With respect to the construction industry, the short-term economic devastation of COVID-19 has consequences for individual projects and capital programs, as well as the demand for engineering and construction services. All of this must be considered in the face of a dynamic and changing backdrop. It is becoming increasingly clear that the impact of the pandemic will continue to be felt once lockdown measures are relaxed and goods and services are remobilized and deals are rekindled. In addition, many governments are easing restrictions gradually rather than directing a full and complete end to lockdown status, eliminating any hope of an immediate return to the way things were. Further, how owners and contractors respond to the easing of restrictions may themselves be the source of claims. Simply put, the impact of COVID-19 on the construction and engineering industry does not have a specified substantial completion date.
The issues and their implications are many. For this reason, we have prepared a three-part White Paper. It does not address in detail the legal doctrines of force majeure, impossibility, impracticability, or the contractual arguments being asserted on individual projects, all of which are important (and on which we have commented in other publications). Instead, the focus of this White Paper is on the global response to the pandemic from both a country and sector perspective, the types of issues that have been (and likely will be) raised as projects shoulder the impact of COVID-19, and strategic considerations as they relate to contract drafting, disputes, and the intersection of the construction business and the law.
Part I, published on May 1, 2020, provided an overview of the recurring issues relevant to the construction industry, as well as specific legislative and regulatory measures implemented in the countries with the most active energy and infrastructure development programs. Many of our clients are located in these countries, have projects in these countries, or depend on these countries for their supply chain. An overview of these issues and measures in multiple jurisdictions is useful to develop a global, proactive strategy rather than a narrow view confined only to the challenges posed by COVID-19 in the jurisdiction where specific projects are located. The construction industry is a global industry and the progress of a major project and its timely and successful completion is seldom a function of purely local conditions in the jurisdiction where the site is located. The COVID-19 pandemic has reinforced this reality.
This Part II provides an overview of the impact of COVID-19 on a select number of key sectors within the construction industry: real estate development; oil and gas; renewable energy; social infrastructure; transport infrastructure; and telecoms. The analysis is from both a transactional and disputes perspective and addresses issues of global relevance, including several questions that Jones Day has encountered in the few months since the start of the pandemic, from owners, contractors, and design professionals. It also reviews the typical insurance policies that cover construction projects and how they may or may not apply to a project that suffers financial consequences as a result of COVID-19.
Part III will offer thought-leadership scenarios that may arise at project inception and during the construction phase, as well as associated strategies that may be adopted in navigating the path of least peril as the consequences of the pandemic continue to be felt.
While this Part II cannot practically address all industry sectors or issues manifested in those sectors, the aim is to provide sufficient coverage of issues to be of assistance to owners, design professionals, and contractors with global operations, all of whom are best served by a global understanding of the legal and sector challenges presented by the COVID-19 pandemic.
Real Estate Development
Within real estate as an asset class, there is no uniform reaction. The appetite for investing in new developments in certain sectors like retail and hospitality has decreased significantly across the globe, whereas other sectors such as logistics and multifamily are, as yet, not as adversely affected. The current climate brings with it a number of new challenges in the negotiation and completion of transactions, as all parties look to protect their positions and seek to allocate risk in relation to the pandemic, the consequences and timeframe of which cannot be fully assessed. The focus of contract negotiations has been on delay risks (and their cost consequences), provisions relating to termination rights and the cessation of works, and the consequences of contractor and subcontractor insolvencies. Lenders' understandable caution during this crisis is inevitably inhibiting investment into and progress with new developments.
While the propensity for disputes to arise out of the pandemic will depend on the specific factual nexus, works, and relationship between the parties, we have already seen repetitive contractual flashpoints in particular subsectors. For example, where the time sensitivity of works is a key factor to the financial modelling of a development scheme (in, for example, the student accommodation sector), the management of delay issues is of paramount importance and increases the probability of disputes developing. Similarly, the adverse impact of the pandemic on the retail sector and the lack of tenant appetite for new leasing space have already seen an increased focus on delay mechanisms, target completion dates, and default "long stop" date triggers within the underlying property and funding arrangements and their interface with the construction documents.
This is not just an issue affecting the owners of real estate development assets. With respect to their existing loan portfolios, real estate lenders are assessing their potential defensive and offensive strategies amid the rapidly changing economic climate. However, we have, for example, already been considering with real estate lender clients the mechanics of enforcement and the legal and practical implications of completing a "project in distress." Popular areas of client interest have included assessing the granular details of title ownership of goods and materials on- and off-site under contractual arrangements, lender "step-in" mechanics, and demands against performance bonds and guarantees. We expect interest in these areas to increase alongside the likely global uptick in distressed real estate development opportunities.
