Measures that have been widely adopted by governments around the world to address the COVID-19 pandemic have already and, will no doubt further, spill-over onto the construction sector.
- From an economic point of view, public projects may potentially suffer from funding issues to complete outstanding works, given the shift of public resources to address the impact of COVID-19. Private projects are likely to be affected by an overall drop in demand in the market and the consequent difficulties to maintain returns on investments.
- From the perspective of a company’s (or government’s) wider project portfolio, where certain investments are no longer viable or are placing an excessive financial strain on the company, alterations in the legal landscape due to COVID-19-related consequences and measures adopted worldwide to combat the virus may open up new options and opportunities to restructure portfolios, projects, supply chains and workforce.
- With respect to contractual relationships and the execution of individual projects, employers and contractors must carefully review their contractual obligations and distribution of risk and understand how these may be affected in light of the impact or potential impact of the COVID-19 crisis and the applicable local law. Parties must adapt their strategy and carefully consider their approach to address the immediate impacts on project works as well as to protect themselves in view of future claims, disagreements and disputes.
Delays and extensions of time
There are many possible ways in which COVID-19 may cause delays to a project. This may include:
- reduction or unavailability of workforce, whether due to medical issues or restrictions imposed by public authorities (see here our e-bulletin about the situation in Spain);
- suspension of operations of public entities and proceedings related to authorisations and required permits;
- closure or restriction of access to construction sites;
- interruption of supply chains; and
- border closures.
Whether a contractor or employer must assume the fallout, such as project delays, from COVID-19 caused circumstances, will depend upon the wording of the contract and applicable governing law. An employer may be required to grant extensions of time to a contractor and/or cover a contractor’s additional costs or a contractor may be required to pay delay damages to an employer for late completion of works.
Construction contracts commonly specify those events that cause delay and who must bear the consequences. Where delays result from circumstances provoked by COVID-19, in addition to clauses addressing pandemics or diseases (if any), parties should consider the application of clauses which address, amongst others:
- changes of law (restrictive measures to combat COVID-19, such as in Spain Royal Decree 463/2020 of 14 March which declares a state of alarm to address the COVID-19 crisis, or Royal Law-Decree 8/2020 of 17 March in respect of urgent extra-ordinary measures to address the economic and social impact of the COVID-19 crisis, may constitute a change in law);
- delays caused by public authorities;
- delay in possession or access to the construction site;
- force majeure;
- suspension of works;
- hardship clauses which address circumstances as a result of which performance of the contract becomes excessively onerous;
- price escalation clauses; or
- variations to the contract or the scope of works.
Where a contractor intends to claim an extension of time, great care must be taken in formulating and preparing the claims and in doing so, carefully consider the issues such as:
- contractual definitions of delay events and possible conflicts with local law;
- whether the right to an extension of time is qualified by compliance with formalities under the contract or local law;
- notification requirements (including time bars and provision of supporting documentation);
- availability and quality of records to evidence the impact and cause of delay;
- the potential existence of overriding concurrent delays (e.g. an unrelated default that started to delay the project prior to the occurrence of the force majeure event);
- notification/information requirements to third parties (e.g. lenders, subcontractors, etc.); and
- the duty to mitigate delays.
When formulating claims for particular delay events, a contractor must carefully consider the event for which the claim is made as certain delay events may give rise to additional time to complete the works but not the right to recover costs, while others may in parallel provide a right to recover costs incurred due to the delay e.g. idle costs, overheads, etc.
Changes of law
One impact of COVID-19 is the imposition by governments of new laws, regulations or orders, which impact project works.
A change in law may entitle a contractor to seek additional time to complete the works and any additional costs incurred as a result, if it affects the contractor’s ability to progress with the works. Whether the contractor has such right will depend upon the wording of the contract. Contractors (and also employers seeking to dismiss such claims) should consider, amongst others:
- whether under the contract a change of the “law” comprises more broadly regulations issued by public entities (e.g. decrees from the government, sectorial regulations form government agencies, etc.) or whether the “law” is more narrowly construed as laws passed by the parliament only;
- whether the contractor can demonstrate that in fact works were affected by the change in law (e.g. its workforce being in mandatory quarantine), or whether contractor’s works form part of a sector that is deemed an essential service that may be exempt from governmental restrictions;
- whether alternative means existed to overcome the difficulties arising from the change of law (e.g. alternative suppliers or alternative workforce);
- whether there are any overriding concurrent delays;
- under what circumstances the contractor may recover costs resulting from the change in law, in addition to the extension of time; and
- whether it entails the right to suspend the works.
In general, if COVID-19 is considered as a force majeure event under the contract it may give rise to the contractor’s right to an extension of time, to suspend works or otherwise alter the contract on the basis of the impact suffered as a result of the virus on project works. If not foreseen in the contract itself, the applicable local laws should also be reviewed as they may provide for force majeure and affect the parties’ of contractual obligations.
The relevant contractual provisions must be analysed carefully with consideration given to issues including:
- whether and to what extent the force majeure event, i.e., COVID-19, is affecting works (i.e. while it may affect the availability of the workforce, it does not necessarily affect the trade of goods and availability of materials);
- whether it is unforeseeable (generally determined with reference to the dates when the force majeure event was first known, and when the parties entered into the contract) – caution is advised with tenders and contracts entered into around the time COVID-19 was declared a pandemic;
- whether the parties could have overcome the consequences of the force majeure event;
- whether there are any overriding concurrent delays;
- under what circumstances the contractor may recover costs resulting from the force majeure, in addition to the extension of time; and
- whether other contractual alterations may result from the application of the force majeure clause, including the possible termination or suspension of the contract.
