COVID-19: who bears the contractual risk for construction project delivery?

On construction projects, in addition to seemingly inevitable supply delays, the virus (and the public health response to it) raises the prospect of labour constraints and the potential closure of work sites and manufacturing facilities. Clients operating at all levels of the industry, in view of extensive quarantines in China and Italy (both major supply hubs for construction components and materials) are starting to ask who will bear the risk of the time and cost consequences that may flow.

While all businesses dust off their continuity plans, anyone involved in a current or planned construction projects should also be:

1. checking how risks are allocated under their existing contracts, and when any notices of delay should be given;
2. considering appropriate steps to mitigate delays and prolongation costs; and
3. ensuring that future contracts provide clarity as to how risk events will be addressed.

The parties’ rights and obligations on current projects will – to a significant extent – depend on the contractual terms in place, and how those terms apply to the factual situation as it unfolds.

On the question of delay/disruption (and claims for money flowing as a result) the general position under un-amended JCT/NEC contracts is considered below.

WHAT DO THE CONTRACTS SAY?

JCT-based contracts entitle the Contractor to an extension of time where a project is delayed due to a “Relevant Event” and to recover loss and expense arising from a “Relevant Matter” (with Relevant Matters much more limited in scope than Relevant Events).

The overarching principles are that (i) the Contractor carries time and cost risk for items within its control (including the supply of labour and materials) and (ii) save for matters expressly within the Employer’s control, delay events are “cost neutral” (in the sense that the Contractor is relieved from delay damages but the Employer does not pick up prolongation costs). The JCT requires the Contractor to give notice of a possible delay “if and whenever it becomes reasonably apparent that the progress of the Works is or is likely to be delayed” and makes the Contractor’s entitlement to time conditional on having exercised its best endeavours to prevent delay.

A delay attributable to COVID-19 might give rise to a time claim if it is caused by:

• government action, such as a prohibition on gatherings or other public health measures that interfere with site operations;
• an Employer instruction or act of prevention, such as a responsible welfare decision to suspend works (not mandated by government) to protect employees and contractors, or in view of wider health and safety responsibilities;
• labour issues caused by civil commotion or union action, such as mass walkouts;
• non-performance by utilities providers or delays in receipt of statutory permissions and consents (e.g. due to their own labour or supply constraints); or
• force majeure (as to which see further below).

Of the above, only Employer instructions or prevention and planning delays would give rise to a claim for additional cost. Notably, force majeure is not a Relevant Matter under JCT terms.

That means that the way in which a delay arises will be critical in determining its contractual consequences. Taking the example of a site shutdown, if that resulted from government intervention or force majeure, the Contractor could claim an extension of time but not loss and expense; if it arose from the Employer’s instruction, however, a claim to both time and money could follow. Delays caused by shortages of labour or materials, on the other hand, would remain Contractor risk items unless they result from a Relevant Event and the Contractor has used its best endeavours to source alternative supplies.

The NEC3/4 terms provide for both time and cost consequences to flow from the occurrence of a “compensation event”, including client instructions or acts of prevention and a force majeure provision that applies to any event which:

• stops the Contractor completing works on time or at all;
• neither party could prevent; and
• would not have been allowed for by an experienced contractor.

NEC’s “all or nothing” approach to time and cost reflects an approach to risk allocation based on the principles of mutual trust and cooperation, with the contractor required to give early warning of issues as they arise to enable collaborative risk reduction steps to be taken. Contractors are required to give notice of a compensation event within 8 weeks of becoming aware that it has happened – and may lose entitlement to relief if they fail to do so.

Force majeure is not defined in the JCT suite (an opportunity missed in successive revamps since 2005), and there is no authoritative guidance on its meaning from the English courts – which leaves real scope for uncertainty.

Case law indicates that a force majeure event must be outside the control of the parties (such that they could not have prevented its consequences), and must not have been foreseeable at the date of the contract. A contractor would no doubt argue that a COVID-19 epidemic or pandemic would satisfy those requirements, and would fall squarely within the scope of the relevant NEC compensation event (at least where the contract was entered into before the spread of the virus became foreseeable).

