Contracting in a COVID-19 world
We may be tired of talking about COVID-19, but contractual and project risk associated with the pandemic is still very real.
Risk associated with COVID-19 should remain a key consideration in project planning, tendering and negotiation activities, and in the delivery and administration of construction and infrastructure projects. To assist, we examine key themes and observations that are relevant to contracting in a COVID-19 world.
COVID-19 has highlighted the need for collaboration – we are all in this together. While New Zealand’s construction industry has not responded through large-scale shifts to collaborative risk sharing contracts (e.g. alliances) as the norm, a focus on collaboration is finding its way into pre-tender and tendering activities, pre-contractual processes (in the form of a renewed trend toward ECI/Preconstruction contracts and co-design) and collaborative contracting principles (see “Plan B contracting”).
Principals need to know that prospective suppliers are thinking about COVID-19. We are designing notices of procurement that ask tenderers to explain how they have planned to deal with the impacts of COVID-19 in a manner that provides best-for- project outcomes. These responses are increasingly becoming part of a principal’s evaluation criteria.
Emergence of “COVID clauses”
One of the main contractual trends is the emergence of clauses specifically addressing and allocating risk for the impacts of COVID-19. Project- specific “COVID clauses” have become particularly important because many traditional relief regimes, such as “change of law” provisions or Force Majeure/extension of time clauses, are unlikely to be sufficiently effective. For example, Force Majeure and other relief clauses generally require unexpected events, but COVID-19 is well-known as are many of the consequences of the pandemic such as the Government’s lockdown responses.
A COVID clause provides (as far as possible) certainty of risk allocation – parties are able to enter into contracts with the understanding of where risk lies, which allows them to plan for that risk including to price and programme for it from the outset.
There is no standard COVID clause. Some provisions are thorough and prescriptive, while others are simple and generalised. Whatever the approach, we recommend a careful balance between achieving certainty for the parties and enabling the parties to be flexible and incentivised to be responsive and adaptive.
What should COVID clauses cover?
The challenge with agreeing effective COVID clauses is their scope and coverage – the impacts of COVID-19 can be far-reaching and their time and cost implications uncertain. Suppliers will understandably wish to have as much protection against the impacts of COVID-19 as possible. Conversely, principals and their stakeholders and financiers necessarily desire certainty, and are therefore reluctant to accept generalised and unabated risk.
Parties should turn their minds to the potential impacts of COVID-19 against the realities of their contract, particularly the contract term and the importance of time, relevant project risks (such as any international procurement or specialist foreign labour supply, or where the project involves a large site-based workforce working in close proximity). A COVID clause prepared with careful consideration of these types of eventualities is a good starting point.
What are appropriate remedies for COVID-19 impacts?
A range of traditional contractual remedies can be made available for COVID-19 impacts, such as entitlements to more costs (variations) and relief (extensions of time), and a right to suspend or terminate.
Relief from performance should be uncontroversial, but the question of cost is more contentious. While the impacts of COVID-19 may be felt differently by the parties, both parties carry risk – the starting point should be allocating risk to the party best placed to manage it. This may mean that some cost is available to suppliers, but it should not be an invitation for an open cheque book.
If compensation is included as a form of relief, it is important that the compensation regime is clear and fair. For example, a principal may be willing to pay for demobilisation and remobilisation costs associated with an escalating alert level, but is unlikely to agree to pay any profit on such costs. The extent of compensation available should be covered in clear and certain terms.
Plan B contracting
COVID clauses are one piece of the contractual puzzle. However, the availability of relief does not protect the parties or their project from risk arising. Any such clause only provides a time and cost remedy once that risk has arisen.
At law, parties are required to mitigate their loss. Contractually, parties may wish to be more prescriptive and agree mechanisms that describe what mitigation entails – or in other words, what “Plan B” looks like. Some examples of mitigation measures and mechanisms include:
- proactive notification regimes as to impacts – including through monthly project reporting and/or advanced notification regimes, and proactive updates to construction programmes.
- rights to re-sequence and new ways of working – investigating new ways of working that enable progress of the works on site. This may involve more off-site fabrication or partial fabrication of materials, or different trades working in different parts of the site at different times, or re-sequencing works to enable compliance and/or efficiencies of operation to mitigate any loss of productivity.
- alternate supply (materials and labour) – collaborative discussions around alternate procurement opportunities (both materials and labour supply), and risk/cost sharing for those changes. Local supply options should be actively investigated.
