Contractual damages (UAE) in the time of COVID-19

This article first appeared in Lexis Middle East, April 2020.

The COVID-19 pandemic has heralded almost unprecedented levels of uncertainty in all industries, and the construction industry is no different. Contracting parties are looking to their contracts to assess their rights - and potential obligations and liabilities – in the event of breach of contract.

In principle, various types of remedies are available for breach of contract, depending on the nature of the breach. With particular reference to the impact of COVID-19, see our article here on the potentially available remedies in relation to construction contracts. In this article, we focus on issues surrounding entitlements to and claims for damages. We will briefly consider:

The basic requirements for establishing an entitlement to damages.
The impact of ‘external causes'.
The impact of exceptional circumstances.
The various types of damages, and what needs to be demonstrated in order to recover them.
The quantification of damages, and liquidated damages.

Basic requirements

When contemplating potential damages entitlements or liabilities, various questions must be addressed. What is the relevant contractual obligation, and has it been breached? What damage has been suffered? Is there a causal link between the breach and the damage suffered? All of these criteria must be satisfied in order to recover damages. These questions are heavily fact- sensitive, and we do not further dwell on them here.

A preliminary consideration is whether specific performance of the relevant obligation (that has been or may be breached) is possible. Article 386 of the UAE Civil Code treats the point, as it were, in reverse. It provides that:

If it is impossible for an obligor to give specific performance of an obligation, he shall be ordered to pay compensation for non-performance of his obligation, unless it is proven that the impossibility of performance arose out of an external cause in which (the obligor) played no part.

This is re-affirmed in the official commentary on Article 386, which states that where “impossibility of performance arose through an external cause in which [one] played no part” then “he will not be obliged to pay compensation, pursuant to the shari'ah rule that God imposes upon no person more than that person can do."

External causes

So in the event of a breach of contract, if the breach cannot be fixed (and often it cannot), then compensation can be claimed for breach of contract, unless the impossibility of performance is attributable to an ‘external cause'. But what is an ‘external cause'? It can include almost anything where the defendant played no part in causing the loss. For example, it may include acts of a third party, acts of the claimants themselves or force majeure events. In these circumstances, no damages are payable. Whilst it is beyond the scope of this article to consider the issue in detail, it is worth bearing in mind that, depending on the facts and the terms of contract in each particular case, COVID-19 may provide a defence to a claim for damages on this basis.

‘Exceptional circumstances'

It is also worth bearing in mind that Article 249 of the UAE Civil Code allows courts and tribunals to adjust the extent of a duty to perform, to the benefit of the obligor, in ‘exceptional circumstances'. It provides:

If exceptional circumstances of a public nature which could not have been foreseen occur as a result of which the performance of the contractual obligation, even if not impossible, becomes oppressive for the obligor so as to threaten him with grave loss, it shall be permissible for the judge, in accordance with the circumstances and after weighing up the interests of each party, to reduce the oppressive obligation to a reasonable level if justice so requires, and any agreement to the contrary shall be void.

Article 249 has not been widely relied upon by the UAE Courts, perhaps because they are generally reluctant to interfere to amend contractual agreements (or to infringe upon pacta sunt servanda). But that has not stopped parties from seeking to rely on the provision. For example, in a 2012 Abu Dhabi Court of Cassation case (261/2012), a contractor (claimant) had entered into a contract with the employer (defendant) for the construction of a building in return for payment of a lump sum price. In consequence of an increase in the prices of materials, the claimant argued that the performance of the contract became too burdensome to perform, and requested the Court to adjust the parties' obligations under the contract in reliance on Article 249. However, the Court refused to do so. It stated that an alteration to the contract would be permitted only in the following circumstances:

When the circumstances were of an exceptional and general nature that did not just impact the specific party to the proceedings, but also a category of the public;
When the circumstances were incapable of being foreseen or predicted (at the time of contract); and
When the circumstances make the performance of the contract, if not impossible, at least burdensome, to the extent that performance would result with the party obliged to perform incurring severe losses that are not customary and that gravely threaten the balance of interests between the parties to the contract.

In that case, the Court held that the fluctuation in prices of materials did not qualify as an exceptional unforeseen circumstance, particularly in the construction industry.

We are yet to see Article 249 used by the Courts to adjust contracts in the context of COVID-19. However, it would be no surprise to see an uptick in instances of parties asking Courts and Tribunals to exercise that power to alleviate the alleged impact of COVID-19 on contractual obligations. If so, it will be interesting to see how such attempts are treated by the courts and tribunals, particularly in relation to contracts entered into at a time when it could be said that COVID-19 and its impacts were not readily foreseeable.

Types of recoverable damages

Direct damages

In broad terms, UAE law recognises an entitlement to compensation in damages only for losses that (i) are actual and have materialised as a direct result of a breach of contract; and (ii) were foreseeable at the date of contract. Both criteria must be fulfilled. Losses whose occurrence is theoretical and therefore not certain, even if probable, are not recoverable under UAE law.

