Varying construction contracts to provide COVID-19 relief (Australia)
Parties to construction contracts are struggling to meet their contractual obligations amid the COVID-19 pandemic. Indeed, governments around the globe have released guidance to government agencies to protect the financial viability of projects, to protect supply chains and to minimise exposure to Coronavirus related project stresses. This is particularly so in those jurisdictions where public health orders and the like have resulted in the complete closure of construction sites, but also in jurisdictions where sites have remained open and work has continued subject to various constraints (such as social distancing measures).
While some contracts include mechanisms for extending deadlines and providing other forms of relief for COVID-19 related delays and hardship, many parties are finding it necessary to adjust or supplement their existing contractual arrangements to provide better, fairer outcomes for all concerned. We start by considering key objectives that owners, head contractors and subcontractors are seeking to achieve. We then look at key considerations that parties should take into account before varying construction contracts to achieve their objectives. Finally, we provide points for negotiation when varying or supplementing construction contracts to provide COVID-19 relief.
Owners and head-contractors
The following are objectives that owners are typically seeking to achieve. Head-contractors usually seek to achieve the same vis-à-vis their relationship with their subcontractors.
- Enabling works to continue;
- protecting against their contractor/subcontractor becoming insolvent. Replacing an insolvent contractor midway through a project almost always results in poor outcomes for the owner;
- ensuring benefits given to contractors are passed down the supply chain;
- limiting contractor/subcontractor claims to only hardship which is caused by COVID-19, and not for delays or additional costs due to poor decisions or inefficiency by the contractor/subcontractor;
- in the case of public sector owners, preventing the contractor claiming relief under the contract and relief from government financial support in respect of the same hardship;
- maintaining value for money by ensuring relief and payments are justifiable; and
- government owners may also be seeking to implement broader government objectives such as stimulus to protect and create jobs, and reducing the spread of the disease.
Head-contractors and subcontractors
Subcontractors are typically seeking to achieve the following objectives as are head contractors vis-à-vis their relationship with upstream contractors or owners.
- Maintaining solvency;
- protecting against contractor insolvency;
- providing a safe working environment for employees and subcontractors;
- providing value for money; and
- performing their obligations so as not to be in breach of contract.
Points for consideration: owners (public and private)
Objective: maintaining cashflow and protecting against contractor/subcontractor insolvency
More regular payments
If the contract provides for monthly progress claims, consider whether moving to more frequent payment cycles (e.g. fortnightly or weekly), would provide cash flow benefits for the supply chain that outweigh the additional administrative burden.
If the administrative burden of increasing the frequency at which the works are valued and payment claims are assessed is too great, consider whether the interim valuation of works can be used as a basis for a claim. In this context, interim valuation of works means assessing the works halfway through a month based on the rate of progress of previous months. For example, the average of the previous three months’ valuation may be used to guide the payment halfway through a month.
An issue with interim valuations is the risk of overpayment. This risk can be largely offset if rights to audit and offset the interim payment to reduce the final payment on account at the end of the month are drafted into the contract.
Revising activity schedules
If the contract provides for payments upon completion of milestones or activities, consider whether revising milestone and/or activity schedules to allow for more regular payments will protect against contractor insolvency. Perhaps milestones could be split, or activities could be re-sequenced, to bring payments forward.
There may be value in amending the contract to provide advanced payment to a contractor so they may secure the continuity of supply of critical works in the short to medium term. Some standard form contracts already provide for advanced payments as identified in the particulars which may be amended by deed to introduce additional payments as required. A key consideration is how and when advance payments are to be repaid, including if the contractor becomes insolvent before the work which has been paid in advance is completed. Security bonds are a common method of securing advance payments. In addition, the purpose of the advance payment should be made plain on the face of the certificate or instrument providing for the payment.
Objective: ensuring benefits given to contractors are passed down the supply chain
Project bank accounts
Project bank accounts ensure payments reach the whole of the supply chain quickly. They also ensure payments to head contractors are used to pay subcontractors on that particular project as opposed to other projects on which the head-contractor is engaged, and provide greater payment security because the funds can be drawn down directly from the bank upon completion of milestones. Owners – both public and private sector – should seek legal advice to ensure a project bank account is suitable for their particular project (in those jurisdictions where it isn’t mandatory).
Consider whether it is necessary to request that the contractor warrant that it has not breached its financial covenants in its financing arrangements, and is not insolvent; or that it is not enforcing security against subcontractors engaged on the project, except as specifically disclosed. Obviously, there will be circumstances where it is perfectly legitimate for a head-contractor to call on their security if a subcontractor has become insolvent and it is important to allow a contractor to exercise these rights. However, where a contractor is exercising security against subcontractor in circumstances where other approaches may be taken, then this would not align with the owner’s objectives.
There may be value in drafting a right for the owner to recover if a contractor fails to apply the relief as agreed, fails to comply with transparency requirements, or acts unconscionably in relation to the relief. In addition, it may be beneficial for the contractor to warrant that they are not claiming from the owner the same costs that they are claiming from a government wage subsidy scheme.
