COVID-19: Impact on the Construction Sector

Introduction

Economic impact

COVID-19, the Novel Coronavirus that has been declared a pandemic by the World Health Organisation, has been described by the OECD as the "biggest danger since the financial crisis" to the global economy.¹  Unlike previous global health crises, the outbreak of COVID-19 is having immediate and far-reaching consequences because the global economy is now more interconnected than ever. Economic output has significantly slowed and the effects are being felt around the world.

Impact on the construction sector

The construction sector faces particular challenges in addressing both the health and economic challenges posed by COVID-19.

1. The sector tends to operate with relatively low profit margins but requires significant resources for works to be progressed both in terms of materials and labour. Therefore, any impact on labour movements and supply chains will quickly give rise to financial pressures.² Equally, the risk of site workers having to self-isolate for 14 days or more has the potential to delay and disrupt the progress of works.
2. While most contracts seek to allocate risk between the parties for certain events, the scale and extent of COVID-19 is unprecedented and was unlikely to have been contemplated by the parties at the time their contracts were entered into.

These factors mean that industry participants have to actively manage both the health and economic risks that they face across different jurisdictions with distinct legal regimes on a day-to-day basis. This will require a careful analysis of contractual risk allocation and entitlement, a strict adherence with procedural requirements (contractual notices and the like) and an understanding of the legal framework governing the contract itself. It is also important to have in mind the law of the jurisdiction in which the works or services are being undertaken, particularly if there are civil law concepts (such as financial hardship), from which parties cannot contract out.

In this article, we consider some of these issues by reference to three common standard form contracts: the JCT Design & Build Contract 2016 (JCT), the NEC4 Engineering and Construction Contract (NEC), and the FIDIC Red Book (2017) (FIDIC). We focus on the potential for non-performance of contract requirements and the potential recovery of additional time and costs, as well as practical implications for managing risk and other commercial considerations. 

Much will depend on the specific terms of the relevant construction contracts and it is possible that COVID-19 may be used as an excuse to cover all manner of problems on a project. Therefore, when considering any entitlement at law or pursuant to the contract terms, it is important to consider carefully questions of causation, including pre-existing issues which mean the impact of COVID-19 is not as serious as might be claimed.

Ashurst's global Construction Group is advising clients in the construction sector on the specific implications of COVID-19 for their contracts in a number of jurisdictions. 

Impact on construction contracts

The possible impact of COVID-19 on construction contracts may range from delay and disruption, cost overruns, changes in the scope or schedule of the works (variations) to preventing performance altogether in more serious circumstances (which may give rise to suspension or termination rights). There are a number of ways that these risks may be allocated in construction contracts and in some cases and jurisdictions the general law may supplement the terms of the contract themselves.

Below we discuss two general ways that performance risk is allocated  – force majeure and frustration – before considering how time and costs are dealt with under the standard form contracts that may be impacted by COVID-19.

Suspension and termination

Force majeure at law

In common law jurisdictions, force majeure does not arise as a matter of law but most construction contracts include force majeure clauses. Therefore, the parties' rights will depend upon the specific contract wording. Often, force majeure clauses will specify the events giving rise to force majeure, requirements for notice of the events, and the consequences that flow from force majeure.

The position is different in many civil law jurisdictions where the substantive governing law of an agreement may provide for force majeure. Again, the scope and operation of these force majeure laws will depend upon their specific wording.

1. For example, in the French Civil Code, force majeure occurs where an event beyond the control of the parties, which could not reasonably have been foreseen at the time of the conclusion of the contract and whose effects could not have been avoided by appropriate measures, prevents the performance of their obligations. Force majeure provides a defence to a claim for damages against the party which cannot perform its obligations. There is a distinction in French law between (i) being unable to perform the obligations at all and (ii) a contract which is capable of being performed but is no longer economically viable. Force majeure is only available in the case of the former and, therefore, it is narrower in this respect than the English law doctrine of frustration (see below).
2. There are many similarities between French law and the civil codes in the Middle East. The codes in the Middle East are heavily influenced by the Egyptian Civil Code, which is itself modelled on the French Civil Code. For example, in the United Arab Emirates, Article 273 of the UAE Civil Code provides that if force majeure supervenes and makes the performance of the contract impossible, then the corresponding obligation shall cease. In the case of total impossibility of contract performance, then the contract will be automatically cancelled. In the case where there is partial impossibility of performance then the part of the contract which is impossible to perform shall be extinguished.

