COVID-19 and Global Issues: A Contrarian's Solution to Construction Contracts?
by Michael Morgan, Thomas Krikke, Krikke Consulting Ltd
Published: March, 2020
Submission: March, 2020
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Global pandemic. Oil trade war. Volatile FX Markets. Market collapse? East African locusts. All of these global issues, and potentially others, will impact existing and new construction projects in Canada and the world over the coming months. However, a delay to a project does not always mean the project will inevitably cost more. Depending on the wording of the contracts in question, due to existing market conditions, prudent owners may be able to complete projects at a lower than anticipated cost as a result of a delay and its effects.
While contracts typically will require all work to proceed without undue delay, it may be difficult at the moment for contractors to comply, especially if further mobility or gathering restrictions are made by relevant governmental bodies in the face of the pandemic. Accordingly, contingency plans ought to be developed based on project financial models, including in relation to schedule, project cost, potential additional entitlements, and owner consequential costs. Normally, when considering owner consequential costs, the owner is able to consider dispensation within the construction schedule so as not to unduly impact operations and owner costs.
In light of the current issues that are rapidly evolving - seemingly on a daily and sometimes hourly basis - prudent owners and contractors should review all relevant contracts including, in particular, force majeure clauses. As an example, the occurrence of an epidemic or pandemic is often, but not always, included within those clauses. And, even if not explicitly enumerated, related triggering events will undoubtedly cause delays, extensions of time (for overheads and indirects), consumer price index (CPI) variations, and consequential costs. Change orders will almost certainly increase in volume going forward. As always, one should seek legal advice before invoking any force majeure clause, as there may be other issues and consequences to consider. [For more information on Force Majeure please see our Business Law Blog: Force Majeure in the Time of Covid-19]
What should contractors and owners do in the face of any delay where the price of commodities has drastically fluctuated? Typically, CPI increases over time and, therefore, if there is a delay to completion, contractors often will have the right to claim an increase in price by way of a change order. However, it is likely in these circumstances that CPI and prices of certain commodities will go down. If that occurs, an owner may wish to seek to claim a reduction in the contract price by way of a change order. This reduction could further be considered as an offset (or partial offset) to the potential time-related additional entitlements.
As a current example, the price of fuel is decreasing. As a result, depending on the wording of the contract in question, an owner may be entitled to claim a reduction to the contract price if there is a delay to completion. This reduction of oil commodity prices could be shorter lived and is influencing the foreign exchange markets, which needs to be factored into the overall CPI issue (Canadian or world markets).
Another example is the price of other commodities such as lumber, steel, copper, and aluminum – the major building blocks of any project. As the following graphs indicate, the prices for those commodities (as with many others) have fallen drastically over the last three to six months, with the world’s prognosticators forecasting further decline.
The decline in commodity prices can also be presented in a tabular format showing North American commodity indices:
Rather than allowing a contractor to continue to charge an agreed upon price escalation of materials (with 2012 to 2019 CPI trends) and thus pocket a potential windfall due to the state of the market, a delay may present a legitimate opportunity for an owner to claim an overall price decrease. While in ordinary circumstances this type of claim would not be contemplated, the current global conditions suggest that such an approach may indeed be warranted, where a contract permits it. As the following graphs indicated, the industry can benchmark the financial collapse of 2008/2009 to see the likely effect and forecasts.
Source: derived from S&P indices published
For projects that are still in the early stages where contracts are still being negotiated, risk sharing of costs may be a fair way to proceed. In the downturn of 2007 — 2009 certain clauses were written into contracts which contemplated either a large increase of CPI prices or a reduction, administered on a reconciliation basis. Such contracts permitted a sharing of risk and allowed the project to move forward without additional delay, the logic being that the costs were the costs and the contract was not an appropriate mechanism for allocating unquantifiable risks.
Owners and contractors need to approach these challenging times with caution and be vigilant about the terms of their contracts now in force, those they are currently negotiating, and in monitoring the state of the markets for commodities and labour (including as reflected in CPI indices). There could be opportunities for owners, contractors and their counsel in the next several months, while the pandemic and other global issues unfold, in considering how the risk of changing costs is allocated and how delay claims are assessed and asserted.
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