Clarity vital element of construction contracts
This is a very challenging time for all of us whose livelihood is dependent on the construction industry. As Dubai experiences the impact of the global credit crisis the number one topic of conversation around town is the scarcity of money. Yesterday's announcement about the $20 billion [Dh73.46bn] bond issue is good news. But it is still not clear as to how much of that money will flow through to the construction industry. Many projects have been stopped and many others are suffering because of the drying up of funds to pay the bills.
A very common question is – what can we do if there is no money to pay the bills? Our clients are asking us, we are asking ourselves and everyone wants an answer. Of course, there is no single answer because each project has its own commercial drivers and objectives. On most projects the only practical solution for the parties is to get together and discuss the options. It may be that the parties can reach agreement on revised timetables, work sequencing or payment mechanisms. Of course, it may be the case that the project is no longer viable regardless of the timing or construction costs. For the purpose of this column let us assume that the objective is to stop work on the project. If the parties cannot agree on how to stop the project then their respective legal positions need to be ascertained.
The first thing we must do is to look at the contractual arrangements between the parties. From our experience, and from what we hear from many other industry participants, even a cursory review of a lot of existing contracts uncovers a major problem. Many projects that have been, and in some cases are continuing to be, undertaken in Dubai have completely inadequate contracts in place. This issue has been ignored during the boom times because the usual problems encountered on construction projects – delays and increased costs – have been solved by the injection of additional money. Of course, when there is no more money the deal as documented (or not) in the contract is exposed.
At this point it is worth considering what should be in a good construction contract – and good doesn't mean an onerous agreement that attempts to put all of the risk on the contractor. When the banks start lending again, and they eventually will, anyone who wants to borrow money for their projects will have to have good contracts in place. The days of getting money without the appropriate project structures and contracts are gone.
A good construction contract should be thorough and clear in relation to three areas:
- Statements of who is required to do what (such as obligations in relation to constructing the works, obtaining the necessary permits, providing access to site and paying the contract price)
- The structures and processes that the parties must follow during the project execution (including progress payments, reporting, testing, directing variations and certifying completion)
- What happens when things don't go as planned (for example delays, damage to the works, latent ground conditions, force majeure type events, suspension rights, dispute resolution procedures and termination rights)
For a project to have every chance to succeed it is absolutely essential that the contract includes provisions that deal with the first two points above. The parties to the contract must put in the time and effort to ensure these provisions are well thought through and clearly written into the contract.
However, in considering the money issue it is the third point that is currently causing many people additional angst. If the contract doesn't have adequate provisions dealing with this subject then the parties are left with no structure in which to deal with the issue at hand.
There should be specific clauses that allow the works to be suspended. Firstly, in circumstances where one party is not performing its material obligations the other party should have the right to suspend. And second, the principal should also have the right to suspend the works at its discretion. However, a principal should be wary of exercising this right merely because it cannot meet its payment obligations. If a principal did exercise such a discretion then in all likelihood the contractor will have the right to recover its costs resulting from such a suspension.
Contracts should also have clauses that deal with the parties' respective termination rights. Properly drafted these clauses will allow a party to notify the other party that it is not complying with the contract and requiring that party to rectify the non-compliance within a certain period of time.
As a word of caution, it is crucial to strictly comply with any notice requirements in the contract when exercising a right to suspend or terminate. If someone doesn't comply and still attempts to suspend or terminate then the consequences may well be a breach of the contract by that person and the other party can recover its losses from the person who attempted to suspend or terminate. In reality, many contracts do not have clear clauses dealing with suspension and termination. In these cases, either party should be very careful about attempting to suspend or terminate a contract in the absence of any express contractual right to do so. Unilaterally stopping work will lead to additional liabilities.
Finally, in a well drafted contract the dispute resolution process will have stages so that the parties can refer the dispute to senior management for resolution before a more formal process is triggered. In the absence of such a tiered process unless the parties agree to hold senior management talks the only contractual remedy is to refer the dispute for formal resolution. It doesn't matter whether the formal process is via arbitration or the courts the outcome of any resolution is almost always slow, costly and, importantly, often random.
Of course, if a well is dry then the parties have to face the reality that the well is dry. If that is the case the only practicable approach is to reach an appropriate agreement on the current project with an eye on the future. Money will again be available, and the bond news is a positive step, so we all need to focus on getting through the hard times with our commercial relationships intact and with a commitment to do things better next time.
- David Nancarrow is partner at DLA Piper Middle East
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