Latin American construction bond insurers look to force majeure for respite
There is no escaping the negative impact of the COVID-19 pandemic on the construction industry in Latin America, both on existing projects and future potential. Each government in Latin America has taken the precautions it has deemed necessary. Some jurisdictions, like Panama, suspended all construction works with few exceptions; others, like Brazil, deemed construction works essential activities and allowed them to continue.
For all projects, nonetheless, there will have been complications: delay in obtaining materials, reduced workforce, slowdown in permits, reduced funding, insolvencies and so on, to mention just a few. Undoubtedly most projects will have suffered a delay.
Will the additional time being granted under construction all risks (CAR) policies following an extension of time granted under the underlying construction contract constitute an aggravation of risk requiring an underwriting consideration beyond additional premium? The cost of pandemic-related delays may be unallocated and to the extent it is not prescribed in the underlying building contract, there is a concern CAR policies may respond or pass the risk on to the surety.
There is notable interest, therefore, in surety bonds, (ancillary (usually) to the underlying construction contract) and how they will respond to the ongoing pandemic. As per our previous article on surety in Latin America, surety bonds in Latin America have some particular risks associated with them, which are now exacerbated due to the impact of the pandamic. Are all sureties skilled enough in construction matters to understand whether the trigger of their bond is genuine or they have become the 'pandemic bank'?
Force majeure or act of God?
Fortunately, there is some light at the end of the tunnel. The legal doctrines of force majeure and act of God may provide respite for concerned re/insurers acting as guarantors under these surety bonds. Whilst each jurisdiction in Latin America interprets these doctrines in their own way, we will focus on the commonalities linking these doctrines throughout the region.
The majority of jurisdictions in Latin America define force majeure and the closely related doctrine of act of God as an unforeseen event that is impossible to resist. Most jurisdictions distinguish between the two by the type of event:
- If it is a natural event (such as a hurricane or earthquake) it is an act of God
- If the event is man-made (such as a government order or imprisonment) it is force majeure.
Interestingly, in Brazil the inverse is true: natural events are considered force majeure, while man-driven events are considered fortuitous events.
It is important to bear in mind that these doctrines are legal justifications for the breach of contractual obligations. However, in most cases, these doctrines do not rescind the contractual obligations in their entirety. For example, Article 956 of the Argentine Civil & Commercial Code says that when the impossibility to fulfil the contractual obligation is temporary, the underlying obligation will only be extinguished in cases where time is of the essence.
There are two common requirements to apply to these doctrines throughout the region - inevitability and unforeseeability. In general, an event can be said to be unforeseeable when the contracting parties could not have reasonably anticipated or prevented the occurrence of the event during the execution of their obligations. As such, unforeseeability, from a legal perspective, is an event that is sudden or unexpected and despite the diligence and care taken to avoid it, still occurred.
An event is inevitable when whomever suffers it cannot reasonably avoid its consequences. It is important to clarify it is not the event itself that needs to be inevitable, but the consequences or damages of that event. We also highlight the following common requirements seen across the region, namely demonstrating:
- A causal link between the force majeure/act of God event and the breach of the obligation
- That the force majeure/act of God event cannot be attributable to the breaching party.
Whilst the legal doctrines of force majeure and act of God may provide respite for concerned re/insurers acting as guarantors under the surety bonds, the majority of jurisdictions in Latin America consider surety bonds ancillary to their underlying construction contracts. As such, any breach in the underlying contract excused via force majeure would also excuse breaches under the ancillary surety bond, unless the bond had provisions that say otherwise. A notable outlier to this line of jurisprudence is Colombia, which does not consider surety contracts to be ancillary to their underlying construction contracts. For this reason, it is a common practice in Colombia to include force majeure exclusions in surety contracts. It is therefore important to undertake an analysis of the application of force majeure/act of God on an ad hoc basis.
Finally, the possibility always exists for the underlying parties to not invoke force majeure or act of God (and all resulting consequences) as a defence to their contractual obligations. Accordingly, a lot will depend on the parties’ intentions.
This article was first published by Insurance Day on 22 June 2020