Concerns of a COVID-19 pandemic continue to rise as it spreads swiftly between countries across most of the world. The situation may be unique in your lifetime to date, as there must now be very few entities worldwide that have not at the least considered the potential effect of COVID-19 on their business.
How is COVID-19 going to affect construction contracts and the adverse consequences of non-performance? In our latest update, we focus on the likelihood of being able to rely on/or resist a claim of force majeure and how you can minimise risk.
The impact of COVID-19
Irrespective of what happens going forward, the impact of COVID-19 is already wide-ranging and potentially global. At a high level, the various effects of this virus on businesses result from factors that include:
- the virus itself i.e. if personnel internally and/or at external business partners catch the virus and/or find themselves quarantined;
- the steps taken internally to minimise:
- the risk to personnel; and
- any negative impact on the business;
- the steps taken to minimise the spread of the virus that are external to the business, including government actions, and the actions of other firms and/or individuals.
Businesses therefore are impacted at every level of operation and may well find themselves unable to fulfil contractual obligations due to factors such as a reduced workforce, or issues flowing through the supply chain. You need to be aware of how COVID-19 affects your contractual position and who bears the risk of its negative effects.
With the spread of COVID-19, to what extent can parties reduce or avoid the consequences of non-performance? The contract will of course determine which party bears the risk of any delay/non-performance - if (and only if) the contract contains force majeure provisions, you need to consider whether or not those provisions will be applicable.
If there are no force majeure provisions in the contract, other considerations will apply, as briefly referenced below. Here, we focus on force majeure provisions and non-performance resulting from COVID-19.
Force majeure arises from your contract (or not)
- The key point to bear in mind is that there is no underlying or prescribed principle of force majeure, so it will only apply if it is provided for in the contract (and only then subject to a number of key consideration as set our below).
- The intention of a force majeure clause is to provide for what happens where there is non-performance which is caused by events beyond the control of the party/parties. Where it is applicable, the non-performing party is "excused" in part usually from the adverse effects of the force majeure.
- How it affects your business however entirely depends on the specific wording of the force majeure provisions in your contract.
Consider for example the standard form JCT 2016 Design & Build (D&B) contract:
- force majeure is listed as a "Relevant Event", entitling the contractor to claim an extension of time if the contractor can prove that works were delayed as a result;
- force majeure however is not a "Relevant Matter" (which would potentially entitle the contractor to loss and expense).
This follows the general philosophy adopted by the JCT that the risk of "neutral" events should be shared between the employer and the contractor - so, the contractor obtains an extension of time and relief from liquidated damages, but is not entitled to claim loss and expense,. Equally, the employer will not have the right to claim liquidated damages as a result of the works being delayed, but does not pay the contractor for any loss and expense.
Aside from force majeure, another "Relevant Event" under the JCT 2016 D&B contract that may become applicable is clause 2.26.12 which refers to "the exercise after the Base Date by the United Kingdom Government of any Local or Public Authority of any statutory power that is not occasioned by the default of the Contract…..but which directly affects the execution of the Works". If the Government directs closures and/or "lock-down" measures in due course, these steps may constitute a "Relevant Event" under this clause (but again not a "Relevant Matter").
Will COVID-19 constitute a force majeure event?
Again, this will depend on the wording of your contract, if it contains force majeure provisions. If there are no force majeure provisions, then it will simply not apply.
- where there is a force majeure provision, force majeure may or may not be defined;
- where it is defined, the definition may (or may not) include reference to an epidemic or pandemic or to government actions/decisions.
Where (say) pandemic is included as a force majeure event, there is likely to be a strong argument that this will include the current COVID-19 outbreak.
Continuing the example above, in the JCT 2016 D&B contract, force majeure is not actually defined in the standard form wording. It is for the party seeking to rely on the force majeure event to prove that the provision applies, but employers should expect contractor claims for force majeure arising out of COVID-19 and its effects.
In terms of building contracts still under negotiation, whether or not to amend the JCT standard wording will generally be a commercial consideration e.g. the developer may wish to be specific (thus hoping to minimise events that fall within the definition) whilst the contractor may wish to resist such an amendment.
What if the contract does not provide for force majeure?
If there are no force majeure or other relevant provisions in the contract (or indeed they do not apply in these circumstances) and one party does not (or cannot) perform its obligations, what is the position?
- the contract will provide for any delay to the completion date and liquidated damages or loss and expense, where applicable;
- ultimately, the non-performing party may be in breach of contract resulting in a claim for damages and a possible right to terminate;
- there may be a potential claim under the principle of frustration, although this is narrowly defined and such claims are not straight forward.
