Impact of the COVID 19 on the Construction Industry

Following on from my earlier blog on the impact of the COVID 19 on the Construction Industry in Malaysia wherein 5 main aftermaths were identified: COVID-19 Economic Aftermath No. 1 – The Supply Chain in Peril COVID-19 Economic Aftermath No. 2 – The High Price of Materials COVID-19 Economic Aftermath No. 3 – The Labor Force Quarantine COVID-19 Economic Aftermath No. 4 – Delay Costs COVID-19 Economic Aftermath No. 5 – Litigation and Legal Implications These issues have the potential to put completion of work and contract obligations at risk, opening contractors/developers to potential liability and claims for non-performance, delays in completion, and potential damages. Contractors and Developers need to be armed with positions and responses in the event owners or other parties in the industry seek to enforce contracts that become virtually impossible to perform.

RISKS TO MANAGE

In the short term at least while the global impact sinks in we have to undertake a risk assessment on the ongoing projects. In any crisis the first step would be to identify the risks associated with the project continuity under the current scenario of the MCO in force till the 14.04.20. The shutdown by the Government is clear in that only critical works which are approved by the Ministry are allowed to proceed with no confirmation of any extension of time wherein it being subject to the agreements signed. More so there was an avoidance of cost escalation due to the suspension being that the matter is beyond the control of the Government. In this light the private sector developers and project owners will have to make a stand similarly as to the implications on such a suspension of works. The areas to identify risks in are thus: 1. Supply Chain 2. Procurement 3. Labour 4. Delay of Projects 5. Insurance 6. Legal

SUPPLY CHAIN

The construction sector is expected to face significant difficulties sourcing construction materials, primarily based in China due to the outbreak. However, these supply chain shortages are not anticipated to be too delayed, with recovery expected to be by the 2nd half of 2020. In the short term however projects may be delayed if construction materials cannot be sourced. With 70% of construction materials from China the risks to the construction sector go broader than just supply chain disruptions. Supply chain restrictions from China, also present the opportunity to diversify sourcing of construction materials locally and in the region. Collaboration between government and industry will enable the Malaysian market, or subsequently alternative markets, to fill the void left by the stalled Chinese construction industry.

Thus, an immediate analysis of the supply chain not only from direct suppliers but as well the sub-contractor’s supply chain is needed to assess the need for alternative sources of materials.

PROCUREMENT

With China ramping back production in the 2nd half of 2020 the demand for their products is anticipated to increase due to the back log. In line with this there will be a subsequent increase in pricing to the market due to the demand spike. In this instance there is a potential risk for project cost overruns due to higher material cost than earlier committed and whether these can be claimed as a material escalation under the construction contracts at hand. For example; In JKR 203 standard form of contracts it does allow for a fluctuation of the price of raw materials whereas in the PAM contract it is more silent on this matter thus opening up the risk more on a PAM contract as a result of the COVID 19. In FIDIC contracts however states fluctuation of prices to be a mutually agreed provision and not an automatic entitlement.

Nevertheless the matter remains the same in that an analysis on the supply chain for both contractors and developers on materials used is required. From this anticipated price hike there is a need to urgently update budgets towards your project cost. With that alternatives can be looked at but more importantly avenues to claim or defend against higher cost from the surge in demand once the projects start moving again.

LABOUR

Construction is essential. While the lock down is a necessary exercise all parties should be ready to commence in full force latest by the 15.04.2020 with action plans being put in place now for when the MCO is lifted. The impact down the line of non-payment and cash flows will ultimately affect the social and economic issues in the country with such a heavy reliance on a foreign labour force and cash flow throughout the entire supply chain. Laying off construction workers and non-payment down the supply chain will push the stagnant economy towards a further decline and many SME s in particular will have no choice but to cease operations. There is always a neglect on the impact of SME s on the economy.