Our more general update on force majeure is available here.

Force majeure in contracts

Under the JCT contract, "force majeure" is referred to  in clause 2.26.14 but is not defined. Broadly, it refers to an event not reasonably contemplated by the parties when the contract is signed, and which is beyond the reasonable control of the party seeking to rely on the provision. The following meaning of force majeure in French law was approved by McCardie J as applying to many English law contracts:

"Force majeure. This terms is used with reference to all circumstances independent of the will of man, and which it is not in his power to control…thus war, inundations and epidemics are cases of force majeure; it has even been decided that a strike of workmen constitutes a case of force majeure."³

However, there are no reported cases on the meaning of force majeure in the JCT contract specifically, and whether COVID-19 constitutes a force majeure event will need to be assessed on its merits in each case. Another relevant factor to consider in that factual assessment is whether the contractor has mitigated any delay.⁴ The contractor is obliged to notify the employer "forthwith" of the material circumstances which are likely to cause the delay and it should be noted that force majeure is not a "Relevant Matter" (such that only additional time can be claimed for a force majeure event, and not loss and expense). Either party may terminate the contract on notice if a suspension for force majeure continues for more than two months under JCT clause 8.11.1.1.

Under the NEC contract, there is no express force majeure clause but the "compensation event" mechanism at clause 60.19 operates as a de-facto force majeure clause as it may entitle the contractor to additional time and costs if COVID-19 impacts the works. This mechanism is discussed further below.

The client also has the option to terminate the contractor's obligation to provide the works if the force majeure event will prevent completion of the works or is forecast to delay it by more than thirteen weeks (NEC clause 91.7).

Under the FIDIC contact (clause 18):

1. Force majeure is provided for as an "Exceptional Event" which "(i) is beyond a Party's control; (ii) the Party could not reasonably have provided against before entering into the Contract; (iii) having arisen, such Party could not reasonably have avoided or overcome; and (iv) is not substantially attributable to the other party". Although diseases or pandemics are not included in the non-exhaustive list of potential "Exceptional Events", it could be argued by contractors that COVID-19 meets this broad definition.
2. Parties will be entitled to an extension of time provided that they are prevented from performing any of the contract obligations because of the Exceptional Event. This emphasises the importance of a proper analysis of cause and effect to avoid COVID-19 impacts being used to mask a series of other failings.
3. In order to obtain relief parties must provide 14 days' notice. Their entitlement to relief will be subject to their duty to minimise any delay.
4. Force majeure normally only gives rise to a right to an extension of time and not additional costs. In certain circumstances costs may also be recoverable but these are unlikely to apply to COVID-19 (war, terrorism, strikes, etc).
5. Either party may terminate the contract if an Exceptional Event causes a delay of 84 continuous days or multiple delays which total more than 140 days.

Clause 18.6 of the FIDIC contract also entitles either party to serve a termination notice if any event arises outside the control of the parties which makes it impossible or unlawful to perform their contractual obligations, and the parties are unable to agree an amendment to the contract. This might be relevant but in the many instances any impact of COVID-19 should be capable of being addressed through the Exceptional Event regime without recourse to clause 18.6.

Frustration

If a contract becomes physically or commercially impossible to perform, the common law doctrine of frustration may apply to automatically discharge the parties from their obligations. However, the threshold for frustration at common law will ordinarily be significantly higher than the threshold for force majeure under a construction contract and English courts have repeatedly given the scope of the doctrine of frustration a narrow interpretation. However, there are a limited number of cases from other common law jurisdictions in which courts have determined that construction contracts have been frustrated.⁵

Frustration is also less likely to be successfully invoked where contracts contain a force majeure clause which addresses the scenarios that may arise as a result of COVID-19. In practice, the doctrine of frustration is likely to only be invoked in the most extreme circumstances and when the relevant construction contract does not have the ordinary mechanisms to deal with those circumstances.