Direct damages are those that flow naturally from a breach of contract. Such damages are recoverable if it was not within the power of the obligee (by making reasonable efforts) to avert the loss. Damages are considered to be indirect if they could not have been prevented even if the defaulting party had performed its obligations. In other words, damage is considered to be direct only if it materialised because of the defaulting party's breach of contract. Indirect damages are recoverable in tort, but not for breach of contract, unless the claimant can demonstrate gross fault or fraud.

In order to be recoverable as damages, losses must also have been foreseeable, assessed by reference to the objective standard of the ordinary man at the date of contract. This means that if losses were not foreseeable when the contract was entered into, then they likely are not recoverable as damages. To take a hypothetical example, say an employer (in breach) terminates a contract, and the contractor had intended to use the profits from the project to invest into another project on which it anticipated making a 5% return. That ‘loss' likely would not be recoverable unless it could be demonstrated as foreseeable by the ordinary man at the time of contracting.

Future damages

Future damages, as the name suggests, are damages that are yet to arise. Future damages are not necessarily irrecoverable under UAE law merely because they have not yet been incurred. The test for recoverability of future damages is the same as for direct damages, with the additional requirement that they must be certain to occur in the future - i.e. they cannot be speculative or hypothetical.

Common examples of future loss are loss of profit and loss of opportunity. Using the example above, another reason the 5% lost return on the future project might not be recoverable is because it was not necessarily certain to occur in the future (e.g. the contractor would not necessarily have won the tender for that project, it could have made a loss, etc.).

Moral damages

Moral damages – including for reputational damage for example – are dealt with under Article 293 of the UAE Civil Code. They can be awarded either as actual damages suffered by a party as a result of an alleged breach of contract (or tort, such as defamation and loss of reputation) or future damages (if there are certain to occur in future). It is however the case that moral damages are more usually awarded in tort. The criteria for claiming these types of damages are the same as for actual damages or future damages. Their assessment is left to the sole discretion of the court or tribunal.

Quantification of damages and liquidated damages

Once an entitlement to damages has been established, Article 389 of the UAE Civil Code becomes relevant. It provides that: "If the amount of compensation is not fixed by law or by the contract, the judge shall assess it in an amount equivalent to the damage in fact suffered at the time of the occurrence thereof.”

In other words, unless quantified in the contract or at law, damages for an established breach of contract are ‘at large', and the court or tribunal is empowered to assess their amount. In this regard, whilst UAE law does not expressly recognize a duty to mitigate, courts and tribunals generally expect claimants to have taken reasonable steps to reduce their losses arising from a breach. Failure to do so may result in a reduction in the damages awarded.

Liquidated damages provisions are a common feature of construction contracts. Typically, they involve the parties agreeing a set amount of compensation to be payable for each day (or week, or some other specified period) of delay. UAE law recognizes the validity of such provisions, and liquidated damages can be claimed as of right under UAE law without the need to evidence any harm suffered as a result of the delay. Moreover, the burden of proof lies with the party in delay (i.e. in breach – typically a contractor), to prove that liquidated damages provisions should be adjusted, or not enforced. However, courts and tribunals do have the power (with the benefit of hindsight) to adjust the agreed amount, so as to ensure that the amount awarded is equal to the loss actually suffered. In principle, such an adjustment can be in either direction, although we have rarely seen courts or tribunals grant more than the liquidated damages clause allowed. This power can be exercised only upon the application of one of the parties (i.e. not of the court or tribunal's own motion), though in the event of such an application, the power arises regardless of any agreement to the contrary.

In addition to damages, parties may also claim interest (in the absence of any contractual agreement to the contrary). See our article on interest for further detail.

Conclusion

When contracting parties are considering the consequences of a potential breach of contract (whether in the context of COVID-19 or otherwise), the issues they should assess include the following:

1. Whether there has been a breach of the contract, and if so, whether the relevant obligation nevertheless remains capable of performance.

2. Whether damage has been (and/or inevitably will be) suffered, and if so, whether it:

Resulted from the breach (i.e. whether there is a causal link between the breach and the damage) and was direct and foreseeable (in which case, damages may be recoverable).
Was as a result of an ‘external cause' (e.g. force majeure) (in which case, damages may be irrecoverable);
Was a result of an ‘exceptional circumstance' (in which case, damages may be adjusted should a court or tribunal decide to adjust the contractual obligations);
Could have been mitigated (in which case the court or tribunal may take this into account when assessing the quantum of damages).

3. What other remedies may be available under the contract and at law.

In practice, it is not always a straightforward matter to determine what damage has resulted from what breach, as there are often a myriad of relevant or allegedly relevant and competing events at play. Courts and tribunals are frequently required to conduct the difficult balancing act of assessing the fair amount of compensation payable in the circumstances. As ever, good record-keeping is essential in order to maximise the prospects of persuading the court or tribunal to exercise that assessment in one direction or the other.

Related items:

Contractual damages (UAE) in the time of COVID-19

Date published

Authors

Mark Wilson