Some examples of the issues that we have encountered to date include:
- In the United Kingdom, we have advised on the critical decision-making process and contractual implications following government COVID-19 guidance and mandatory measures enacted and, in particular, the closure of sites across a number of large multifamily and student accommodation portfolios throughout the United Kingdom. There are different contractual consequences from a cost and time perspective depending on the actions taken by the employer and contractor, and we have been advising clients on these consequences alongside their ongoing statutory duties and the regularly updated site operational guidance.
- Across Europe, we are working with a number of large landlords in the commercial and retail sectors in relation to the contractual consequences of delays to works they are procuring under their construction, property, and financing documents, and the interplay between these documents. We have, for example, been assisting in the management of extension of time notices and potential delay claims, and advising on scenarios where there are competing delays. Further, we have considered the contractual interpretation of events of default under construction, property, and financing documents, including the interpretation of the usual event of default under development facility agreements relating to an abandonment of developments for a continuous period.
- In Asia, we have advised developers on claims of force majeure with respect to construction delays caused by shortages or unavailability of construction materials (e.g., concrete and gravel, rebar, reinforcing wire, template nails, and steel plate) as a result of supply chain disruptions in China. For this early stage issue, we are advising on how to react to the force majeure notice received from the contractor as well as the availability to our client of force majeure, the evidence that is required to substantiate the event, and the loss that flows from the event, together with what the client is contractually required to do, and can do, to minimize the effects of the event.
- In the United States, we have been advising real estate development clients, including developers, landlords, tenants, and investors, in two primary areas: (i) interpretation of existing contract language related to delay or performance relief; and (ii) negotiation of delay or performance relief in the midst of COVID-19. The concept of force majeure under U.S. law is jurisdiction and contract-specific, with the precise language of the clause and common law dictating its applicability to the facts of a particular occurrence. Likewise, we have analyzed the relevant rights, remedies, notification requirements, and mitigation obligations implicated by these clauses, as they vary significantly from contract to contract. Additionally, since some states and local jurisdictions have restricted or prohibited construction activities altogether, we have analyzed the impact of government action
- on the application of these clauses. Where force majeure or other delay or performance relief is not expressly made available in the contract, we have also considered the applicability of common law relief, such as impracticability, impossibility, and frustration of purpose.
- Regarding new contracts entered into during the COVID-19 crisis, we have considered the extent to which the delays real estate development clients are facing would be considered foreseeable and / or beyond the impacted party's control. Since the COVID-19 outbreak has been ongoing in many U.S. jurisdictions for some time, its impact on real estate development has existed for a period of months. We have considered the extent to which foreseeability and / or a party's ability to contract around a particular COVID-19-related delay may negate potential relief under a force majeure or similar delay or performance relief clause. We have, for example, assisted in the review and revision of standard force majeure and other delay relief language in form contracts to more specifically tailor the provision for delays that, although considered unforeseeable and / or beyond a party's control several weeks ago, have now become commonplace in the industry.
- Energy: Oil and Gas
- Globally, the oil and gas sector is suffering from a perfect storm that combines the effects of generally lower demand and oversupply of oil as a result of globally stagnant economies, a further collapse in prices resulting from the oil price issues between Saudi Arabia and Russia, and a further, deep drop in global demand arising as a consequence of the COVID-19 pandemic. The combined effect has resulted in historically low oil prices, with some indices temporarily falling into negative territory. For those contracts that link LNG pricing to an oil-based price curve, customers are benefiting from substantially lower prices. Those prices, however, are making some existing and planned projects uneconomical, with knock-on effects to the industry. At the same time, continued malaise in the price of natural gas (particularly in the United States) has created opportunities for investment for those projects that utilize natural gas as a source of fuel or component part of an industrial process, provided that demand is otherwise in place.
- The situation remains uncertain and difficult to predict, but the sector is unlikely to experience a quick V-shaped recovery, even if measures (including those currently being taken by OPEC and Russia) lead to a meaningful reduction in global supply. Despite very early indications of demand firming and prices recovering, it is likely there will continue to be significant volatility as factors out of producers' control continue to impact the levers of demand (and, therefore, prices).
- The low prices, price volatility, and decreases in demand have impacted the feasibility of related construction projects, causing industry participants to cut capex budgets and reconsider proposed exploration and developments. Construction projects that have not yet commenced may be delayed, suspended, or shelved entirely. In addition, we have been advising clients on how to cost effectively curtail projects already under construction based on strategic and other considerations arising as a result of the pandemic.
