COVID-19: Construction Companies; Issues, Challenges, Remedies

The Indian government announcement regarding national level lockdown to curb the spread of the novel coronavirus pandemic (COVID-19) has affected the majority of businesses in India. Construction work in the country has come to a standstill, which has raised concerns for construction companies in terms of revenue loss. The impacts have arisen from disruptions to the supply chain and raw materials, state or local government lockdown orders, and workforce disruptions at every level.

In this article, the author has highlighted the various legal issues and challenges which the construction companies are facing and what possible precautions can be taken to tackle those issues and challenges.

Issues

Due to the prevailing situation, construction companies are facing various issues. Some of these legal issues are as follows:

i. Delay in performance of the Contract: In many construction contracts, parties generally specify the time for completion and/or expressly state that time is the essence of the contract. The Contract can be a milestone-based contract wherein time for completion of various steps is provided or there can be an overall time given to the performance of the contract. Some contracts also provide for Liquidated Damages for the delay done.

ii. Financing arrangements: In order to finance the construction projects, the construction companies take debts from the financial institutions. The present situation is preventing these companies to comply with the debt servicing obligations.

iii. Disruptions to the supply chain: Most Indian construction companies import at least some components of construction from China. The hold on Chinese exports has largely affected the supply chains. It should be noted that heavy reliance on China for steel and related products is a cause of concern for the industry. All of this have lead to increase in the costs and reduction in the profit margins of construction companies in India.

iv. Payment of rentals: Mostly construction companies hire various formwork structures and machines from different companies on rental basis. Due to the complete stoppage on the construction activities, these machines are of no use however these construction companies have to pay the rentals which is putting another financial burden on them.

Force Majeure, Frustration or MAC (Material Adverse Change) Clauses

Certain clauses under the contract exempt the performance of the parties. The question then comes that whether COVID-19 will be covered under these clauses or not. Let’s understand these concepts and see whether COVID-19 will be covered under them or not.

i. Force Majeure

This clause is designed to excuse a party from the performance of its obligations under a contract upon the occurrence of certain specified events under the clause which are beyond that party’s reasonable control. A classic example would be in the event of a natural disaster like tsunami, earthquake etc.

The key determinant of whether an event would fall under the force majeure clause is the wordings of the clause itself. The wordings of a force majeure clause will determine whether the COVID-19 pandemic will fall within its scope. The force majeure clause can be either illustrative or exhaustive. In situation where the force majeure clause may refer specifically to a pandemic, or to other events which have occurred as a result of the pandemic, for example, an act of government which has prevented contractual performance, COVID – 19 may fall under the force majeure clause.

It will also be essential for a party seeking to rely on a force majeure clause to demonstrate that the COVID-19 pandemic has prevented the party from

performing its contractual obligations. Again, this will largely depend on the wording of the clause and the particular factual scenario. However, the mere fact that a contract becomes more expensive or onerous to perform as a result of a force majeure event is generally insufficient to constitute a force majeure.

It should be noted that force majeure clauses often require the party seeking to rely on the clause to (i) give the other party notice of anticipation or occurrence of a force majeure event; and (ii) take reasonable steps to prevent or mitigate the effects of a force majeure event. Even if a force majeure clause does not expressly contemplate for an obligation to mitigate, the obligation may be implied by law, so it is prudent for parties to take steps to mitigate the impact of a force majeure in any event.

On successfully establishing that COVID-19 will be considered as the force majeure event as per the terms of the contract, the party relying on it may be entitled to:

· temporarily suspend contractual obligations with an extension of time to perform those obligations;

· relief from liability for non-performance or delayed performance for the duration of the force majeure event; and

· terminate the contract if the force majeure event continues for a specified period of time.

