Over the past few years, the construction industry has faced – and continues to face – many challenges.  The unprecedented goods and labour shortages that arose during the COVID-19 pandemic were followed and compounded by the war in Ukraine. This led to significant supply chain disruption due to changes in law, governmental action and sanctions. The cost of raw materials increased dramatically, coupled with the ongoing disruption to procurement routes, which caused critical delays to many major construction projects.

In 2023, supply chain disruption continues to affect many construction projects, whether due to existing or new geopolitical conflicts, the fluctuating cost of raw materials, inflation, or the recessionary environment more generally.

FIDIC Red Book: contractual mechanisms

As we noted in our recent insight 'FIDIC: Round-up of the past 12 months – and what's next' , FIDIC published a memorandum entitled "FIDIC guidance on the effects of inflation and unavailability of goods and labour following the global COVID-19 pandemic and the war in Ukraine" (the "Guidance Memorandum"). The Guidance Memorandum is intended to assist FIDIC users in understanding how contractual mechanisms may be used to address the effects of inflation and shortages of goods and labour. It contemplates various scenarios that may have arisen in the aftermath of the pandemic and the war in Ukraine and may still be giving rise to contractual disputes.

The contractual mechanisms which may be used to address such scenarios will, of course, also apply to other supply chain risks that have emerged since the publication of the Guidance Memorandum or may be yet to emerge, including fluctuations in the costs of materials, new geopolitical conflicts and recession.

In this article, we outline the remedies available to parties under the Sub-Clauses (SC) of the FIDIC Red Book 1999 (RB 1999) and 2017 (RB 2017) – with reference to the Guidance Memorandum – in circumstances where the parties may be affected by:

  • A shortage of goods and labour caused by epidemic or war.
  • Increased costs / inflation, which affects the continuing performance of the contract.
  • Impossibility to continue performance of the contract due to existing or new geopolitical conflicts.

What is an event of Force Majeure / an "Exceptional Event"?[1]

In light of the supply chain disruption described above, parties have given greater consideration to Force Majeure / Exceptional Event (FM / EE) clauses under the FIDIC forms and potential time and / or cost relief. The Guidance Memorandum considers in detail whether each of the scenarios it contemplates could constitute FM / EE and what relief will be available in each case.

Under SC 19.1 (RB 1999) / SC 18.1 (RB 2017), in order for an event to qualify as FM / EE, it must be an event that is "exceptional" and:

  1. Is beyond a Party's control;
  2. is one which the Party could not reasonably have provided against before entering into the contract;
  3. having arisen, such Party could not reasonably have avoided or overcome; and
  4. is not substantially attributable to the other Party.

SC 19.1(i)-(v) (RB 1999) / SC 18.1 (a)-(f) (RB 2017) set out a non-exhaustive list of events or circumstances that may constitute FM / EE, provided the conditions above are satisfied.

An affected party may only give notice of FM / EE if it "is or will be prevented from performing any obligations under the Contract" as a result of that event. The FM / EE provisions will not be engaged in circumstances where performance simply becomes more onerous or expensive as a result (as a result of, for example, inflation).

Shortage of goods and / or labour caused by an epidemic or war

War - including "hostilities (whether war be declared or not)"

Where a party is prevented from performing any of its obligations due to the outbreak of war, it may be entitled to:

  1. An Extension to the Time for Completion under SC 19.4(a) RB 1999 and SC 18.4(a) RB 2017; and
  2. costs under SC 19.4(b) RB 1999 and SC 18.4(b) RB 2017,

provided that the event passes the test for FM / EE set out in SC 19.1 (RB 1999) / SC 18.1 (RB 2017) and the affected party provides the requisite notices. This could encompass, for example, the inability to procure goods from suppliers due to the outbreak of war either in the country of the project or in another country. War (unlike the other EEs listed in SC 18.2(b)-(e)) is not required to occur in the "Country" to give rise to an entitlement to cost relief.

