At the time of writing, the conflict in Iran has dominated the global news for some two weeks and cascaded into neighbouring states in the region.
For contractors and developers based in the region watching the situation unfold, the unrest has given rise to uncertainty that resembles those who steered their businesses through the global COVID-19 pandemic in 2020 or navigated the effects of the breakdown of diplomatic ties between Qatar and some of the Gulf states between 2017 and 2021.
The continued effects of the current regional unrest have resulted in the closure of airspace and disruption to global shipping routes via the Strait of Hormuz. On the ground, the impact has extended to construction projects which have suffered delays, reduced productivity levels and supply chain disruption given the obvious impact to international trade.
What this Means for Contracting Parties
Parties involved in large-scale infrastructure and development projects are facing uncertainty, which may give rise to various legal entitlements. Principles of force majeure, hardship, impossibility, material changes in circumstances and exceptional circumstances coupled with parties’ express contractual provisions will be factors when considering the issue of claims and the relief available.
What Constitutes a Force Majeure Event
Under the Civil Codes in the region, an event of force majeure is typically one that is unforeseeable, outside of the party’s control and renders a party’s obligation impossible to perform (entirely or partially). This is different from “exceptional circumstances” where a party’s obligations have become unduly onerous, although not entirely impossible, to perform due to the occurrence of a public event with wide-ranging effects. In construction contracts, events that constitute force majeure are typically expressly set out. For example, Clause 19 of the FIDIC Contract For Building and Engineering Works Designed by the Employer 1999 Edition (“FIDIC Red Book”), which is still widely used for construction projects in the region, categorises a force majeure event (referred to as an “exceptional event” in subsequent editions of the FIDIC Red Book) as an exceptional event that is beyond a party’s control and which, amongst other things, is not substantially attributable to the other party. These may include war or hostilities (whether war is declared or not).
This article considers some of the claims that could arise out of a force majeure event and what rights and entitlements a party may have in such circumstances.
Potential Claims
1. Extensions of Time and Prolongation Cost
Where a force majeure event causes unavoidable delays which are outside of the parties’ control, contractors could be entitled to an extension of time.
For employers, Clause 17.3 of the FIDIC Red Book is critical since war or hostilities (whether war is declared or not) are listed as an Employer’s Risk. In other words, it is the contractor which would benefit from any entitlements arising out of a force majeure event that causes delay to the works.
A party seeking to rely on a force majeure event is required to give notice to the other party within 14 days after it became aware or should have become aware of the event in question. The affected party has a duty to mitigate or minimise delays to the performance of its obligations and must give notice when it ceases to be affected by the force majeure event.
Whilst a contractor may avoid liquidated damages through the entitlement to extensions of time, prolongation costs for any compensable delays may not be recoverable in the usual way, unless the contract says otherwise. For instance, Clause 19.4 of the FIDIC Red Book provides an entitlement to costs reasonably incurred including site and head office overheads but not profit in the event of force majeure.
If the obligation to complete on time is rendered entirely impossible, that obligation is “extinguished” and falls away (i.e., the time for completion will extend to when the works can be completed or there is no longer any obligation to complete the works at all).
As such, whether the protection arises under contract or at law, contractors have relief from delays arising out of force majeure events and employers should be aware of the same.
In contrast, if a party relies on the principle of exceptional circumstances for its extension of time claim, then a court or arbitral tribunal has the discretion to balance the interests of the contractor and employer and decide on a reasonable extension entitlement.
2. Lowered Productivity and Disruption Cost
Distinct from delays to completion, the impediments on work force arising out of the impact of the conflict may result in lowered or loss of productivity. This can arise where, for example, the site is declared unsafe for the workforce to operate or transportation routes are disrupted. Claims arising out of such loss of productivity are typically referred to as disruption claims.
Entitlement to compensation depends on the contractor demonstrating a reduction or loss in productivity on the project caused by the force majeure event, which has caused loss and/or expense. The evidential threshold is high.
Proper substantiation would take the form of high quality and complete contemporaneous records such as correspondence, meeting minutes, site reports, photographs and other documentation to demonstrate the planned versus actual progress on the site and allocation of resources like labour and plant.
Clause 8.4 of the FIDIC Red Book may also afford the contractor relief where completion is or will be delayed by an unforeseeable shortage in the availability of personnel or goods caused by governmental actions. An entitlement to an extension of time could arise where governmental safety directives or regulations issued in light of regional unrest prevent the flow of personnel or goods to the site.
