A Contractor’s Guide to Managing the Commercial Impact of the COVID-19 Virus on Construction Projects

Introduction

On 30 January 2020, the World Health Organization (“WHO”) declared the Novel Coronavirus (now called COVID-19) a “public health emergency of international concern”. The outbreak of the COVID-19 has already had a significant effect on global businesses due to shortages in the labour market and disruptions to supply chains.

Jon Howes

The construction industry is far from immune to such effects and concerns are being raised by contractors and employers alike as the commercial impact of the outbreak is being immediately felt across the globe. This update is intended to provide some guidance to contractors seeking to analyse the issues that apply in their specific situations. It focusses primarily on common law jurisdictions and uses the FIDIC Red Book (First Edition 1999) as an example contract but will hopefully be of more general use for contractors to start to and draw up a plan to manage the commercial risks.

This note focusses on the contractor’s ability to excuse liability for non-performance, to obtain additional time and recover cost. Of course issues relating to employees’ health and safety are of paramount importance. These are the subject of other guidance from Clyde & Co.

Areas of Impact

There are essentially three main areas of impact:
1. Difficulty in procuring materials and plant: Many cities in China were and still are under an unprecedented lockdown with labour unable to move around freely; the reopening of some factories after Chinese New Year has been delayed and some shipping carrying plant and materials have been unable to leave China;

2. Difficulties in movement of staff to and from China and within the region (labour as well as executive management): Staff may be unable to leave or return to China, or are subject to compulsory quarantine periods. In addition to the lockdown of some cities, various countries have restricted entry of Chinese nationals or foreigners who have travelled to China. Many airlines have halted their flights to China. Travellers have been placed under quarantine, or have cancelled their business trips to China fearing they would be quarantined upon returning to their home countries; and

3. Difficulties caused by implementing preventive measures on site and/or dealing with the effects of a COVID-19 outbreak on site and/or production facilities: These include everyday measures such as additional cleaning and temperature checking for labour and visitors; mandatory leave of absence, quarantine orders, additional accommodation for replacement labour etc.

Sources of Relief

Broadly speaking there are two areas that a contractor should consider when looking at ways to manage the impacts of the COVID-19 outbreak on its projects:-

1. General Contractual Provisions and legal principles which excuse liability for non-performance; and

2. Specific Contractual Provisions which may give entitlements to additional time and money.

General Contractual Provisions and Legal Principles

If a contractor is facing problems which are substantially impacting on its ability to carry out the works, the starting point will be to look at 3 general routes that may excuse the failure to perform. Two of these routes will depend upon the presence of specific types of clause in the underlying construction contract. The third is a generally available source of relief, albeit that it will also be impacted by the applicable contractual provisions.

1. Force Majeure

In common law jurisdictions, Force Majeure arises out of the contract rather than the underlying law so all will depend upon whether there is a Force Majeure clause in the relevant contract (although most construction contracts have one) and the specific wording of any such clause.

The Definition of Force Majeure

Sean Hardy

Some Force Majeure clauses are general in nature and do not attempt to define the specific events that may amount to Force Majeure, whilst others take the opposite approach and set out an exclusive list of events that may amount to Force Majeure. Still others (like the FIDIC Red Book Clause 19.1) take a middle course by setting out the general requirements for Force Majeure to apply together with a non-exclusive list of events or circumstances that may amount to Force Majeure.

The definition in the FIDIC Red Book is as follows:-

“In this Clause, “Force Majeure” means an exceptional event or circumstance:

1. Which is beyond a Party’s control,

2. Which such Party could not reasonably have provided against before entering into the Contract,

3. Which, having arisen, such Party could not reasonably have avoided or overcome; and

4. Which is not substantially attributable to the other Party.”

Christopher Short

Although disease and/or epidemics do not feature in the non-exclusive list of events and circumstances that follows this definition, it seems likely that the COVID-19 outbreak would in principle be covered by the general definition set out above. It is an exceptional circumstance, caused by neither party, which the contractor could not reasonably have provided against, avoided or overcome.