The plan however needs to be ready and should contain three parts: 1. Get construction sites open as soon as the MCO is lifted. 2. Keep construction sites hygienic and safe for workers in line with the health guidelines and especially with regard to the COVID prevention procedures. 3. Address business continuation needs including cash flow for companies down the line and at least ensure payments are up to date prior to the COVID 19 event occurring. Safety as the top priority. We need to fully understand that in order to keep construction sites operable, the industry needs to take all of the necessary precautions to perform their jobs safely and securely. The construction industry is inherently linked with safety measures in order to perform, and following new stricter guidelines is nothing new for the industry. During this crisis, it is essential that extra vigilance to adhere to public health guidelines. Our construction workers often receive monthly, weekly and even daily training on the latest safety measures. In fact, at this point, we should go above and beyond – taking extra precautions to keep our employees safe. Construction, by nature, is a practice of social distancing. Most projects have workers dispersed on tasks located more than 2m apart. Consequences of construction work stoppage. There will be several significant consequences both direct and indirect, for not only the construction industry itself as cash flow flowing throughout the supply chain is a key lifeblood of Malaysia’s economy. At a time when the unemployment infrastructure is already being stressed, adding more construction workers would be catastrophic. Further to this with the restriction imposed is whether the labour force is still in place ready to proceed or have they been released already as that will have further impacts on the timelines moving forward.

We should be working around-the-clock to keep members of the construction industry safe and well-informed. Assess labour resources when the MCO is lifted and not only how to reduce exposure now. We all hope for a swift end to this pandemic and for the social and economic impacts to be minimised.

DELAY

Delay of all projects have impacts to Developers and parties funding the development. Securing debt as well today will deliver into a market two to three years from now, well after the virus outbreak has recovered. “These are two-year construction projects, and the world is going to be okay in two years when these projects start to lease up. People are still going to be around and they will still need a place to live. While lenders haven’t released any official guidance for developers with who could face stalled projects as a result of the virus, I expect lenders will be compassionate to the situation. For Contractors, the delay in any cash flow prior to the occurrence happening is something that needs to be pursued now as the following months will require buffers in cash flow to handle the disruptions in the market.

With the MCO running to 14th of April 2020 the efforts from the industry leaders and developers prepare as below:

1. Increase welfare and hygiene facilities and protecting the workforce. 2. Liaising with funders and banks to secure sufficient credit. 3. Setting up project-specific communication networks with their supply chains. 4. Reviewing safety-critical elements of their projects. 5. Reviewing programs. 6. Protecting business-critical functions such as payroll and accounts departments. 7. Splitting teams if activities are still hindered on site. 8. All through the supply chain is imperative to make prompt payment 9. Asking our project team members to set up clear communication channels to all suppliers on their contracts and projects and provide regular updates.

Ensure projects are ready to recommence work as soon as possible.

INSURANCE

In Malaysia, the standard contractor’s liability insurance are the Contractor’s All Risk insurance, Third Party Liability Insurance and Plant Insurance and Workmen Compensation Insurance. In all these the coverage infectious diseases are generally exclusions under the coverage. As such there is a need to review insurances procured by the Developer or Project Owner in these instances: The apt insurance to look at would be the consequential loss insurance. Property Developers have to carry risks it is part and parcel of their business. The risk due to consequential losses on a construction site is a high one as there are so many factors that could delay completion and then so many headings under which additional expense or actual loss of anticipated income could arise. If any party involved with the construction will require consequential loss cover of any kind it is very unlikely that any insurer will be willing to assist unless it also provides the CAR insurances on the Contract Works. The reason for this lies with the fact that only by the insurer controlling the settlement of the material damage claim can the size of the consequential loss be minimised. To avoid the possibility of the Employer effectively paying enhanced premiums for such Contract Works cover it is worthwhile making clear to the Contractor from the outset that the Employer is paying for its own cover i.e. for risks beyond the control of both parties to the contract such as the COVID in this instance. The contract price quoted by the Contractor should then reflect this. In order for the Employer to secure adequate Consequential Loss Insurance at a competitive rate he should ensure that those responsible for arranging the policy have a full understanding of how the project is to be financed, the programming of the Works and the financial implications of any delay

Review insurance cover notes for any perils cover against epidemics if taken. There may be a need moving forward for developers to look at a consequential loss insurance coverage or if they have taken this already to engage their insurers in mitigating the project and business continuity risks.

