Covid-19 sparks contract issues

The rapid spread of the Covid-19 illness has led to an unprecedented ripple effect on the Middle East’s economies.

Business closures, project suspensions and employee layoffs are taking place in labour-intensive sectors across the region. Heavy industries such as construction, transport and oil and gas are among the most exposed to the business risks spurred by Covid-19.

Force majeure has subsequently arisen as a subject of keen interest for firms in these sectors that may be looking to scale back, forestall or otherwise reorganise their business plans for the rest of 2020.

Many other organisations as well as governments are reviewing the seldom-used force majeure clauses in their contracts to understand what terms they have signed up to and what options or risks they are open to. The Chinese government was the first to move when it began looking to declare force majeure to opt out of energy deals.

 

Regional rulings

The issue became a regional one on 22 March, when the Iraqi government declared the ongoing pandemic constitutes an event of force majeure for “all projects and contracts”. In a statement, the government’s crisis cell said the period of force majeure would be effective from 20 February.

Such an announcement from a government entity is highly unusual and has increased uncertainty within Iraq’s projects sector. It also has the potential to “cause chaos on site as well as in terms of negotiations and compliance”, says Andrew Mackenzie, a partner at multinational law firm Baker McKenzie.

Prior to the government’s announcement, most contractors, employers and other developers were thought to be handling the Covid-19 crisis on a case-by-case basis based on existing conditions within contracts.

Now, this process has effectively been bypassed, yet Mackenzie cautions that: “Whether a court or a tribunal will accept this remains to be seen”. This is due to the fact the declaration was made by the crisis committee, not parliament, and “so there will be debate over its legal standing”, he notes.

The force majeure proclamation could now cause disputes relating to contracts governed by English law, because parties are likely to try and import it, saying the matter of the project is based in Iraq and the contractor was constrained by the government announcement that the event was force majeure.

In Saudi Arabia, the Finance Ministry issued a circular confirming that coronavirus-related issues qualify under Article 74 of the Government Tenders and Procurement Law, approved by the Council of Ministers in July 2019, which allows Saudi entities to extend contracts in exceptional cases.

The announcement covers delays in the execution of works and procurement, the delay of project delivery or item supply at the specified time, and the completion of works related to continued-execution contracts.

“This means allowing the extension of contracts for these works and exemption from penalty or fines,” it affirms.

Contractual scenarios

Short of such extraordinary state interventions, the outcome of regional force majeure claims will be influenced by the set-up and administration of the contract, as well as the quality of the records being used to substantiate the claims.

If the contract stipulates a different governing law to the jurisdiction in which contractors are operating, then they must review how the civil code of that jurisdiction treats force majeure.

As an example, Article 273 of the UAE Civil Code sets up what Mackenzie describes as a “fairly straightforward procedure” that helps establish whether an event qualifies as force majeure.

In the article, force majeure is defined as an event that renders the performance of the obligation impossible, is unforeseeable and is unavoidable at the time of entering into the contract. “Once you’ve been able to evidence these three factors, you stand a fairly good chance of being able to show that the event is force majeure,” says Mackenzie.

As of mid-April, construction is one of the sectors that is exempted from outdoor movement restrictions imposed by the UAE government.

“Therefore, you do not have a very easy hook to hang your hat on and say force majeure, because you are suspending works,” says Mackenzie.

Indirect impact

However, while project parties are required to mitigate risks, adjust work programmes and continue working under most standard contracts, Covid-19 has an indirect impact on site works through domestic movement clampdowns and
regional border closures, as well as business suspension and delays in major export markets such as China.

Claimants are contractually required to notify their employer of these delays to preserve their rights, Mackenzie explains. For example, a subcontractor importing cladding materials from shuttered Chinese factories must point at the time to Covid-19 as an event that is beyond their ability to ‘foresee and avoid’, rendering their site works impossible to conduct.

Most standard form contracts allow for Covid-19 to be covered as a force majeure event, but risks may arise if agreements have been amended or poorly administered, says Haroon Niazi, partner and head of the Middle East region at HKA.

Documentation will play a crucial role in how force majeure claims related to Covid-19 are received. Record-keeping is critical to the substantiation of claims, but has historically been among the chief causes of construction disputes in the Middle East. The significance of this process will only increase as more force majeure discussions get under way in the aftermath of the coronavirus pandemic.

“There are a lot of nuances to a force majeure claim that have to be carefully considered,” Niazi explains.

“For example, a disruption claim on a project will be affected because of social distancing. The contractor might have planned to have five people working in a team painting a room, but because of social distancing it may be down to three people. That will cause productivity losses and disruption, and it will have a cost impact. The key is how that record is maintained and how it is going to be produced to substantiate the claim.”

Coronavirus-related slowdowns are also exacerbating the cash crunch in the GCC’s real estate and construction sectors.

The severity of this liquidity crisis has some contractors worried about employers potentially re-engaging in bad behaviours, such as excessive bond-calling, last noted during the global financial crisis of 2008-09.

Niazi says it is “absolutely possible” that some projects may be too expensive for clients to resume. “The claims that may be coming from contractors will be significant,” he says. “Some projects may be suspended and clients may terminate contracts.

“Clients will be looking at the overall situation on a project. A project could have already been delayed or behind schedule even before the Covid-19 impact kicked in. So if we do end up in a situation where suspensions and terminations kick in, the risk of bond-calling increases accordingly.”

Future projections

So far, Iraq is the only regional government to have declared Covid-19 as an event of force majeure. In Saudi Arabia, a key regional market for the construction and oil and gas sectors, the position under sharia law is that force majeure can generally be claimed irrespective of whether the contract explicitly provides for it. However, the threshold is high and the burden of proof rests on the claimant.

Factors influencing the court’s determination include proof from the claimant both that performance is impossible or frustrated and that remedial action is ineffective or unavailable. A paper by Baker McKenzie states that a Saudi court would also consider the duration or likely duration of the event and the terms of the agreement. An event that lasts, or is likely to last, for a few months may not be deemed sufficient by the court to excuse a party of its contractual obligations.

There is nevertheless a clear uptick in contractors and subcontractors across the region issuing notices to inform clients and employers of force majeure-related events linked to Covid-19, according to Niazi. “We are seeing different clients respond to force majeure notifications in different ways,” he says. “Generally, at the moment, the notices are being rejected by clients, and we have seen various different reasons being given for rejecting that notice.”

Project friction

The seldom-used nature of force majeure clauses could cause some friction in regional construction, as Richard Stratton, partner and managing director for the Middle East at UK-based consultancy Cundall, explains. “I see force majeure clauses as probably a more exceptional version of similar clauses that cover change, variations and delays,” he says.

“We’re probably less used to dealing with them and, potentially, there may be a tendency to misunderstand what constitutes force majeure or the way that you should notify it.”

The most critical condition to remember is that force majeure clauses cannot be used to escape contractual obligations linked to documenting change, minimising risk and ascertaining revised costs.

“I saw this during the GCC diplomatic crisis [of 2016], when there were blanket force majeure letters flying all over the place,” says Stratton.

“It’s probably not really appropriate to start sending force majeure letters to your client until you have an understanding of what impact that event may have on your ability to deliver services and on the project, and what the mitigating circumstances may be.

“It’s at that point that you should start writing to your clients, because otherwise it devalues the whole basis of notifying a force majeure event.”

By Neha Bhatia and Wil Crisp