Although the clause does not expressly introduce a requirement of unforeseeability, the test of whether the contractor could reasonably have provided against the event or circumstance clearly raises some issues of foreseeability. It should also be noted that foreseeability does feature as an express part of the definition in some other contract forms. If a contractor needs to demonstrate that the COVID-19 outbreak satisfies the contractual requirements as to unforeseeability, all will depend on the specific wording of the contract. This issue is discussed further below.

The Effect on the Works

Having satisfied the definition, the Force Majeure clause is then likely to require that the relevant event or circumstances impacted on the works. Clause 19.4 of the FIDIC Red Book provides that:-

“If the Contractor is prevented from performing any of his obligations under the Contract by Force Majeure ….”

Thus the contractor must have been prevented from performing at least one of its contractual obligations. The question then arises as to whether this clause covers a situation where the obligation is still capable of performance but has become more time-consuming thus causing critical delay to the works (e.g. labour is available but not in sufficient quantity or is subject to delays in getting to site). The contractor’s obligations include proceeding with the Works in accordance with the Programme (Clause 8.3) and to complete by the Completion Date (Clause 8.2) so the requirement that the contractor has been prevented from performing some of its obligations would appear be satisfied. However, it is unlikely that this argument would be available if the contract also contains an extension of time provision which allows the completion date to be extended in the applicable circumstances (as discussed below). The clause would appear not to apply at all where performance is still possible but has become more costly (e.g. alternative labour is available without critical delay but at additional cost).

The Entitlements

Once again the precise terms of the contract will determine the contractor’s entitlements in a Force Majeure scenario. Depending on the contract and the severity of the problems caused, the contractor may be required to continue with the contract but obtain entitlements to time and/or money or may be excused performance altogether.

Under the FIDIC Red Book, for less severe delays, the contractor will be entitled to additional time but not cost. However, if the execution of the works in their entirety or a substantial part thereof is prevented for a continuous period of 84 days or multiple periods totalling 140 days, either party may serve notice to terminate the contract. If the contract is terminated, the contractor will be paid for work done and materials procured plus other costs reasonably incurred, excluding profit.

Force Majeure Certificates

One issue that may arise is the availability of Force Majeure Certificates from the China Counsel for the Promotion of International Trade (“CCPIT”). According to the CCPIT, the certificates can “partially or completely absolve parties of liability for non-performance, defective performance and late performance of contracts” and is recognised in over 200 countries.1

The effect (if any) of these certificates on international contracts outside China is likely to be at best an evidential one i.e. they may help to prove the occurrence of the relevant facts and it will be for the contract to determine whether Force Majeure applies. It has been reported that a French oil company has already rejected a Force Majeure Certificate from a Chinese liquefied natural gas buyer². However, CCPIT certificates may have greater effect in China itself and may, for example, operate to prevent an arbitration award being enforced or a bond being called.

2. Impossibility

The second possible general route to relief is impossibility. Some contract provisions may relieve a contractor from its obligation to execute all or part of the works on the grounds of impossibility. Once again, it is important to note that the contract must contain such a provision. In the absence of such a clause, a party who agrees to do something which becomes impossible is liable for the losses caused to the other party by its failure to perform (subject to possible arguments regarding frustration which are discussed in the next section).

In the FIDIC Red Book the impossibility provision is included at Clause 19.7:

“Notwithstanding any other provision of this Clause, if any event or circumstance outside the control of the Parties (including, but not limited to, Force Majeure) arises which makes it impossible or unlawful for either or both Parties to fulfil its or their contractual obligations or which, under the law governing the Contract, entitles the Parties to be released from further performance of the Contract, then upon notice by either Party to the other Party of such event or circumstance:

1. The Parties shall be discharged from further performance, without prejudice to the rights of either Party in respect of any previous breach of the Contract, and

2. The sum payable by the Employer to the Contractor shall be the same as would have been payable under Sub-Clause 19.6 if the Contract had been terminated under Sub-Clause 19.6.”