LEGAL

In assessing the legalities of projects in the aftermath the easy go to clause would be a force majeure clause which has its interpretation and considerations of foreseeability, causal link and impact, mitigation, notice requirements and consequences. Questions to be answered; 1. Is the event reasonably provided for? 2. Does the event prevent or hinder parties from performing their contractual obligations? 3. Has the party defaulting on the performance displayed enough evidence to show mitigation plans have been put in place? 4. Has all the notice provisions been provided for? 5. What are the liability arising from the consequence of not being able to perform on the contract? The standard form of contracts in Malaysia and the international FIDIC contract as each construction contract will differ, however in general terms the following provisions may bite:

PAM Standard Form of Contract

The PAM contract is quite clear as regards to COVID 19 in terms of an extension of time in that it refers to a strict compliance to notices issued by the appropriate authorities. Any actions taken by the government in a bid to control the outbreak may well fall within this definition, for example, a nationwide lockdown which requires closure of the site would have a direct effect on the execution of the works. However the Contractor would still need to prove that it used its best endeavours to prevent and mitigate the delay upon the occurrence of the delay. However based on the provisions of the PAM contract COVID 19 would be an entitlement for an extension of time however not necessarily will the Client be liable to pay compensation in these circumstances as it is beyond the control of all parties.

JKR FORM OF CONTRACTS (PWD 203)

The Government form of contract as well is clearer in that the rights of the Government to suspend the works does tantamount to an extension of time however much clearer that in the event of a force majeure costs are only recoverable up to the point of the event occurring and not after.

FIDIC

Under the most recent editions of the FIDIC contracts, the contractor is entitled to an extension of time to complete the works where the contractor has diligently followed the procedures laid down by the relevant legally constituted public authorities which delays the contractor’s work and was not reasonably foreseeable. The term of an “Exceptional Event” being defined as an event which is beyond the parties’ control, could not have been reasonably provided against before entering the contract, cannot be reasonably avoided or overcome, and is not substantially attributable to the other party. The occurrence of certain Exceptional Events will (in addition to an extension of time) entitle the contractor to their costs as a result of the disruption caused by the event, but it is difficult to see how those particular events would be triggered as a result of the COVID-19 outbreak as it is not expressly defined as an event that can lead to cost recovery due to the extension of time.

AIAC STANDARD FORM OF CONTRACT

Under the AIAC form of contract it is in line with the PAM form and no specific mention on force majeure is expressly stated in the contract but is defined in the form of the instruction by the authorities to suspend work for reasons beyond the foresight of the Contractor.

FRUSTRATION

In the event that a contract does not include an express force majeure clause, a party may be able to discharge the contract using the doctrine of frustration. A contract may be frustrated by the coronavirus pandemic where it becomes physically or commercially impossible to perform, or where, as a consequence of coronavirus, a party’s contractual obligations become radically different to what was envisaged at the outset. If a contract is frustrated, the contract will immediately be terminated, and both parties released from performance. In utilising frustration the parties will need to assess:

1. Impossibility of Performance. Impossibility of performance is a principle of law that excuses a party’s performance of a contract in certain circumstances. The principle generally means that where, after a contract is made, a party’s performance is made impracticable without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his duty of performance is discharged unless the language of the contract or the circumstances indicate to the contrary.

2. Prevention by Government Regulation or Order. Another principle of law that is potentially applicable to the current circumstances involving COVID-19 is when a party’s performance is adversely affected by a government order or regulation. Under this doctrine, if a party’s performance is made impracticable by having to comply with the government regulation or order, the regulation or order is considered to be an event the non-occurrence of which was a basic assumption on which the contract was made.

TERMINATION

Certain Construction Contracts provide for a right to terminate if the effect of force majeure continues for a significant period. For example the FIDIC provision for prevention of works for more than 84 days a termination may be exercised by either party.

Thus in all legal interpretations the force majeure clause can come into play towards the granting of an extension of time for COVID 19 however the entitlements for costs are not a clear entitlement and will need to be proven with the key emphasis being on mitigating the loss.

Where there not being a standard form in place the legal arguments will have to be on the doctrine of frustration of the contract which will need to be proven and not an automatic entitlement.

These principles and steps can be an effective defence to minimize or nullify the adverse effects of the COVID-19 virus on contract performance. The coronavirus outbreak requires immediate action. The construction leadership should consult their in-house and outside counsel for assistance to comply with its contracts and applicable law. If you require further assistance on manoeuvring through the impact of COVID 19 on your projects, please contact me using the details below. Shaun Kumar +6012 784 0039