Objective: insulating COVID-19 delay claims from more general project related claims
As stated above, it is important to identify whether a delay claim is caused by the COVID-19 pandemic or whether the claim is being used as a cover to other pre-existing or concurrent project delays. In order to do this, consider the following points.
- The pre-COVID-19 status of the project must be assessed and documented. This will better help the owner or future consultant understand where the project was at the moment in time before COVID-19. For a head-contractor, it will help capture where COVID-19 impacted the critical path.
- Create a pre-impact schedule that represents the status of all work prior to the impact of COVID-19. It goes without saying that the date that is selected for the pre-impact schedule will be project specific. Dates will vary according to project locations and will depend largely on the jurisdiction that the project is in. Give consideration to the dates that state government issued orders and directions.
- Document pre-COVID-19 costs. That is to say, it is necessary to capture the cost position prior to the impact of COVID-19. The claim can then be compared to this position and the projected cost position (absent the COVID-19 impact) to determine the underlying status of the project that the claim is purporting to be based on. As much information as possible should be included such as turnover, labour rates and man hours.
- Document the status of material deliveries during, and prior to, the impact of COVID-19. This document can then be compared to the program to determine the underlying cause of the delay.
Negotiation points: owners (public and private)
The following points should be considered in exchange for any contractual relief granted to head-contractors or subcontractors.
- In return for more regular payments, owners may wish to consider seeking stronger rights to audit and reconcile payments after the event, and to offset any overpayments against future payments (or otherwise recover overpayments).
- Consider negotiating for greater open book transparency from the head-contractor or subcontractor to gain a clearer picture of their position. Greater transparency of fixed costs and variable costs that the contractor has to meet will minimise the risk of overpayment and has the added benefit of assisting to isolate COVID-19 delays from other project related claims.
- Rights may arise for head-contractors and subcontractors, both under the contract and at common law, to allow them to claim an extension of time, additional compensation or to terminate the contract if COVID-19 impacts their ability to perform the works. If an owner/head-contractor grants a concession outlined above, it will be an important protection for the owner/head-contractor that, in exchange for such a concession, the head contractor/subcontractor foregoes any pathways to termination or to claim relief that may arise. As there are potentially a number of different rights that may arise at different times, for example, under the common law principle of frustration or a force majeure clause under the contract, it is important to seek legal advice on this point to minimise exposure to the risk of a claim or future claim once a concession is granted.
- While certainly relevant for public owners, all owners should consider whether government health objectives can be formalised in the contract in exchange for a concession outlined above. That is to say government objectives may provide a point for negotiation. Parties may agree to properly implement social distancing, have a COVID-19 safety plan and allow for additional safety audits in exchange for contractual relief.
Points for consideration: head-contractors and subcontractors
While head-contractors and subcontractors may not be in as stronger position to negotiate, the following are points for head-contractors and subcontractors to consider to achieve their objectives.
Head-contractors may consider whether there is value in encouraging suppliers to invoice on a more regular basis to assist with cash flow. For example, see whether invoices can be paid weekly or fortnightly instead of monthly. Obviously the issue of disputed invoices from suppliers will be an area for negotiation, however, this concern may be alleviated by drafting in a robust mechanism for the head-contractor to reconcile disputed invoices and recover overpayments.
Early release of retentions
To assist with cash flow, subcontractors may consider whether head-contractors are open to negotiating for the early release of retention amounts retained under a building contact. A key risk of course is that the release of a retention amount or security may result in the head-contractor taking on risks that are not in its control and which are inappropriate for it to bear (for example, defects during the defect liability period or latent defects). However, the head-contractor may consider the release of a percentage of a retention amount where works have been completed in substance and only minor defects remain which do not prevent use but cannot be closed-out due to COVID-19. Alternatively, swapping a retention amount for a security bond might be a way of releasing cash to the supply chain without harming the head-contractors security position.
All parties: general points
Some contracts will already include provisions that allow for some of the measures discussed above, but many will require amendment, or a supplementary agreement, to properly document the agreed relief arrangements. It is important to seek legal advice when considering any amendments.
Consider whether there are existing issues that can be settled as part of the deal to grant COVID-19 related relief.
As part of the general negotiations, parties may consider amending the general contract terms to reflect the fact that a party has been granted relief. This will help to properly document relief and to protect against double claims.
It is trite to say that COVID-19 is impacting all aspects of society and the construction industry is not immune from its effects. However, despite the prevailing cynicism, there is no reason why COVID-19 need result in adverse outcomes for projects. Parties must recognise that contracts can be amended and that outcomes can be achieved by first understanding their legal positions and then through careful negotiation. While there may be existing mechanisms in construction contracts to deal with COVID-19, the chances are they are insufficient. Parties should seek legal advice to properly document any changes and to best protect their positions in any negotiations going forward.