- In Australia, we have already seen delays to several new developments and planned expansions in the oil and gas industry. Several large LNG projects have been shelved. In Saudi Arabia, Aramco announced that it expects capital spending for 2020 to be between $25 billion and $30 billion as the result of current market conditions and recent price volatility, compared to a projected $35 billion to $40 billion. Several of the oil majors have announced multibillion-dollar reductions in their capital programs. Producers elsewhere have made major curtailments in their projected capital spending, in some cases by as much as 50%, to account for the evaporation of demand, lack of access to traditional sources of capital, and other financial and operational pressures. This means, in part, that those with access to capital, and much longer investment horizons, will continue with certain of their planned capital projects (particularly for projects that are at a stage in their development cycle that would create more liability for breakage costs than the completion of development). But most are less fortunate, and the reduction of spend in the upstream will have significant ripple effects through the remainder of the value chain in hydrocarbons.
Oil and gas related construction projects that have already commenced will encounter a range of difficulties resulting from the current environment. In addition to the (well-publicized) increasing number of force majeure claims (for example, as a result of a contractor experiencing an outbreak of COVID-19 among its workforce, or due to government restrictions leading to labor difficulties or supply chain interruptions), a number of contractual issues that have a particular impact on the oil and gas industry may arise. We are advising our clients in the sector to consider: (i) change of law clauses where parties are financially impacted by relevant government restrictions; (i) issues arising under joint venture agreements where a participant is experiencing cash flow difficulties; and (iii) issues around the application of credit support clauses where the financial standing of a party to a contract is affected.
Self-evidently, such issues have the potential to lead to disputes between contracting parties and JV participants, and we expect to see an increasing reliance on the dispute resolution clauses in relevant contracts. Disputes common to the construction industry may also occur, including disputes concerning force majeure claims, principles of frustration or economic impossibility and impracticability, extension of time and delay cost claims, the application of delay liquidated damages clauses, and termination (for breach or convenience) provisions. In the oil and gas industry in particular, disputes may also arise throughout the value chain when project principals have entered into supply or sales contracts with third parties in order to support the development and / or financing of a project, where a delay in construction affects the sponsor's ability to meet its supply or sales obligations.
Clients are looking beyond the principles of force majeure or frustration, and as noted above, we are now advising our clients in relation to several sector-specific issues affecting their projects. These include:
- Where a party to a contract experiences an increase in costs or a decrease in benefits due to the government response to COVID-19, it may seek to pass through such increase or decrease to its counterparty under a change of law clause. This may occur where costs of obtaining labor or supply increases due to government restrictions (such as, in the Australian and Saudi Arabian context, where restrictions impact the availability of the fly-in, fly-out workforce, and in jurisdictions such as the United States where different state-by-state responses to the pandemic complicate the free flow of workers and goods). We are seeing issues around the drafting of such clauses and the extent to which relevant government policies and regulations may form the basis for a pass-through.
- Issues have arisen where a joint venture participant has been financially affected and does not have sufficient cash flow available to meet its cash call or approval for expenditure obligations, particularly with respect to expenditure for major construction projects. Failure to comply with funding obligations may trigger various contractual consequences under the joint venture agreement, including a right for nondefaulting participants to dilute the interest of the funding defaulter. Disputes may also arise around the application of these contractual mechanisms and the failure to fund generally. We expect to see a significant amount of attention on such provisions in the very near future.
- If a party is experiencing financial difficulties (or considers that its counterparty is), it should be aware of the circumstances in which credit support (or additional credit support) may be sought under relevant contracts. We see an increasing number of attempts to rely on such clauses where parties have been impacted by the pandemic or low oil prices generally. Triggers entitling a party to require credit support (or additional credit support) may include a decrease in the credit rating of an entity or a material deterioration in financial standing.
While renewable energy projects were originally forecasted to have a boon year in 2020, the COVID-19 pandemic has changed that, both for this year and potentially beyond.
For example, most renewable energy projects rely on a supply chain of equipment and materials that is sourced from around the world. Many of these projects are at risk of being delayed due to slowdowns in the delivery of materials and parts from overseas as result of, among other things, port closures, and reduced manufacturing operations. Wind and solar projects are particularly vulnerable in this regard because China is one of the major producers of solar photovoltaic panels and turbines.
However, with regard to financing requirements and obligations, funders and banks typically have not exercised the draconian rights available to them under the relevant financing agreements. Instead, they have agreed to the necessary waivers (albeit sometimes with conditions) to ensure that the project remains financially viable and continues through to the completion of construction or the end of the financing term. Construction delays that affect the financial base case may lead to the revision of finance documents, but the complete restructuring of projects (as occurred in the 2008 financial crisis, which affected most of the existing financing structures) is unlikely to materialize.
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Originally published May 2020.
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