A contract is considered to be frustrated where an event occurs after the formation of the contract and that event is unexpected and beyond the control of the parties and either makes it impossible to fulfil the contract, or transforms the obligation to perform into a radically different obligation.
Minimising the risk
COVID-19 is undoubtedly beyond the control of contractors and, if your contract contains force majeure provisions, these need to be considered. Taking an example, if a subcontractor factory is closed because the Chinese government has closed it, this is an event preventing the subcontractor supplying the contractor. In turn, the contractor cannot fulfil its obligations under the main building contract because their subcontractor has not supplied. That may arguably amount to force majeure, but as set out below, other factors will be relevant, such as whether or not the materials can be obtained elsewhere.
Hopefully you won't end up in a dispute situation but there are some points to consider that will help you to protect your position going forward.
Five points to watch out for if the contract contains force majeure provisions:
1. Are there contractual notice requirements? - many contracts require notice to be given of a force majeure event as a pre-condition to relying on the event, so check carefully to ensure both the requisite timescales and any provisions governing the service of contractual notices are complied with.
2. Amendment to the standard form wording Standard terms are likely to be amended at the negotiation stage - check what is and what isn't included as a force majeure event, if the standard clause has been or is to be changed. The force majeure clause might be amended to provide that events in existence at the time of the contract (e.g. COVID-19 now!) or that are foreseeable at the time the contract is made will not constitute force majeure events.
Bear this in mind if you are just about to sign - will you list "epidemic or pandemic" as a force majeure event?
3. Duty to mitigate. Subject to provisions under the contract, there is likely to be a duty to mitigate the impact of the force majeure. So contractors will need to try and overcome the force majeure e.g. by using an alternative supplier or use existing stocks etc. They cannot just sit back, do nothing and call force majeure.
The obligation to mitigate is limited to reasonable steps so contractors will need to demonstrate reasonable steps have been taken. It also means that if a contractor can partially perform their obligations then they may be obliged to do that - they cannot necessarily use a force majeure event covering a small element of the works to justify suspending all performance.
It will be important to be able to prove the steps that have been taken to mitigate the impact, so both from the employer's and the contractor's perspective, keep clear records which will help resolve any potential areas of dispute.
4. Must the force majeure be the sole reason? Whilst each case turns on its own facts and specific contract wording, the courts have tended towards a construction that does not allow a party to rely on a force majeure event if there was another reason preventing performance - e.g. party X's "real" reason for failure to perform is say, defective workmanship (i.e. a breach) and then X seeks to rely on a concurrent force majeure event. If there was no force majeure, could the contractual obligation have been performed? If not, then the courts have tended towards a finding of no force majeure (on the basis that it is not the only causative event). This raises important issues of concurrency which again depend on the facts and contract wording.
5. Could the event/situation have been anticipated? Subject to the wording of the contract, if the affected party could have reasonably anticipated the event, it might be argued that it cannot be said to beyond the reasonable control of the party and so in turn, that it cannot be a force majeure event.
Whilst use of the term force majeure in a contract without defining what force majeure actually means (as in an un-amended JCT 2016 D&B) does leave an uncertainty as to the prospects of success, you can see that it would be difficult to say that factually, the COVID-19 virus was reasonable to anticipate for most contracting parties. Contrast this to for example, UK importers and exporters who will now struggle to claim they had not anticipated the UK might Brexit.
Within the construction industry, the losses arising from non-performance or delayed performance may be significant.The terms of the main building contract are pivotal both for the parties to that agreement and across the project. Agreements for lease and development agreements mostly define force majeure to include anything that entitles the contractor to an extension of time under the building contract (unless caused by the employer).
So if the contractor can claim an extension of time under the building contract as a result of COVID-19, there is likely to be a corresponding entitlement to an extension of time under the contracts up the chain i.e. agreements for lease and development agreements.
There is relatively little case law on force majeure and each case turns on its own specific facts and contract wording. As with all contract interpretation, the courts will start with the natural and ordinary meaning of the words used but the courts (at least English courts) generally interpret force majeure events narrowly as they are treated as a limitation of liability, for which very clear words are required.
That said, when something happens that is self-evidently an unforeseen and major event (e.g. COVID-19) then there will no doubt be claims that this constitutes a force majeure event - it will depend on the wording of the specific contract whether or not that claim succeeds.
If you have any queries, please contact Michael O'Shea.