Financial hardship in civil law

Some civil codes do not permit parties to exclude certain rights and, therefore, for projects based in those countries, the local law will need to be considered even if the rights under the contract restrict a party's ability to claim relief.  

An example is Article 249 of the UAE Civil Code . It provides that if exceptional circumstances occur as a result of which the performance of a contractual obligation, even if not impossible, becomes oppressive so as to threaten the party in question with grave loss, then it is permissible for a judge (or an arbitral tribunal) to reduce the oppressive obligation to a reasonable level. Similar hardship provisions apply in other civil law jurisdictions.

Under the FIDIC contract, clause 18 will only provide rights to the contractor if performance is prevented and it does not address circumstances where a party can continue with its obligations but to do so would cause financial hardship. However, local law may step-in to assist in these circumstances.  

Extensions of time and additional costs

Industry participants will be more familiar with the allocation of risk for time and costs under their contracts and the operation of the relevant mechanisms. Where performance of contracts is still possible despite COVID-19, the virus may still have time and cost impacts that will need to be assessed and allocated between the parties.

Under the JCT contract, the contractor is entitled to an extension of time where completion of the works or a section is likely to be delayed beyond the relevant completion date by a "Relevant Event". The list of Relevant Events does not expressly include global virus outbreaks such as COVID-19. As mentioned above, force majeure is listed as a Relevant Event so the contractor may be able to claim additional time in respect of delays caused by COVID-19, subject to the factual assessment and mitigation factors. In addition to force majeure, Relevant Events include the "the exercise after the Base Date by the United Kingdom Government … of any statutory power…which directly affects the execution of the Works." If the UK Government exercises a statutory power (e.g. a change of law) after the Base Date to control the virus, and this delays the contractor's progress, then this may constitute a ground for an extension of time.⁶ Change in law is not listed as "Relevant Matter" so the contractor would not be able to claim for additional loss and expense incurred.

Under the NEC contract, additional time and money are not treated separately but are instead assessed together as a "compensation event". There are a number of potential compensation events that might arise as a result of COVID-19, including compensation events for a failure by the client to provide something in time. In particular, clause 60.19 provides that there will be a compensation event when an event occurs which:

"stops the contractor completing the whole of the works or

stops the contractor completing the whole of the works by the date for planned Completion showing on the Accepted Programme

and which

neither Party could prevent,

an experienced contractor would have judged at the Contract Date to have such a small chance of occurring that it would have been unreasonable to have allowed for it."

This provision may entitle the contractor to additional time and/or money as a result of the impact of COVID-19 on the works in the event of, for example, the need to self-isolate a material part of the workforce or the lack of materials as a result of shortages caused by the virus.

Government legislation can only be a compensation event if Option X2 (Changes in the Law) has been selected. If so, a change in the law of the country in which the site is located will be a compensation event if it occurs after the date of the contract.

Clause 61.3 prescribes a strict 8 week time period for the contractor to notify the project manager of the compensation event, otherwise the claim for a compensation event will be invalid. This should be considered alongside the contractor's ongoing obligation to give an early warning of matters which could increase the prices, delay completion or a key date, or impair performance of the works in use (clause 15.1). If the project manager decides that the contractor did not give an early warning which it could have, the project manager will assess the compensation event as if it had received an early warning, thus reducing the quantum of the compensation event in part or possibly entirely (clause 63.7). 

Under the FIDIC contract, contractors are entitled to an extension of time for delays caused by "unforeseeable shortages in personnel or Goods… caused by epidemic or governmental actions", as well as unforeseeable delays caused by authorities.  It is likely that either or both of these entitlements may be engaged by COVID-19. As for the recovery of both time and costs, "Variations" and "Value Engineering" proposals may be submitted by the respective parties to change the works if unforeseen circumstances arise and changes in law also give rise to an entitlement to time and cost (including changes in permits and licenses). In limited circumstances, adjustments for increases in labour, goods, and other inputs into the works may also be made. 