There is a further question (to be resolved by reference to the contract wording) as to whether a force majeure event must render performance physically or legally impossible, or whether it is sufficient if it merely hinders performance. The courts have not examined the JCT or NEC wording from this perspective, and there are arguments either way:

• JCT anticipates an extension of time if force majeure “delays” (as opposed to “prevents”) performance, but only if the Contractor has used best endeavours to prevent delay – and unless supplies of labour and materials are unavailable from alternative sources, that will be a high burden to meet (the spread of COVID-19 would need to worsen materially before we reach that stage);
• the NEC compensation event is only engaged if the Contractor’s performance is “stopped” (rather than “hindered” or “impeded”) and the fact that compensation events carry time and costs consequences might suggest a tighter reading, but the provision is to be read in the context of the “spirit of mutual trust and cooperation” that the parties are to uphold.

The related common law doctrine of frustration seems unlikely to assist Contractors unless the situation worsens materially. The courts may excuse non-performance if it arises from an event which is neither party’s fault, makes it physically or commercially impossible to fulfil, or renders a party’s obligation radically different from that undertaken when the contract was entered into. Importantly, however, relief will not be available if the event in question is provided for (expressly or impliedly) by the contract (which, arguably both JCT and NEC contracts do), if it makes the contract less profitable or if it was foreseeable.

CONCLUDING THOUGHTS

Unless the Employer or government interferes with project delivery, it is at present far from clear that contractor claims for time or money arising from COVID-19-related disruptions will be successful. Moreover, unless the impacts of the virus worsen significantly, there is a real chance that contractors will remain responsible for managing the risk of disruption to their workforce and supply chains (depending on how the Contract Administrator/Employer’s Agent/Project Manager assesses a claim based on force majeure). The position should of course be kept under review, particularly as matters develop in key supply hubs, such as China and Italy.

Communication between Contractors and Employers will be vital in ensuring appropriate mitigation steps are put in place. As a starting point, these discussions should include considering supply impacts (and potential alternative sources, delivery methods or specification adjustments) and site regimes (including meeting protocols and monitoring the circulation of subcontractor personnel between projects). As ever, the parties should maintain clear project records and should be mindful of notification requirements.

Some commentators predict that the spread of COVID-19 may peak in the next few months and then dissipate over the summer. There is also a further suggestion that, like influenza, it may return in variant strains each year. If dealing with Coronavirus becomes a seasonal consideration, it will also need to be a regular feature of negotiation – and given outbreaks of SARS, swine flu and Ebola in recent years, there is a growing argument that epidemic illnesses are foreseeable events that contractors should reasonably take into account. In any event, the experience of the first months of 2020 show that clarifying the intention of the force majeure provisions in standard contracts is well worth doing.

As significant public gatherings and sporting events are cancelled or delayed, there are growing concerns that the pipeline of associated temporary and preparatory works will also dwindle. Lengthy delays to ongoing projects may lead to contractual terminations. In a similar vein, industry and government may also need to turn their minds to wider structural issues in the sector to address the longer-term effects of project interruptions, including:

• the risk of insolvencies if contractors’ balance sheets (which operate on tight margins in any event) are tested by extended periods of inactivity and stinted cash flows;
• the need to explore supply chain resilience as part of business continuity planning; and
• the scope for project insurances to assist in risk mitigation.

The range of possible peripheral ramifications from the COVID-19 outbreak is beginning to be discussed, from accelerated adoption of flexible working to a reduction in overseas travel and an uptick in virtual conferencing. For the construction sector, one of those ramifications may be renewed focus on reforming payment practices and managing project finances.

As with any emerging risk event, our advice is to plan ahead to the extent possible and stakeholders in construction projects would be well advised to keep risk mitigation measures under review as the spread of COVID-19 unfolds. Our team of construction experts is advising on a host of related issues, and would be pleased to assist.

This article has been co-written by Dominic Jones and Sophie Latham.