UK: The Show Must Go On - Contracting Strategies For The Impact Of Brexit

The true effects of the events of the last few days have yet to be seen. With the mainstream political parties acting like participants in a 'Compose a Greek Tragedy' competition, a government unlikely to exercise any meaningful executive functions until autumn (at least), the currency and financial markets in turmoil and the future uncertain on a range of factors, it is tempting to succumb to a condition of inaction whilst waiting to see how the cards fall.

What is happening at a macro level, between nations, political parties and economic and other institutions will undoubtedly have a profound effect on the construction and engineering industry.  However, this does not mean that the participants in the industry, whether employer, contractor, sub-contractor, supplier or consultant, cannot take steps to protect their own interests in the short/medium term.

This is not the Global Financial Crisis

The Global Financial Crisis is still at the forefront of our collective memory and its effects were still being felt as at the close of polling at 10 pm last Thursday.  However, the events of the last week are very different and there is no reason to expect the same immediate effect upon the industry.  The economic results of the seizure of liquidity in Western economies and banks was felt almost immediately in 2008.  This swiftly led to insolvencies at every level from funders, developers/purchasers (often under pressure from their own funders), main contractors, sub-contractors and other suppliers.  These insolvencies, and the associated issues, were not at first driven by a reduction in the levels of activity within the construction and engineering industry, although issues with activity levels certainly arose soon after that.

There is no sign at present of an immediate economic collapse as a consequence of the recent events, comparable to that in 2008.  Money remains in the system; for instance the Governor of the Bank of England pledged the availability of GBP 250 million of additional funding to support the financial markets and economic analysts anticipate that a further reduction in the Bank of England Borrowing Rate may shortly be on the cards.  The immediate problems are ones of effective governance/decision making, the fall in the value of Sterling (and the corresponding inflationary effect on imports) and overwhelming uncertainty.  These factors may well take a significant economic toll but any such pain is likely to be felt over the medium/long term as the economy and government budget is restructured following the negotiation and settlement of the new European order.  

Although the uncertainty caused by the result of the referendum last Thursday and the associated political fallout will no doubt lead to the deferment of public and private investment, and future investment may well be curtailed by funding and viability issues, it is hoped that the industry will be spared  the immediate crippling effect seen in 2008.  If the roof is going to fall in, it should fall in slowly at least.

So what to do?

In a complex industry such as construction and engineering there are a great many parties whose interests are varied.  Each party is likely to face different challenges and therefore must consider different strategies for how best to protect themselves.  

Clyde & Co's global projects and construction group will consider the types of strategic decisions that may now be necessary in respect of existing projects in a series of papers which explore themes including:

Change is inevitable - cancellation, termination and descoping

In the first of our papers we will look closely at the risky business of unwinding projects.  Given the upheaval it must be the case that purchasers of projects will take a long hard look at their investment decisions and decide whether now is the time to invest, consolidate or scale back.  

We anticipate that purchasers are going to look hard at the cancellation of projects to which they are not yet committed and the termination, suspension or descoping of projects to which they are. Equally main contractors are unlikely to give up their historic investment and future profits on any project without a fight (or significant incentive), particularly in uncertain times where the profitability (or even availability) of the future projects cannot be accurately predicted.  Periods of suspension are likely while purchasers and their funders look at the viability of projects.

We will consider a range of issues which look at what must be the first issues on the agenda:

  • The safe and orderly disentanglement from negotiations on projects where there is (or appears to be) no formal commitment;
  • The cancellation of projects where the status is less than clear - for instance those subject to a letter of intent/early works agreement or where, through conduct and 'mission creep' the parties have behaved as though they are subject to a formal contract even though the papers themselves remain unsigned;
  • Where a contract is in place and formal termination is necessary, whether for breach by the contractor or 'at will' and the likely consequences and risks of these actions.
  • The descoping of part of the project and the corresponding risks.
  • The short and long term suspension of projects whilst waiting for the situation to become clear. 

Business as usual - supply chain issues and payment

In the absence of any effective 'Brexit Clause' operable by the contractor, those main contractors who were delivering, or committed to, projects on the morning of 23 June 2016 will also have been equally bound to perform at 10 pm on the same day.  Many contractors have all too recent experience of the lagging effects of inflation in the sub-contracting markets over recent year.  We have spent the last two years dealing with disputes which were often driven by the strengthening of bargaining position of sub-contractors, suppliers and trades over time; jobs bid for in 2012/2013 based on the (then) current availability of resources/market prices have often proved to be undeliverable by main contractors on time and on budget when the sub-contracting market had changed by 2014/2015.

Although current indications are that there will be no immediate choke to the supply of skilled labour from the EU, let alone the repatriation of those workers here at the moment (perhaps to the surprise of many of those who voted for Brexit), the current skills shortage is only likely to become more rather than less acute over time.  Not only will this increase the cost of delivering projects but, as the last couple of years have shown, issues relating to the availability of supply of resources can lead to delay and disruption to the works, normally to the contractor's cost - with uncertain economic conditions ahead it is easy to envisage employers rejecting claims for loss and expense and strictly enforcing their own rights by levying liquidated damages for delay. 

An immediate issue is likely to be the increased cost of plant, equipment, goods and services from overseas given the fall in the value of sterling.  In the future it seems possible that there will be the additional frictional cost of bureaucracy, delay and even tariffs relating to the purchase of goods, services and labour from overseas.

Over the last couple of years contractors have been able to take advantage of a hardening attitude of the courts relating to the payment of interim payment applications.  However, the lax control of the payment mechanism by employers which has permitted the use of the 'smash and grab' adjudication has for the most part been identified and tightened and there are signs that the Courts may be rowing back from the extreme position seen in ISG v Seevic and other cases.  However, this remains a highly rewarding area for receiving parties and an area of great risk for paying parties.

In the second paper we will consider the likely impact of these issues and what can be done by contractors to protect themselves against such issues and, furthermore, the steps that Employers may take to insulate themselves.

Redefining supply chain participants - insolvency

As was seen in 2008 and the years that followed, supply chain insolvency has the potential to be a huge issue for employers and contractors alike.  In our third paper we will look at the strategies available to employers and contractors in order to manage the situation where part of the supply chain suffers issues with its solvency or enters into some kind of formal insolvency process.

Equally, when looking up the payment chain the use (or perhaps more specifically, the threat) of one party invoking an insolvency process against another is an often underused but potent way of unlocking funds.  However, this process is highly risky and must be both pursued and resisted with a great deal of care and skill.  Our third paper will also look at this process.

The following weeks and months

Only time will tell how nations, governments and industry will fare following the outcome of the referendum.  Despite all of the uncertainty, employers and contractors alike need to understand and, if necessary, deploy the tools at their disposal to advance their own interests as best they can at a project level.  Hopefully the next three papers will help to focus those strategies over the uncertain times ahead of us.

The Show Must Go On - Contracting Strategies For The Impact Of Brexit

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