COVID-19: termination, suspension and pacing of construction works as remedies in the United Arab Emirates
As this is a fast moving topic, please note that this article is current as at 31/03/2020. For further information, please contact Celine Abi Habib Kanakri or Khalil Mechantaf.
This article first appeared in Lexis Nexis in March 2020.
The impact caused by the spread of COVID-19 and the resulting government actions has been (and continue to be) tremendous on the economy and the construction sector in particular.
Whether the pandemic can be qualified as a force majeure is inevitably a question of fact and will depend on the circumstances of each case. Given force majeure is circumstantial and is subject to the parties' agreement, it may not always be upheld by the courts. Therefore, in a situation of default caused by COVID-19, other remedies such as termination, suspension or pacing of works may be considered by construction practitioners. It is very common for construction contracts to regulate any situation of default or failure to perform one's obligations. Such failure could in fact be very well expected, whether for the contractor facing an interruption in the supply chain and shortage of resources caused by COVID-19 related travel bans. It could also be expected by the employer facing difficulties in securing due and outstanding payments or issuing timely variations.
UAE law recognises termination in both of its forms: termination for convenience or default. Termination for convenience is set out in Article 267 of Federal Law No. 5/1985 (the Civil Transactions Code), expressly allowing a party to terminate for convenience if agreed before in the construction contract. Such agreement should be express, allocating the right of termination for convenience to one or both parties. In such case, termination is unilateral and need not happen as a result of default. Such termination can be expected in the case of COVID-19 when the contractor had just completed a major milestone or stage in the project, but is unable to initiate the works associated with further stages, such as in mixed use developments where the works are performed by the waterfall methodology.
Termination for default is also recognised in bilateral agreements where one party fails to perform its contractual obligations. In this respect, parties usually set out in their contract a list of events which, if failed to perform, entitles one or both parties to terminate the contract. This is otherwise known as termination for cause, requiring the creditor to demonstrate the debtor's default and the reasons thereof. It is yet to be seen whether the failure to perform an obligation as a result of COVID-19 will be considered a reason justifying termination for cause. It may be the case that, in such scenario, the failure to perform is considered justified by considering COVID-19 an event of force majeure, an extraneous cause or an oppressive circumstance.
It is worth noting that a notice of termination, whether for convenience or default, is required to be properly served on the other side unless the parties expressly contract out of this statutory obligation.
Under Article 274, the effect of termination is that the contract is deemed inexistent and both parties will return to their respective pre-contractual situations. If this is no longer possible, which is inevitably the case in complex construction projects, the party in default will be required instead to pay relevant compensation. In case of termination for convenience, the consequences thereof are usually prescribed in the contract and will generally include, payment of outstanding amounts, return of documents and performance security and demobilisation from the site.
Where the debtor disputes the creditor's right to termination, the contract remains enforceable until the court decides on the lawfulness of the termination.
From a contractual standpoint, termination would require the cancellation of work permits and re-issuance of new permits before any newly appointed contractor can be instructed to proceed with the performance of the works. This may be time-consuming from a commercial perspective, especially when the issuance of all permits and licenses has now been frozen as part of governmental efforts to curb the spread of COVID-19.
In any event, the parties should be aware that the time required for the issuing of new permits depends on the classification of any nominated contractor, its profile, the nature of the works and the magnitude of the project for which the relevant licenses/permits must be granted.
An alternative to termination, which is often considered a nuclear option that is best threatened with rather than used, where the contract excludes a pandemic as not being of force majeure, a party facing a default as a result of COVID-19 could, instead, resort to suspend the performance of its obligations. The right to suspend is set out in Article 247 of Federal Law No. 5/1985. However, this must be applied cautiously and in good faith. For instance, enforcing the right of suspension should be proportional and depends on the percentage of the performance by the other party of its own obligations. Therefore, a timely suspension is essential and its validity will depend of the facts of each case.
In the wake of COVID-19, parties are also advised to consider part suspension as opposed to full suspension. Part suspension as an interim remedy will maintain marginal activity on site and may hold lenders in reserve of any unwanted reaction.
Equally, any progress of the works should be reflected and emphasized in contractors' monthly reports to the employer and the lenders.
Instead of suspending all or part of the works, a contractor could pace the works in the event of an employer's default. Pacing allows the contractor to delay its progress and not to proceed in line with its schedule of works, albeit without causing further critical delay arising from the situation of default caused by COVID-19. Pacing could also allow the contractor to protect its entitlement for extension of time absent the pacing measures.
Pacing measures are often prescribed in construction contracts and can be demonstrated by developing and implementing a risk management and control plan covering risk management activities during the affected period. The purpose of the risk management plan is usually to identify risks related to the project with the aim of developing a risk mitigation strategy which includes adequate corrective actions.
Pacing measures can also be demonstrated in the contractor's monthly reports. Crucially, the contractor should be able to demonstrate an intention to pace in reaction to the employer's delay event and the actual effect of its pacing measures.
Often, partial suspension or pacing (or both) are sufficient to mitigate any event of delay. Whether these remedies are convenient in the situation of COVID-19 will depend on the parties' agreement and the impact of such pandemic on the performance of the parties' respective contractual obligations.
More importantly, parties are advised to maintain record as this will become a crucial element for demonstrating any claim in the future.
Finally, in the present circumstances, parties should carefully review their contractual terms, objectively assess whether COVID-19 has had any direct impact on the performance of their respective obligations, consider ways to mitigate the event and balance the legal, contractual and commercial remedies before deciding on any course of action.
As developments unfold, Kennedys experts across the world advise on what the COVID-19 pandemic means for you and your business.Go to focus area