The topic of impossibility is a broad one and a full discussion is beyond the scope of this article but some general observations can be made:-

1. Although the clause includes Force Majeure Events, it is much broader in scope and covers all events or circumstances that might render it impossible to carry out the works;
2. The clause does not include the restrictions in the Force Majeure clause, such as requiring that the affected party could not reasonably have provided against the event;
3. However, as with Force Majeure, the event or circumstance must arise after the contract has been entered into (this is not actually spelled out but is implicit in the clause);
4. The clause covers legal (i.e. the party could carry out the contract but would break the law in doing so) as well as physical impossibility (i.e. the party cannot carry out the contract);
5. It does not cover a situation where it is still possible for the contractor to carry out the works but it has become more expensive for it to do so (note however that where the increase in cost has become prohibitive it may be possible to raise arguments of so-called “commercial impossibility”); and

Finally, at first blush, the clause might not seem to cover a situation where it is possible to do the works but not possible to comply with the time obligations. Once again, a full discussion is beyond the scope of this article but it would be possible to raise an argument similar to that discussed above in the context of a Force Majeure Event preventing the contractor from following the programme or hitting the Completion Date.

The Effect of Impossibility

If the contract contains an impossibility clause, the clause will also determine the contractor’s entitlements in the event that the clause has been triggered. In the FIDIC Red Book the entitlement is the same as that provided if the contract is terminated due to a Force Majeure Event (i.e. payment for work done and materials procured plus other reasonable costs).

3. Frustration

In English law, if there are no applicable Force Majeure or impossibility provisions in the contract, the contractor may seek to rely on the common law doctrine of frustration. The doctrine of frustration was developed by the Courts to deal with situations where circumstances change fundamentally after a contract has been entered into.

The classic statement of the doctrine of frustration was set out by Lord Radcliffe in Davis Contractors v Fareham UDC [1956] AC 696.

“…[Frustration] occurs whenever the law recognizes that without default of either party a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract. Non haec in foedera veni. It was not this that I promised to do… There must be as well such a change in the significance of the obligation that the thing undertaken would, if performed, be a different thing from that contracted for.”

One classic example of the application of the doctrine of frustration is the so-called coronation cases (e.g. Krell v Henry (1903)). Some people who had rented apartments at high rents to watch the coronation of King Edward VII were able to escape their contracts because the coronation was cancelled when the King fell ill with appendicitis. Although the contracts remained in one sense capable of being performed (i.e. the apartments were still available and could have been rented) the courts held that the contracts were voided on the ground of “frustration of purpose”. The circumstances had become radically different and the clear purpose of some of the contracts (i.e. to enable the lessors to get a grandstand view of the coronation procession) had become frustrated.

However, the bar to establish frustration is a high one. The Davis Contractors case, from which Lord Radcliffe’s statement above is taken, is illustrative. Davis Contractors agreed with Fareham UDC to build 78 houses over eight months for GBP 92,425. The Work ended up taking nearly 3 times as long (22 months) and costing GBP115,233. However, notwithstanding this very fundamental change, the Court found that, although the performance of the contract had become very much more onerous, the contract was not frustrated.

In order to establish frustration, the change in circumstances must be truly radical. One example might be the destruction of the subject matter of a contract (a contract to fit out a factory which subsequently burnt down) or a supervening illegality (it becomes illegal to carry out the work). Whilst, it is possible to conceive of circumstances where the doctrine might apply in connection with the COVID-19 viruses, such cases are likely to prove to be the exception rather than the rule.

Because frustration is the result of events occurring which the parties did not contemplate when they entered into the contract, the doctrine will not apply if the circumstances were expressly contemplated under the contract terms. Thus the doctrine of frustration will not apply if the event is covered by a Force Majeure clause, or the underlying contract expressly allocates the relevant risk. In addition, the doctrine will not apply if the circumstances leading to the frustration are the fault of one of the parties.