As already stated above, the relief will also depend upon the terms of the contract. The entire jurisprudence on the concept of Force Majeure has been well summarised in the case of Energy Watchdog v. CERC, (2017) 14 SCC 80. Some key points of the judgment are as follows:

· If contract has an express or implied force majeure clause, it will apply over the principles of Section 56 (Frustration) of the Indian Contract Act, 1872;

· A rise in cost or expense will not frustrate contract; and

· Force majeure clause will not apply if alternative modes of performances are available.

ii. Frustration

If there is no force majeure clause in a contract or the agreement, a party that is unable to perform its obligations will need to consider other possibilities. In certain circumstances, it may be possible for a party to rely on the doctrine of frustration, which can allow termination of the contract and discharge all parties from future obligations. The doctrine of frustration has been well-codified in India under Section 56 of the Indian Contract Act, 1872.

The doctrine of frustration is applicable when an unforeseen event occurs after the contact was entered into, which renders performance of the contract impossible or radically different from what was agreed by the parties when the contract was formed. Such event should not be foreseeable.

The word “impossible” has not been used in the sense of physical or literal impossibility. The performance of an act may not be literally impossible but it may be impracticable and useless from the point of view of the object and purpose which the parties had in view. Therefore, if an untoward event or change of circumstances totally upsets the very foundation upon which the parties rested their bargain, it can very well be said that the promisor finds it impossible to do the act which he promised to do.

The Apex Court in Madhya Pradesh Power Co. Ltd. vs. Renew Clean Energy Pvt. Ltd., (2018) 6 SCC 157 noted that the frustration of a contraction under the Indian Contract Act, 1872 is as a result of impossibility and impracticality of performance of the contract whereas a force majeure event is a situation which adversely affects, prevents or delays the performance of obligations momentarily during the subsistence of the Force Majeure event.

iii. Material Adverse Change (‘MAC’) Clause

In a situation where both force majeure or frustration of contract are not applicable, your contract may have a clause allowing termination or adjustment of obligations in the event of a “material adverse change” (MAC) or a “material adverse effect” (MAE) on the business or its operations. While the outbreak of COVID-19 pandemic subsists, the parties to a contract may resort to renegotiations or avoidance of performance of their contractual obligations by invoking MAC clause. The party invoking the MAC clause should prove that the pandemic has materially affected the transaction.

Practical Consideration for Construction Companies

In order to deal with various issues arising out in the present scenario, the construction companies should consider the following:

· Reviewing the contractual terms: Identify key clauses implicated by COVID-19. The companies should note the kind of reliefs they are entitled to under these clauses. The companies should also note that what is required to be done in order to preserve the rights (e.g., required notice) to claim this relief, in terms of notice and other documentation.

 Identification of specific impacts and documenting the impacts: The company should prepare a list of all delays which the company is facing. They should also note how are their suppliers are affected. How will that impact the company down the road? Answer these questions and document impacts as they emerge and evolve. It is essential to document all delays and how the delays were caused.

· Formulating a strategy: All parties have a legal duty to mitigate the losses. Identify these impacts and the steps which can be taken to lessen their effect. Is there any other way of performing the obligations despite all the governmental shutdowns? Maintain communication with clients, contractors, suppliers, etc. Monitor updates to legislation and other governmental orders, which continue to evolve and vary state to state.

· Communicate to inform: Formal notices and other written and verbal communications among the parties should be precise and factual. The point is to inform while also satisfying technical notice requirements. Being aggressive against the other side and putting them on the defensive mode may yield a short term tactical advantage, but it can also have the opposite effect and make it more difficult to mitigate or resolve anything in both the near term and long term. Think of how your communications will be received by the other party and how they will look to a third party in a worst-case scenario. You should appear reasonable and prudent in all these communications.

· Renegotiating & invocations: The companies are encouraged to negotiate the contractual terms and obligations in this present scenario. In case the negotiations fail and one decides to invokes force majeure clause under the contract, the notice requirements (if any) under the contract should strictly be met.

Conclusion

There is no clarity as to the period up to which the restrictions would continue, the number of cases are rising on day to day basis. Under these circumstances, it becomes crucial that the construction companies formulate a proper strategy to deal with the legal issues arising and the future problems which the industry will face. Availability of labourers would be crucial post the pandemic and therefore this aspect has to be kept in mind while entering into new contracts or renegotiating the earlier contracts.

A practical strategy along with certain precautions can help the construction companies to survive this COVID – 19 pandemic.