Doctrine of frustration and other local law remedies
Local law may provide for other remedies for COVID-19 related circumstances and should be reviewed. The rebus sic stantibus doctrine in Spain or the doctrine of Frustration in England and Wales, are such examples. Contracts may be considered as frustrated if it is no longer possible to perform the contract, or performance thereof would radically change the subject matter of the contract.
In general, the application of doctrines of this type tends to be exceptional and requires a material impact on the performance on the contract.
Suspension of works on the basis of health concerns
The suspension of works may be a consequence of any of the above issues i.e. it may form part of a force majeure or other delay event, or it may be an autonomous right under the contract or local law upon the occurrence of certain impediments. The right to suspend works may not however, necessarily attract an automatic right to an extension of time.
COVID-19-related health concerns may be a valid ground to suspend works, whether on the basis of contractual health and safety obligations or measures adopted by public authorities, which provoke the suspension of works. Caution must be exercised in formulating claims for extension of time together with a suspension of works. If works are invalidly suspended by a contractor, an employer may claim indemnities, delay damages or even in some circumstances, terminate the contract.
Construction and infrastructure contracts commonly impose detailed insurance obligations upon the different parties intervening in a project, and frequently regulate who should be included as additional insured under each policy as well as the precise scope of the insurance coverage required to be taken out. The measures adopted by governments in different countries to address the COVID-19 pandemic, have affected the normal development of the projects as a consequence of which, may activate the following types of insurance covers, amongst others:
- loss of profit derived from the prohibition to carry out non-essential activities;
- third party liability and/or workers compensation as a consequence of a possible omission, late or deficient implementation of preventive measures to address COVID-19-related risks;
- liability of directors and officers for the above omission, late or deficient implementation of preventive measures as against shareholders or creditors; and
- credit and political risk insurance in the event of failure to fulfill payments or an insolvency.
To be effective, an insurance policy may require the compliance with certain formalities as set out in the international master insurance policy of a given group of companies as well as under local policies therein. There may also be further additional requirements depending on the local law applicable to an insurance claim and the invoked policy, such as:
- timely notification of the circumstances giving rise to an insurance claim;
- supporting documentation of an insurance claim;
- measures to reduce the risk, mitigate damage, sue and labour, salvage and protect the eventual recovery; and
- notices of risks aggravation.
With respect to liability insurance, it will be necessary to review whether any of the company's actions taken as a result of the COVID-19 pandemic could give rise to a claim by third parties (including by workers in relation to the prevention of occupational risks). In these cases, a preventive notification to the corresponding insurer of the circumstances that may give rise to such claims should be considered.
Conclusion and planning ahead
Before either party to a contract makes a decision to take any action in light of an event caused by COVID-19 affecting project works caution is advised in the following respects. Both parties must carefully review the relevant contractual clauses and seek local law advice. Caution must be exercised to ensure that all relevant contractual steps are taken, including the issuing of notice and also in determining, monitoring and documenting the beginning and end dates of the force majeure or other impeding event.
While it is generally in the employer’s interest to put an end to the force majeure event (or any other delay event) as soon as possible with reference to e.g. the date when governmental measures are lifted, in practice the consequences of a force majeure event may be ongoing beyond such date, an example being the enduring effects of material or labour shortages. It is important to adequately analyse any notices sent by the other party and to substantiate with contemporaneous records any ongoing effects of a force majeure event (e.g. attempts to contact suppliers or to recruit workers).
If a company is considering or adopts any course of action as a consequence of COVID-19, the following issues must be considered and should form part of the wider strategy on a project and overall portfolio level:
- notifications and follow-on actions with subcontractors (e.g. back-to-back work suspensions, extensions of time, etc.);
- notifications and temporary demobilisation of workforce – see here our ebulletin in respect of COVID-19-related labour law aspects, including ERTE’s carried out in Spain, the adoption of remote working arrangements and the suspension of employment contracts;
- negotiation of a disputes standstill and an agreement to refrain from calling bank guarantees until the situation normalises and the parties are in a position to ascertain the full extent of each other’s claims;
- notifications and follow-on actions with lenders (e.g. debt restructuring, waivers in respect of events of default, grace periods, etc.);
- in relation to the insurance coverage, identification of insurance policies that may reduce losses and analysis of their conditions in order to ensure compliance with notification requirements and mitigation obligations to prevent further loss and damage;
- review of supply chains – see here our ebulletin in respect of the EU’s border management and travel restrictions, and here our ebulletin about exceptional measures considered by the Spanish government to address potential supply shortages; and
- assessment of alternative supply chains and the cost of switching – the drop in overall demand may have the effect that certain materials are no longer needed, or that these can be obtained at a better price elsewhere in the market. While distribution and supply contracts often foresee the right to exit the contract, the exercise of such rights commonly entails financial consequences that need to be assessed on a case-by-case basis in light of timing, cost and the alternatives in the market.
The contents of this publication are for reference purposes only and may not be current as at the date of accessing this publication. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2020