In the rare instances where frustration is available as a remedy, the effect will be that the parties’ obligations under the contract end from the date of the frustrating event. This used to lead to inequitable results, for example a party might not be able to recover a pre-payment made under the contract. Statute has intervened (in English law the Law Reform (Frustrated Contracts) Act 1943). This allows pre-payments to be recovered or, conversely, where a party has derived considerable benefit from a contract prior to the frustrating event (i.e. because the works are partially complete), equity can intervene to require that the party receiving the benefit makes payment for it.

However, a contractor should look very carefully at the situation, and the likely recovery under the contract before invoking the doctrine of frustration.

Specific Contractual Provisions Giving Entitlement to Time and Money

The other route to relief is to examine the normal provisions in the construction contract that give entitlements to additional time and/or recovery of costs to see if these provide a remedy. There is likely to be more than one such clause and it will be worth the contractor looking at the contract in the round before deciding which clause or clauses to invoke.

Clauses giving Entitlement to Time and/or Money

The Extension of Time provisions in the contract may provide relief. Clause 8.4 of the FIDIC Red Book provides for an extension of time entitlement if delay is caused by:

“Unforeseeable shortages in the availability of personnel or Goods caused by epidemic or governmental actions.”

On its face this clause would seem to give scope for relief. It should be noted that the clause would seem to include all governments and not be restricted to the government in the country where the works are being carried out. A further potentially helpful clause in the FIDIC Red Book, which is limited to the country where the works are being carried but may be broader in scope in that it seems to catch all public authorities and not just government, is Clause 8.5 :-

“If the following conditions apply, namely:

1. the Contractor has diligently followed the procedures laid down by the relevant legally constituted public authorities in the Country,

2. these authorities delay or disrupt the Contractor’s work, and

3. the delay or disruption was Unforeseeable,

then this delay or disruption will be considered as a cause of delay under [the extension of time provision]”.

It will also be seen that (unlike the Force Majeure provision) this clause introduces a foreseeability test. The FIDIC Red Book includes a commonly used definition for “Unforeseeable” (Clause 1.1.6.8) as follows :-

“Unforeseeable” means not reasonably foreseeable by an experienced contractor by the date of submission of the Tender.”

It would of course be possible to argue that in the light of the recent history of novel viruses (SARS, Swine Flu, MERS) the emergence of another such virus was foreseeable and indeed was predicted. However, almost everything that can be imagined is in one sense foreseeable. Outbreaks of new viruses are not everyday events and we would suggest that the specific effects of the COVID-19 virus on China and its supply chain were far from being reasonably foreseeable by an experienced contractor and a strong argument could therefore be made that the requirement is satisfied.

All of the above clauses give an entitlement to additional time but do not allow the contractor to recover additional cost incurred. Clause 13.8 of the FIDIC Red Book is of course designed to allow for adjustments in the cost of materials and labour but is often not used. If this clause does not allow recovery, it will be helpful to consider all of the relevant circumstances and contractual provisions to see if a claim can be brought.

By way of example, Clause 13.7 of the FIDIC Red Book allows for additional time and money in relation to changes in legislation. It provides that:-

“The Contract Price shall be adjusted to take account of any increase or decrease in Cost resulting from a change in the Laws of the Country (including the introduction of new Laws and the repeal or modification of existing Laws) or in the judicial or official governmental interpretation of such Laws, made after the Base Date, which affect the Contractor in the performance of obligations under the Contract.”

The clause is of course limited in scope and requires a change in law but the definition of Laws is broad (including regulations and by-laws). Thus if the contractor can identify changes in law or regulations, or their interpretation, arising as a result of COVID-19 virus, which have impacted on the works, it may be able to ground a claim for additional cost.