However, a distinction must be drawn between:

  1. inability or impossibility of procuring goods (an example of this would be where goods were to be supplied by Ukrainian manufacturers who were prevented from shipping those goods following the outbreak of war in March 2022); and
  2. difficulty procuring goods due to them being in short supply / more expensive following the outbreak of war. This would not constitute FM / EE since the fact that performing is delayed, or becomes more difficult or onerous, does not equate to being "prevented from performing any obligations under the Contract" as required by SC 19.2 (RB 1999) / SC 18.2 (RB 2017).

The affected party's knowledge of events at the time of formation of the contract will be relevant when assessing whether an event qualifies as FM / EE. A party who entered into a contract in late 2022 / 2023, for example, ought to have been aware of supply chain risks involving Ukrainian parties. It could, therefore, have reasonably provided for such risks before entering into the contract, thereby failing to satisfy the second limb of the test for FM / EE under SC 19.1 (RB 1999) / SC 18.1 (RB 2017).

Epidemics / pandemics, such as COVID-19

Although "pandemic" is not listed as one of the examples of FM / EE in SC 19.1(i)-(v) (RB 1999) / SC 18.1 (a)-(f) (RB 2017), FIDIC indicated in 2020 in its FIDIC COVID-19 Guidance Memorandum that the pandemic was likely to be classed as a "natural event". However, this interpretation would be subject to the governing law.

It therefore seems likely that, in the event of future epidemics / pandemics which may prevent a party from performing its obligations, that party may be entitled to an Extension to the Time for Completion under SC 19.4(a) (RB 1999) and SC 18.4(a) (RB 2017). As above, it will be necessary to demonstrate that the FM / EE test is satisfied – and again, the factual background will be relevant in determining this. For example, a contractor will need to show that it could not "reasonably have provided against" the events before signing the contract, and could not "reasonably have avoided or overcome" them, such as by implementing health and safety measures.

SC 19.4(RB 1999) / SC 18.4 (RB 2017) does not, however, give rise to any entitlement to cost in respect of natural catastrophes under SC 19.1(v) (RB 1999) / SC 18.1(f) (RB 2017).

In the event of a shortage of goods and /or labour caused by an epidemic, a contractor may also be able to rely on SC 8.4(d) (RB 1999) and SC 8.5(d) (RB 2017). These Sub-Clauses entitle the contractor to an Extension of Time for Completion in instances of "unforeseeable shortages in the availability of personnel or goods (or employer-supplied materials) caused by epidemic or governmental actions."[2]

However, these Sub-Clauses again only provide a right to claim for delay – no cost relief is available. Further, relief will only be available if the shortages were "unforeseeable". This is defined as "not reasonably foreseeable by an experienced contractor" by the date for submission of the Tender (RB 1999) / by the Base Date (RB 2017). The factual matrix and the date of formation of the contract will again be relevant, as parties may argue that this condition is not satisfied where contracts were entered into after the first wave of a pandemic such as COVID-19.

Relief may also be available under SC 13.7 (RB 1999) or SC 13.6 (RB 2017) where the contractor has suffered delay or incurred increased costs due to "any change in Laws". First, it is important to establish that a particular event amounts to a change in "Laws" (which are broadly defined under FIDIC). Secondly, the change must be to the Laws of the "Country", i.e. the "country in which the Site (or most of it) is located, where the Permanent Works are to be executed."

If this is established, and a contractor suffers delay and / or increased cost as a result, it will – subject to the provision of the requisite notices – be entitled to an extension of time for such delay and payment of any such cost (including prolongation costs and additional costs).

Inflation

The FIDIC Red Book is a remeasurement contract with a Bill of Quantities (BoQ), meaning that the contractor will be paid for the quantities of work executed at the rates or prices set out in that BoQ. In circumstances where the market price of raw materials or goods may have skyrocketed, is the contractor entitled to any relief or re-rating of those rates or prices?

The Guidance Memorandum emphasises that the contractor bears the risk of the pricing of BoQ items and will in most circumstances be "held to its pricing bargain".

