by these unprecedented circumstances.

Whilst we have seen parties cooperate in the short-term, positions will harden and there will be an increase in related disputes in the medium to long-term if parties are unable to resolve issues commercially with a focus on what is best for the project.

We have set out below the Top 5 COVID-19 issues that we see arising out of the current crisis, and our advice on what steps businesses should be taking now in response to these issues.

(1)    Solvency of contractors and suppliers

Even before COVID-19, solvency was a live issue within the construction industry, not helped by a gloomy economic outlook in the wake of Brexit. Profit margins on construction projects are routinely reported to be in the region of 5-6%, which gives little margin for error.

Suspension of works and decreased productivity reduces the flow of cash to contractors and their supply chains. Increased cost of plant and materials further erode tight profit margins.

Government intervention and stimulus has provided some relief but cannot last forever. Reported increases in administrations and insolvencies of construction SMEs is concerning. Any failures in the supply chain can have serious knock-on effects causing disruption and increasing costs. When these compound, it can be fatal for even the biggest of construction companies and wreak havoc on major projects.

Solvency issues may also impact a party’s access to financial resources and their ability to renew any security in place, which may in turn result in an increase in calls on performance bonds.

(2)    Liquidated or delay damages

Delays and disruption due to COVID-19 will increase the risk that contractors will be liable for delay damages, which puts further pressure on cashflow. In many cases there will be a limited contractual basis for the contractor to avoid paying delay damages (see ‎(4) Contract administration and assessment of contractor claims).

Increased risk of insolvency may mean that employers will seek to withhold payments where the contract allows. However, a prudent employer will see this as a dangerous game of brinkmanship which could seal the fate of a contractor and have a serious adverse impact on the project.

(3)    Ongoing disruption and pressure to increase productivity

There has been considerable focus on the immediate delays arising out of the first wave of the virus. However, the bigger issue will be how to deal with the longer term impact of COVID-19.

If productivity does not improve, most projects will suffer significant delays and increased costs for the foreseeable future. It is impossible to assess the impact of this disruption in the long-term with any certainty. It is fair to say, however, that for many construction and infrastructure projects with works periods measured in years or decades, the potential costs of ongoing delays and disruption will be material.

There is also pressure on contractors to increase productivity. The Roadmap to Recovery issued by the Construction Leadership Council sets out a strategy to “accelerate the process of industry adjustment to the new normal”. This may take the form of increasing working hours, re-sequencing works or changing construction methods. Any such steps may further increase the contractor’s costs. Once again, typical construction contracts rarely provide clear grounds for the contractor to recover these costs. 

(4)    Contract administration and assessment of contractor claims

Where a contractor has made a claim arising out of COVID-19, contract administrators will find it difficult to grant satisfactory relief. It seems likely that, in most cases, contractors’ claims for relief, especially of a financial nature, will be rejected.

(a)     There are likely to be limited grounds for relief. Few construction contracts include provisions which effectively allocate all risks associated with a global pandemic. Contractors are likely to attempt to rely on other terms, such force majeure or acts of prevention; or illegal or impossible acts, government intervention or change in law. Even if the contractor can find a trigger event that applies, it may not allow both time and additional costs (e.g. force majeure under JCT suite only acts as trigger for claiming more time).

(b)     Lack of available information. As the true impact of COVID-19 remains an unknown, contract administrators are likely to refrain from granting relief rather than risking making a determination which may not be revisited and which could increase in scope over time..

(c)      Lack of trust. There is a suspicion that contractors will inflate claims arising out of COVID-19, or use them to hide delays for which they are culpable.

(5)    Negotiation or risk increased adjudication and litigation

Government advice remains that, where possible, parties should cooperate and avoid enforcing contractual obligations. The success of any project may require serious consideration of re-scheduling and re-pricing, which is easier to do at an early stage.

Rises in costs, risk of insolvency, along with potential changes to the way we work and live, may simply result in many projects ceasing to be commercially viable. Where no commercial agreement can be reached, parties may seek to terminate contracts to avoid ongoing obligations.

However, the general uncertainty makes it difficult for parties to construction contracts to accurately price and schedule future works. Even if the key objectives of a project (i.e. time, cost and quality) are re-negotiated, the contractor will be expected to take on the ongoing risks associated with COVID-19, which could make its position unprofitable and make future claims unavoidable.

Parties may have to face a wide range of external threats to their business and, with the failure of their contracts to prescribe solutions, may become entrenched in their contractual positions. This is likely to lead to an increase in adjudications and litigation/arbitration, as parties seek to resolve claims to unlock cashflow.

What steps should businesses be considering now?

Aside from engaging in constructive dialogue, parties to construction contracts should take steps to protect themselves such as:

(a)     Maintain detailed contemporaneous records of the status of and progress to the works surrounding COVID-19, including all additional costs, to be in a position to (i) prepare for or respond to any claims, and (ii) properly assess the long-term cost and time implications to the project.

(b)     Regularly review and update the programme for the works so that it reflects the anticipated effect of current events on the completion date.

(c)      Carefully review those contractual rights and obligations associated with COVID-19 so that the allocation of risks is understood.

(d)     Ensure that all notice requirements and timescales are strictly complied with. Keep a careful eye on payment notices as there must be a heightened risk of a cash-strapped party deploying aggressive ‘smash and grab’ style tactics in order to obtain payment in the short term.

(e)     Where any contractual compromises are reached, ensure that proper consideration is given to the ongoing allocation of risks associated with COVID-19.