Over the past two months, the majority of enquiries from the construction industry in the UAE involved disputes, said the Dubai office of the international law firm Clyde & Co.
"The number of enquiries have gone up by 68 per cent and the majority of them involve suspensions, terminations and reduction in work scope elements," said Mark Blanksby, partner at Clyde&Co. "Though the industry has not yet reached the courts, a lot of contractors, sub-contractors and suppliers are waking up to the fact that the people who have engaged them might not have the funds.
"This will eventually flow through to formal disputes, arbitration and the courts. And we see an increase in disputes in the next six months," he said.
However, there are solutions, said the firm. "Developers who will best see through the downturn will be those who are transparent with contractors, discuss finance and ask them to slowdown work based on staggered work schedules," said David McElveney, partner at the firm in Abu Dhabi.
"Then there are others terminating for convenience. But the ones that will cause the worst problems are those who will not be transparent and use default mechanisms within the contract to terminate contractors. They are storing up for different problems for the industry, especially, if they compound the situation by making demands on the performance bonds, which will guarantee a trip through courts."
Blanksby said the ticking time bomb lies in the two primary bonds [advanced payment bond and a performance bond], which are necessary from the contractors' side. "These are demand bonds, which the bank is obliged to pay. What we will see more of is that as projects get into a distress stage and the owner is strapped for cash, unscrupulous developers might face the temptation to prematurely call on the bonds," he said. "The contractor will be left in a situation where he has to chase the developer to get it back. And this might destroy relations and lead to disputes."
Michael Grose, also a partner at the firm, said calling a bond is like pushing a nuclear button. "Both parties will end up spending a lot of time in litigation. If the industry is rife with this, then the banks will start to get nervous about issuing new bonds and this will affect the lending industry," he said.
The firm also warns that developers who fire the contractor for default might end up with more costs than they started with. "Termination of a contractor for default will involve the developer paying the contractor for the value of work performed, demobilisation costs and the loss of profits if the project would have continued," said Grose. "It will also involve adjusting the additional costs that the developer incurs for terminating the contractor and hiring new ones. However, this is an expensive exercise since new contractors might be nervous on taking on a project where a contractor has already worked on and has been fired. Again, sub-contractors will rebel and ask developer to pay the money owed to them by the previous contractor. Then the developer will have to pay the previous contractor the original contract amount and also the latter, hence paying twice."
But Grose said contractors are coming up with solutions such as value-engineering to deal with the current liquidity crunch.
"The industry is also beginning to respond with novel ideas such as contractors taking interest in the buildings that they are working on. In case of default of payments or as payment, they might take a floor or five floors. These are some creative ways to get around the current impasse in projects," Grose said. "The other solution is where the developer will discuss the budget for the next 12 months with the contractor and ask them to slowdown progress to match the money on hand. The contractors will be happy to do so since they might already be struggling to finish their work on time. This way, they can pace themselves with the cash that is coming in and continue with the project."
Blanksby added that another possibility involves a situation where the contractor is offered 70 per cent of payment as the project goes along. "Thirty per cent of the payment is deferred so that the developer can have the option to pay in cash on a later date or transfer floors in a building to the contractor," he said.
Clyde &Co's regional arm has 150 lawyers in the region with 20 partners. Established in 1989, it has three partners and 11 lawyers in the region specialising in construction and projects.
McElveney said he has already seen a case of the contractor stepping in during a crisis. "I have already seen a case where instead of the financier stepping in, the contractor said he will step in and take an equity position in the project."
And Blanksby added that this could be a possible solution. "There are contractors here who are long-established and have a better credit history than some of the developers. They are better off in investing in the project and seeing it to completion than getting involved in a dispute over payments."
Meanwhile, the firm said there is a greater shift in focus from new projects to infrastructure. "We see a slowdown in the construction of residential properties in Dubai but a positive in the continuation of infrastructure projects with the Dubai Government focusing on spending on rails, bridges and rail," said Blanksby.
McElveney said contrary to the belief, Abu Dhabi is not immune from the downturn. "Though it is financially in a good position, one will see a rationalisation of projects, market maturity and requests to rethink and relook at contracts. But the landmark projects announced have to proceed to sustain the reputation of the emirate and TDIC announced recently it would continue on schedule with the Guggenheim project, which is a good sign."
On a more positive note, Blanksby said that building through a downturn will have its own benefits. "If you look at Dubai and Abu Dhabi and the wider GCC, it has to move away from the dependency on oil and generate a newer and more modern economy built around the service industry or tourism. Works such as the Museum project in Saadiyat Island in Abu Dhabi and Dubailand in Dubai have to happen at some point to create underlying economies for future. Building through a downturn will see the UAE get to a new economy in five years time instead of 10 years. If the master plan for Dubai, Abu Dhabi and the GCC was valid until last year, then it must be valid today. We must start to see the GCC states building through the recession to some extent to moving away from their dependence on oil."
Grose added: "Oil at $50 a barrel over the next one year will ensure revenues will go to infrastructure and building. The outlook for the Middle East construction has to be quite positive since the governments will have to invest that revenue in construction to provide economies that will support the populations over the next 20 to 30 years."
"Generally speaking, it is a matter of if and when confidence returns, which is probably be linked to oil and the world economy and when financing returns."
McElveney said there is still hope. "Comparing with other economies around the world, the construction industry in the UAE is still in a better shape," he said.