Parties faced with fluctuating costs may wish to consider:

  1. including the optional price adjustment provisions in SC 13.8 RB 1999 / SC 13.7 RB 2017 – if still at the contract negotiation stage. If these Sub-Clauses are selected then the goods / labour elements that will be adjusted for inflation will need to be identified in a schedule, and price indices for each of those elements will need to be included. However, even where such price adjustment clauses are included, this does not necessarily fully de-risk inflation: if the index does not rise in line with actual inflation, then the contractor takes the remaining inflation risk (as per the 3rd paragraph of the SC).
  2. the possibility of a re-rating of rates or prices in the BoQ under SC 12.3(b) (RB 2017) – this is however subject to certain thresholds being met, and limited to certain situations such as variations;
  3. any relief available by virtue of the governing law, e.g. hardship provisions.

In general, as noted above, inflation / increased costs will not amount to FM / EE under the FIDIC forms, since it does not generally result in the contractor being prevented from performing its obligations under the contract. Instead, it simply makes performance more expensive or onerous.

Where the inflation affects the continuing performance of the Contract such that it is no longer economically viable, termination of the Contract (as discussed in further detail below) may be an available option.

Performance of the contract becomes impossible due to epidemic or war

There may be instances where the execution of the works by the contractor and subsequent use / operation by the employer is no longer viable. For example, an inability to procure materials may make it impossible to complete certain aspects of the construction on time. However, it is arguable that this would cause a delay in the performance of the obligations, but would not necessarily make it impossible to perform the contract.

In instances where it becomes impossible to perform the contract, we outline below three options that may be available to the employer.

  1. The employer may terminate the contract under SC 15.5 RB 1999 / 2017, which is a termination for the employer's convenience and not because of the contractor's default. An employer is entitled to terminate the contract at any time provided it gives 28 days' notice and returns the Performance Security.
  2. If an event of FM / EE, such as an epidemic or war, prevents "execution of substantially all of the Works in progress" for a continuous period of 84 days or multiple periods exceeding 140 days, then either Party may terminate the contract under SC 19.6 RB 1999 or SC 18.5 RB 2017. In the event of such termination, the employer has to pay the contractor in accordance with SC 19.6 RB 1999 / SC 18.5 RB 2017.
  3. If it becomes impossible or unlawful for either Party to fulfil its obligations, and the Parties are unable to agree on an amendment to the contract that would permit continuing performance, either Party may give notice to release the Parties from the performance of the contract under SC 19.7 RB 1999 / SC 18.6 RB 2017.

In instances of termination for the employer's convenience under SC 15.5 RB 2017, the amount due for payment may include loss of profit and other losses or damages incurred by the contractor due to the termination.

Conclusion

The severe disruption caused to the supply chains by COVID-19 and the war in Ukraine has caused parties to be more acutely aware of the risks that war and epidemic can pose to projects, ranging from delay and disruption, cost overrun, variations etc. giving rise to suspension or even termination of the contract in some instances. While there are various remedies and courses of action available, as outlined above, parties should also bear in mind that:

  • A failure to comply with the notice requirements (either in terms of timing and / or in terms of content) under the contract may result in the loss of contractual entitlements.
  • Parties are under an obligation at law and, in some instances, pursuant to the express contractual terms to mitigate their loss, which may include, where possible, sourcing materials elsewhere.
  • Maintaining accurate contemporary records where entitlement to time and / or money is available is paramount.
  • The governing law of the contract may be a source of further relief, e.g. hardship provisions.

For upcoming projects, parties may seek to mitigate against future uncertainties by:

  • Including cost fluctuation provisions to safeguard against increasing costs of materials.
  • Using provisional sums for certain works to allow greater price flexibility.
  • Contractors may seek to impose cost-reimbursable contracts, whereas employers may prefer to opt for fixed-price tenders for greater certainty.

If you have any questions about this article, please contact Mike Stewart, Paul Green or Adain Bailey.

Footnotes:

[1] 1999 editions uses the term Force Majeure whereas the 2017 editions refer to Exceptional Events.
[2] SC 8.5 RB 2017