While contracts generally contemplate foreseeable contingencies, they are unlikely to have made allowance for the pandemic outbreak and its far-reaching impact in the absence of any recent and related experience. In mitigating such impact and providing insight into bolstering recovery efforts, contract management plays a significant role, more so in capital-intensive fields like construction. The fall in construction prices in the last two years in the aftermath of a recession-induced slowdown in construction demand saw execution of contracts on thin margins with minimal scope for errors. Procurement difficulties, enhanced compliance requirements and increased post-pandemic claims have further exacerbated the problem with the result that the projects have been delayed, suspended or cancelled, creating cash flow crunches.
Immediate contract issues
The immediate contractual concern revolved around review of force majeure (FM) clauses. In the absence of one and impossibility of performance of obligations by either of the parties, the doctrine of frustration may come into effect. Since FM language varies widely between contracts, some being generic and some citing specific examples, they need a careful review. For it to apply, the FM clause itself has to be expressly stated in the contract and cannot be implied under law. Whether it applies to COVID-19 or not will depend upon whether the clause listed pandemic or provided for unforeseen, extraordinary circumstances and events beyond reasonable control.
While FM has received renewed relevance and attention post the outbreak, other contract risks related to indemnification, termination, limits of liability, notices, litigation, governing law and change in laws, also deserve careful consideration. They need to be analysed and reviewed to understand the available contractual and business options, decide on an action plan, and conclude negotiations. The decision to engage in negotiations itself depends on severity to which either of the parties is affected, alternatives available and the relationship itself.
For pursuing their claim, the contractors must prove the entitlement, causation and the damages. If the contract provisions do not allow contractors to recover their increased costs, it may change the economics they had relied upon at the time of execution of the commercial contracts, which are not reimbursable. This may be particularly true in the case of contractors, whose already tight margins before the pandemic outbreak have been put to test by the extended lockdown, equipment preservation and new guidelines. In the absence of pragmatic efforts from the client contracts team, contractors exposed to risks of financial troubles or insolvency may resort to the use of termination provisions to exit or re-negotiate the contract.
To overcome the effects of the pandemic and in consideration of the industry survival, it is important for the clients and their contract administrators to take a fair-minded approach and consider sharing the burden of the contractors, irrespective of the contract provisions. This may include sharing of reasonable costs during and after lockdown and interim price and payment adjustments. Sharing of cost burden associated with the recent, more stringent changes to financing, guarantees and insurance conditions may be considered. Contracts should appropriately liaise with counsel and receive guidance on the use of legal theories in settling any claims and timing of their engagement.
Rising construction costs
Though construction is not as dependent on global supply chain as the other sectors, it is highly contracts and procurement intensive, accounting for around 45 - 60% of the total construction costs depending on the nature, size and location of the project, among other considerations. Construction costs that rose globally in 2019 and were expected to continue to rise this year will now be further influenced by the lesser productivity caused by social distancing requirements, enhanced health compliances and increased supply chain costs.
In addition to the pandemic caused supply chain disruptions from China and resultant construction delays, a likely distancing from this market may force companies to opt for costlier alternatives to materials and labour. Costs may also arise due to an enhanced focus on health and safety of workers and the need to implement new job site safety and health policies such as social distancing, staggered shifts and health checks. The pricing for risk associated with the above coupled with the uncertainty of the duration and treatment of the virus will influence the contracting prices in the near future.
Contract provisions for risk allocation assumes more importance in renegotiating or executing new contracts, but it may be borne in mind that for a similar future event, FM will offer less protection when tested for foreseeability; it may have to be suitably modified to address impacts based on the levels of foreseeability. What constitutes change in law will need careful consideration given the time and cost claims associated with implementation of new legislation, directives, and guidance to contain the spread of the pandemic. Factors like health and safety, engaging local resources and robustness of the contract management systems to tackle similar future disruptions will find enhanced and redefined importance in the contractor selection process. The adequacy of indemnity and insurance, notices, suspension, termination and disputes resolution clauses may also need reconsideration in light of the recent events.
As a solution to address the volatility in labour and material costs, prefabrication and modular construction may gain renewed importance. In addition to better achieving workers’ health and safety under familiar and controlled premises, it will also bring about competitiveness in pricing.
The current crisis has revealed the importance to quickly review the contracts and assess the impact of the quickly escalating event on all stakeholders. In recognition of this compelling need, construction companies may be required to make the right investments in working smart and digitalisation that enhances efficiency and productivity and creates competitive edge, while meeting the project requirements in a sustainable manner. Proactive digitisation will help contracts managers to stay prepared to conduct mass scale analysis of data from a centralised pool, to tackle future similar external shocks; as an example management of contracts with the phasing out of LIBOR in 2021 and the use of alternative interest rate benchmarks. Connected job sites using smart systems and process that involves digitalisation, artificial intelligence, machine learning and language-based analytics are likely to be implemented across the industry mainly in areas of contracts, supply chain, construction surveillance, and inspections and monitoring.
In summary, the contract personnel need to evaluate the effects of the pandemic, explore opportunities to support construction contractors to recommence and continue the work, reduce the overall cost of project delivery and deliver the projects. They need to beget contract resilience as part of project continuity planning and evaluate price fluctuations, warranties, guarantees and insurance to assist in risk mitigation. Contract lifecycle management and administration process are to be reevaluated for enhanced contract performance in the post epidemic scenario. Contract managers must secure training in new digital technologies not only to navigate automated contractor interfaces, but also to stay relevant and employed. It is important that they reimagine the future work site, project activities, risks and resource requirements and transform the contract organisations traditionally created for efficiency to one designed for resilience.
Written by Ajith Muralidharan, Oil and Gas Consultant.
Read the article online at: https://www.hydrocarbonengineering.com/special-reports/28092020/construction-contract-strategies-post-covid-19/
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