Summary table

Practical considerations

In addition to understanding the allocation of risks relevant to COVID-19 at law and in their contracts, it is essential that industry participants consider the practical and commercial matters that may best help them to address both the health and economic challenges posed. 

Communication, notices and commercial considerations

Communication between the parties, governments and employees is an essential part of ensuring that the most up-to-date health and safety measures are being implemented. Legally and contractually speaking, communication requires knowing and complying with government directives as soon as possible and ensuring that contractual notices are submitted on time with the necessary supporting information. Each of the suspension, termination, variation and extension of time clauses referred to above is subject to a notice requirement and parties risk losing their contractual entitlements if notice provisions are not complied with.

In this regard, it is common in times of significant uncertainty for contractual parties to look outside of their contracts for ways to address that uncertainty. For example, "standstill" agreements can be implemented to preserve the parties' positions and stop the running of time for contractual notices, so that they can otherwise focus their efforts on addressing more pressing health and economic concerns if necessary. Otherwise, instead of making contractual claims, parties may consider that it is preferable to vary their contractual terms to deal with the significant change in circumstances that incidences such as COVID-19 may represent. In any case, careful consideration should be given to changing or reaching new commercial bargains while the global outlook remains uncertain. 

Record keeping

The retention of documents and keeping of records is generally important on construction projects as they provide a contemporaneous records of what was actually happening at any given time during the project.  The retention of records is likely to be critical in respect of the impact of COVID-19 to enable a proper analysis of events and timelines should a dispute arise in the future.  For example, as a result of COVID-19 urgent work may be carried out on projects that was not initially envisaged or covered by the contractor's scope of work (e.g. additional cleaning).  Detailed records of such decisions will be of assistance should a reconstruction of events be required in the future.

Existing contracts vs new contracts

It is also important to draw a distinction between contracts currently in existence and those currently under negotiation. As mentioned above, the applicability of a force majeure provision may depend on whether a particular circumstance was unforeseeable at the time the contract was entered into. It may now arguably be the case that the future impacts of COVID-19 are foreseeable such that a claim for force majeure may now not be possible once contracts currently under negotiation are entered into.

It follows that it might be necessary to expressly deal with the potential future impacts of COVID-19 in any contracts that are entered into while the global outlook remains uncertain. For example, Ashurst's global Construction Group has already received instructions from parties requesting that their contracts provide for an extension of time if delays are caused by the virus.

Insurance

Finally, insurance is also an important consideration. Parties should check their insurance policies to see whether the disruption and delay that may be caused by COVID-19 is covered.  Notably, several large insurers have already confirmed that their business interruption policies will not pay out for COVID-19 unless it is specifically named in the policy terms (i.e. there is no general class of notifiable diseases which the insureds can claim under).

To stay up-to-date with Ashurst's analysis of COVID-19 visit our Corona Virus Hub here.

Authors: Tom Duncan; Sadia McEvoy; Luke Carbon and Chris Whitehouse.

1. http://www.oecd.org/economic-outlook/
2. In the first few months of the outbreak, departures from Chinese ports and Chinese manufacturing output alone decreased by approximately 20% respectively and governments around the world have moved to restrict travel in attempts to contain the virus.
3. Lebeaupin vs Crispin [1920] 2 K.B. 714 at 718.
4. Clause 2.25.6.1 requires the contractor to "constantly use his best endeavours to prevent delay".
5. See: Codelfa Construction v SRA of New South Wales in Australia [1982] 149 CLR 337 (as works could no longer be lawfully carried out) and Holcim (Singapore) Pte Ltd v Kwan Yong Construction Pte Ltd [2009] 2 SLR (R) 193 (deemed an abnormal and unexpected situation).
6. The UK Government's action plan, published on 3 March 2020, provides that the Government will consider legislative options, if necessary, to help systems and services work more effectively in tackling the outbreak.