- staging of works or new separable portions – where commercially beneficial and practical, staged handovers of parts of the works and/ or the introduction of new separable portions provides the principal the benefit of early access or occupancy, and for the supplier to achieve an early release of retentions.
- requiring acceleration – acceleration options for the principal to off-set delays and/or losses in productivity. This could be facilitated by additional weekend and/or night shifts (subject to allowance in or amendment to consented hours of work).
- prioritisation – identifying project priorities and allocating resources to those priorities.
- relaxing working constraints – for those projects being delivered in operating environments (e.g. extension works to existing buildings), opportunities for principals to relax working constraints (e.g. site working hours), particularly in circumstances where those environments are themselves subject to lockdown constraints (e.g. shopping centres) or with reduced use (e.g. road works).
Long-lead procurement regimes
To mitigate supply chain delays, a contract could usefully enable or may even mandate long lead procurement activities. Suppliers will likely look to principals for partial or full advances for those materials (or letters of credit), which introduces security considerations for the principal such as advanced payment bonds. For materials in New Zealand, principals should be protecting their security position by registering security interests over the materials and being aware of the physical storage arrangements (including location and the identity and substance of the organisation storing those materials) and ensuring insurances are in place. Extended warranty periods may be needed to account for any delay between procurement and installation or use.
Suspension regimes are an important tool for principals navigating unknown impacts of COVID-19.
Discretionary suspension rights provide principals the ability to “press pause” on their projects or specific contracts, enabling them to consider next steps (including with their key stakeholders and financiers). Suspension regimes need to be fair to suppliers – this involves appropriate notification requirements (in advance of the suspension if possible and in relation to lifting it), suitable compensation entitlements, and certainty of suspension periods such as longstops.
Termination for convenience rights
Termination for convenience or “termination at will” clauses allow a principal to unilaterally terminate or cancel a contract, without reason. In the current climate, these are receiving much attention as they provide a useful tool for principals to end a contract that has become overly burdensome, financially unviable or commercially comprised due to COVID-19 – circumstances that the pandemic is presenting in many construction sectors including retail, hotel and tourism.
For suppliers, these clauses are harsh, not least because a supplier has planned its business to complete a contract and to receive a profit. If a principal is requiring a right to terminate at will, principals should also consider advanced notification periods and fair compensation regimes.
COVID-19 is creating financial risk and uncertainty. Where commercially appropriate, principals may be able to agree to different payment regimes that generate quicker cashflow to its suppliers. This could include:
- advances for works and materials (with appropriate securities, e.g. advance payment bonds in place);
- flexible payment cycles, for example moving from monthly payment cycles to fortnightly or weekly payments to ensure that contractors/ suppliers have a steady cashflow;
- payment milestones against achievement of works milestones to incentivise project centric approaches; and
- release of bonds and retentions.
It is important for mechanisms to be put in place to ensure that contractors pass on the benefit of alternative payment measures to their supply chain. This may be achieved through requiring contractor declarations with payment claims and audit rights to ensure that cash is flowing through the supply chain as intended. Contractors should also be open to providing accurate and timely cashflow schedules with each monthly project report or payment claim.
Health and Safety
Fundamentally, New Zealand’s legislative framework for health and safety, including the Health and Safety at Work Act 2015, its regulations and approved codes of practice, has not changed. PCBU’s duties remain. However, the prevalence of COVID-19 and the Government’s directives for conducting business within alert level constraints require different approaches from construction organisations to achieve compliance. Construction Health and Safety New Zealand (CHASNZ) promulgated standards and protocols to assist the construction sector to operate safely under alert levels 2 and 3.
Health and safety management plans and organisation systems need to be fit for purpose and revisited in light of COVID-19. P&G Specifications should be updated and backed-up by organisational and site-based behaviours that align with those requirements.
Embracing new technologies
COVID-19 has emphasised the importance of investment in technology that allows for off-site project monitoring and management. In an increasingly digitised world, parties should look to embrace technology to increase productivity and reduce costs, (e.g. through digital workflow management, real-time progress tracking, 4D simulation and modular construction). Given global labour shortages, overseas companies have begun developing technical solutions to reduce the need for physical labour and mitigate rising labour costs in response to increased health and safety requirements. The construction sector is likely to see significant investment in technology over the next few years.
COVID-19 in New Zealand