3. Cost Escalation and Increased Price Adjustments
The disruption to shipping routes and other transportation avenues arising out of the present situation in the region has also started to impact energy costs and the flow of goods and materials. This in turn can lead to increased costs for contractors as the production and movement of materials becomes more expensive, slows down or even stops completely. The contractors’ costs to complete and progress the works overall will likely be affected.
It is important that the parties’ contract accounts for such eventualities either by, excluding any entitlement to the contractor for such increased costs (in favour of the employer) or setting out the basis on which the contractor’s entitlement is to be calculated. Where there is no entitlement to increased costs under the contract, the contractor will usually seek to price the works accordingly to account for the risk.
For contracts that are premised on the FIDIC Red Book, Clause 19.4 enables the contractor to claim the “Costs” arising out of a force majeure event, which as mentioned above, includes all expenditure reasonably incurred whether on or off the site but not including profit. As such, where the price of materials increases owing to regional unrest, the contractor may have an avenue to recovering increased costs provided it has complied with the claims procedures under the contract.
A force majeure event can also create economic constraints and disrupt banking operations and facilitation, which could impact cashflow in the project, particularly where the employer has obtained debt financing. The FIDIC Red Book does not offer the employer any protection against an inability to make payments in the event of force majeure and so, careful contract drafting is required to ensure the necessary protections are in place.
The region’s Civil Codes offer some level of protection where impossibility can be established, in which case the obligation may be “extinguished” or where exceptional circumstances exists, in which case the parties’ obligations may be adjusted to a reasonable level, albeit at the discretion of the competent court or arbitral tribunal.
4. Omission and De-scoping
A force majeure event may result in changes to the design, intent and/or the flow of ongoing construction and infrastructure. This may result in variations, omissions, de-scoping or the substitution of materials, amongst other things. The variation or omission clauses of the contract may offer relief.
Clause 13 of the FIDIC Red Book sets out procedures for varying the contract whereby, variations are to be approved by the Engineer in any event. This includes “negative variations” where the scope of the contractor’s works is reduced or partly omitted. A contractor would normally be entitled to the additional cost arising out of a variation. If works are omitted or descoped and awarded to another contractor for no valid or justifiable reason, the existing contractor may be entitled to loss of profit and damages.
5. Suspension and Termination
It is plausible that employers or contractors may consider suspending or even terminating projects due to a force majeure event (for instance changes in the region’s priorities and focus for projects).
Under the region’s Civil Codes, the parties’ performance of their contract is automatically cancelled (or terminated) where performance of the whole contract becomes impossible due to a supervening force majeure event, partially cancelled in the case of partial impossibility or suspended in the case of temporary impossibility.
In cases where the contractor has commenced the works and played no part in the cause of the suspension and termination, it may be entitled to the value of work done which it has completed and the expenses it has incurred in the performance of the contract up to the amount of benefit the employer has derived from the works.
Under the FIDIC Red Book, where the works are in progress and are prevented for a continuous period of 84 days due to a force majeure event or for multiple periods amounting to more than 140 days due to the same force majeure event, either party may terminate with 7 days’ notice. In such circumstances, the contractor is entitled to receive sums including, amounts payable for any work carried out which is priced in the contract, the cost of plant and materials delivered to site for the works and notably, the cost of repatriation of the contractor’s staff and labour employed solely for the works, as determined by the Engineer. Under the FIDIC Red Book, loss of profit is not available for termination due to force majeure.
Takeaways
- Properly assess the impact of a force majeure event – whether that impact is permanent or temporary and affects the whole or part of the construction works.
- Review impediments to the parties’ entitlements – notice requirements, clauses limiting liability and loss amongst others – and the extent to which any legal provisions allow these clauses to be circumvented or mitigated.
- Understand the cost recovery limitations – under the FIDIC Red Book, costs are recoverable for force majeure events but profit is not.
- Where matters cannot be resolved and disputes arise, preconditions to legal proceedings in the agreed forum come into focus as well as key procedural and legal strategy considerations, which must be established early on. The availability of accurate and complete records will be of key importance to a successful claim or defence.
Key Contacts
Khushboo Shahdadpuri, Partner, k.shahdadpuri@tamimi.com
Rashid Khan, Senior Associate, ra.khan@tamimi.com