May 2020

When performance of construction contracts is infected by coronavirus

COVID-19 has thrown the Australian economy into meltdown over the past 3 months and despite Australians successfully flattening the curve, how we proceed through the pandemic recovery phase is not yet clear.

Councils, like all businesses, have no doubt had to review all aspects of their operations, including their contractual commitments with construction contractors.

Whilst the effects of COVID-19 are not as immediately severe as in other industries such as travel and retail, the construction industry is not immune and will continue to feel the effects.

Whilst construction activities are still allowed, and in fact hours have been extended to allow sites to operate on weekends and public holidays, performance under a construction project is challenging and may become increasingly difficult.

Supply chains under stress

The most predominant impact is the shortage of building materials and products. These shortages are felt by businesses of all sizes, from those awaiting significant products such as curtain wall and vertical transportation units to smaller trades who source product from trade suppliers such as Bunnings and other construction retail suppliers.

Due to internal and international bans on general contact, travel and movement and supply chain restrictions (especially in and from China), there is a shortage of labour, materials and transportation to deliver building projects. This brings into doubt a contractor’s ability to reach practical completion by the contracted date.

Brian Seidler, executive director of the NSW Master Builders Association is quoted recently as saying:

‘We don’t want to be alarmist, but we are finding that contractors are starting to experience a lack of supply of materials like paint, glass and building cladding which are all manufactured in China.”

James Cameron, Executive Director of the Australian Construction Industry Forum, recently noted that more than 60 per cent of $6 billion worth of construction- related materials is sourced from China. This represents a massive challenge for the industry if supplies continue to be affected.

As manufacturing in China slowly resumes, Bartier Perry is hearing of significant delays at the Chinese ports as the backlog of materials and products builds, with a corresponding 3-fold increase in the cost of airfreight due to the shortage of commercial air transport.

The impact on those councils and their project managers tasked with delivering construction projects include:

  • Delay

  • Liquidated damages

  • Cost overruns

  • Changes to scope

  • Changes to scheduling of works.

A solution in the contract?

This great uncertainty has seen councils looking to their contracts for direction on how to mitigate any such impacts.

Construction contracts define the rights and obligations of the parties and allocate risk between them. Most construction contracts for the delivery of current projects for or on behalf of councils were entered into at a time when the COVID-19 risk could not have been anticipated. Contractual provisions relating to time and cost relief under the contract were negotiated when the risk of a viral pandemic was not reasonably contemplated.

As parties review their contractual obligations, Bartier Perry has seen an increase in requests for assistance from both public and private clients in relation to issues including:

  • Extension of time and delay damages claims from construction contractors

  • Non-delivery of materials and equipment from overseas manufacturers and suppliers

  • Supplier insolvencies resulting in not only lost payments made on account in anticipation of the supply but loss of supply options

  • Recourse to rights of suspension and

  • Application of rise and fall provisions in anticipation of increased costs.

In particular, parties are looking to understand the legal and contractual consequences and applications of force majeure clauses and the legal doctrine of frustration. We explore this further below, together with other options that might be considered.

Force majeure clauses

Also known as an ‘act of God’ provision, a force majeure clause is a provision enlivened by the occurrence of a defined event which can excuse a party, or both parties, from further performance of obligations under the construction contract, either permanently or temporarily.

Under Australian law a force majeure clause cannot be implied into a contract where the contract is silent on the matter. It must be express.

The clause will advise whether the contract is terminated because of the occurrence of the defined event or whether performance of the contract is suspended until it can be resumed by the parties.

Common examples of force majeure events that our team sees in construction contracts include:

  • Floods, storms and bushfires

  • War and acts of terrorism and

  • Workers strikes and declared states of emergency.

None of these would presently cover the COVID-19 pandemic as a state of emergency has not been declared, as it was during the bushfires of Christmas/ New Year 2019/20.

It is also worth noting that the party that relies on the force majeure event generally has the burden of proof that the event falls within the clause and has actually occurred.

Frustration

‘Frustration’ of a contract occurs where neither party is in default of the contract, but an intervening event has occurred which prevents the contract from being performed as originally intended. The consequence of frustration is that the contract is automatically terminated.

Under the doctrine of frustration, further performance of the contract must be impossible, illegal or significantly different to what was originally intended.

Performance that is harder or more expensive than anticipated, or temporarily impossible, is unlikely to give rise to valid termination for frustration.

The fact that a construction project will take much longer than anticipated, or cost more money to complete, or become less profitable, or be unable to be performed for a short period of time; is unlikely to result in the contract being considered ‘frustrated’.

The event must radically impact future performance.

Circumstances where frustration would result in a contract being terminated might include:

  • Performance under the contract is rendered illegal by a change of legislation

  • Performance of the contract becomes impossible to perform or

  • Where the subject matter of the contract, such as a building that was being upgraded, ceases to exist.

Whilst some clients are enquiring as to their rights under force majeure clauses and frustration, the reality is that in these current circumstances they most likely will not apply.

Other options to adjust contractual terms

Many of our clients have advised us that they do not actually want to terminate their contracts but rather want to put them on hold during these difficult times.

Contracts may include a right to suspend but often this right is dependent on default of the contract by the other party. In our experience, only very occasionally, and almost never in construction contracts, does one party have the right to suspend for its convenience (i.e. without the other party being in default).

In the present circumstances a negotiated extension of the program or complete suspension of the works may be the best outcome. In such cases, the parties will need to consider and agree on the term of the suspension, which party would bear the costs of things such as demobilisation, preliminaries or the cost of maintaining the tower crane which is to remain on site for use when the work resumes, and the cost of making safe and the protection of the site during the period of suspension.

The best option is always to talk

Most of our government and business clients involved in contracts of all types are strong and regular communicators and negotiators.

The best option in our view is to try to negotiate a commercial arrangement with the other party. This option is almost always more efficient and preserves an otherwise good relationship that can be resumed when normality and stability is restored.

Author: Mark Glynn

Contributing partner: David Creais

Read further articles in Council Connect