Other Potentially Relevant Clauses

There will of course be other clauses which may be relevant. For example, Clause 2.1 of the FIDIC Red Book places an obligation to the employer to give the contractor “right of access to, and possession of, all parts of the Site.” A failure to comply with this obligation triggers an entitlement to both time and money (including reasonable profit). Thus if the site is closed or access restricted because of the COVID-19 virus, this may be the best route to recovery.
Similarly, the employer itself may take action as a result of the virus outbreak which may trigger an entitlement. For example, the employer may change the requirements as to where the contractor may source its labour (triggering an entitlement to a variation) or take more drastic action such as suspending the works.

It is also worth considering the question of entitlement to variations. Certain contracts place a positive obligation on the employer to order variations which are necessary for the completion of the works. Such clauses would trigger an entitlement to a variation order if it was not possible to comply with the strict requirements of the contract (e.g. because the specification required that materials were to be obtained from a factory or facility which was closed).

However, even for contracts which do not place such an obligation on the employer (and the FIDIC Red Book is one such) the contractor may be able to make use of the variation provisions in the contract. Thus, for example, the Value Engineering Clause in the FIDIC Red Book allows the contractor to submit written proposals which will, if adopted, accelerate completion of the works or reduce the cost to the employer of executing the works (Clause 13.2). In circumstances where performance has been delayed because of non-availability of specified materials, such a written proposal might be appropriate.

In any event, the availability of reliefs, including possibly the contractor’s entitlement to end a contract on the basis of Force Majeure or Impossibility, may prove to be a powerful bargaining tool in negotiations. A contractor who is entitled to bring a contract to an end because the strict requirements of the contract have become impossible to comply with, will be able to put a forceful argument to an employer that a variation to relieve such impossibility is a sensible way forward.

Conclusion

It is hoped that the above analysis provides some general guidance to contractors who are struggling with the commercial effect of the COVID-19 outbreak on construction projects. The starting point will be to carry out a careful review of the general remedies (i.e. Force Majeure, Impossibility and Frustration) that may be available to excuse non- performance. In most contracts the most likely source of relief will be the Force Majeure clause but the other two routes certainly merit consideration.

This review of general remedies should be followed by a careful review of the specific contractual provisions giving entitlement to time and money. This review should be broad ranging and not just limited to consideration of those clauses that are most obviously relevant (e.g. epidemic). Consideration should be given to all of the effects of the outbreak, including for example changes in legislation or regulations and problems with site access.
The above review will enable to contractor to identify the route to take to obtain the best commercial outcome and be well placed in negotiations with the employer as to how best to manage the situation, including the possibility of varying the strict terms of the contract.

It is doubly important in difficult commercial situations to ensure that basic contractual housekeeping is followed, including compliance with all necessary legislation and requirements of authorities, timely service of contractual notices, as well as keeping proper records of site progress and cost to substantiate claims.

Finally, it is important to mention that, as well as focussing on the FIDIC Red Book, this article has focussed on common law jurisdictions and English law in particular. The common law generally takes a hand off approach and leaves the contracting parties to allocate risk. Many civil code jurisdictions take a more interventionist approach and, for contracts subject to a civil code, there may well be alternative routes to excuse non-performance or to recover additional cost through the applicable code.

For further insights, please check out our recent webinar ‘COVID-19 and Construction in Singapore: A Contractor’s Guide to Managing the Fallout‘ and visit the Clyde & Co Coronavirus Information Hub.

Please do not hesitate to reach out to the authors for more information so that we can help better protect your businesses in light of COVID-19 and the potential consequences.

Authors:

Jon Howes, Partner, Singapore
E: Jon.Howes@clydeco.com

Eugene Tan, Partner, Singapore
E: eugene.tan@clydeco.com

Sean Hardy, Partner, Singapore
E: sean.hardy@clydeco.com

Christopher Short, Counsel, Hong Kong
E: christopher.short@clydeco.com