Elliot A. Smith, Danna Donald, Jagriti Singh
Mar 24, 2020
In this Update we:
- Discuss the growing impact of COVID-19 on construction projects and the trend towards project participants issuing one another early notice of potential impacts prior to claiming force majeure
- Examine how best to respond to the receipt of these advance notices of a potential force majeure claim and potential implications under financing arrangements
The growing impact of COVID-19 on construction projects
We are living in unprecedented times with COVID-19, which has infected over 400,000 people across the globe and continues to escalate rapidly. In our previous Update, we noted that the majority of the impacts on construction projects that we were seeing from COVID-19 were related to the unavailability of material sourced from China, owing to the extensive lockdown imposed by the authorities. What we are seeing now, just a few weeks later, has evolved considerably.
All levels of government, corporations and individuals are taking swift measures to address the crisis resulting from the widespread outbreak of COVID-19. A number of provinces have declared states of emergency, including Ontario, Alberta, British Columbia, Manitoba and New Brunswick, and the federal government has indicated that it is considering exercising its authority to do so as well. In addition, the provinces of Ontario and Québec have ordered all non-essential workplaces to be shut down. In the case of Ontario, the list of exceptions to this order includes construction projects and services associated with the healthcare sector; construction projects and services required to ensure safe and reliable operations of critical provincial infrastructure; construction work and services, including demolition services, in the industrial, commercial, institutional and residential sectors; and construction work and services that support health and safety environmental rehabilitation projects. The Québec exceptions for the construction sector are much narrower, and include construction firms for emergency dispatching or security purposes; electricians, plumbers and other trades for emergency services; and rental equipment. In addition, the Québec exceptions also include construction, maintenance and the maintenance of essential activities related to public and private infrastructure that may pose a threat to public health and safety.
As a result of this, the latest impacts on construction projects include disruptions to local supply chains by factory shutdowns, as well as restricted labour availability on account of an increasing number of people testing positive for COVID-19, in self-isolation, in quarantine, or otherwise not showing up to work.
Pre-force majeure notices
The measures being taken in response to COVID-19 have generated an unprecedented level of uncertainty for construction projects, including on project schedule, ability to maintain site access, labour, and supply chains. We have seen a trend towards the parties to a construction project (including suppliers, subcontractors, general contractors and owners) sending one another notices of a potential event of force majeure (which are referred to in this article as a “pre-force majeure notice”). While sometimes these notices may be project-specific, often they are generic in nature and being sent to all of the issuer’s counterparties, simply advising of the potential for a forthcoming force majeure claim.
While open communication between the parties is helpful to prepare for a potential force majeure event, the party issuing a pre-force majeure notice should be clear in the notice whether they are intending it to have contractual effect or if it is being issued for informational purposes only. Given that the prevalence of COVID-19 is already widely known, sending a notice that this is occurring is not itself particularly helpful. In order for a pre-force majeure notice to be useful, it would be advisable to include a description of possible impacts to the specific project, even if they are as yet uncertain, any mitigation measures being taken or that may be taken by the party issuing the notice, and any mitigation measures that could be taken by the recipient of the notice (such as taking early delivery of products or sourcing alternative suppliers for certain goods). If the recipient of the notice is unclear on the contractual status of such a notice (i.e., whether it is a formal claim of force majeure under their contract or just an informational update), the receiving party may need to respond to confirm their own understanding of the effect and intent of the notice.
As discussed in our previous Update, it is important for stakeholders to closely review their material project documents and financing documents to understand the rights, obligations, and risk allocation among the parties during a force majeure event. The receipt of a pre-force majeure notice should be considered in light of the specific terms of their contracts. While a pre-force majeure notice may not have a contractual implication under the contract between the sender and the recipient, the receipt of such a notice could have other effects:
- depending on the magnitude and irreplaceability of the contract, it may constitute a material notice that needs to be shared with the project lenders which will in turn involve questions and follow up;
- a potential change in timing of services or materials may require amendments and changes to material project documents, payment schedules and financial models; and
- a formal response to the sender may be required along with consideration of whether any cascading pre-force majeure notices are required to be given by the recipient in order to preserve cascading force majeure rights of the recipient with other contractual counterparties, such as power purchase agreements or other supply contracts.
The receipt of a pre-force majeure notice could in some circumstances be considered actual knowledge of an event having a material adverse effect on the underlying project. From a project finance perspective, borrowers need to be aware of the provisions of their specific financing agreement, including a common obligation to promptly share any material notice and represent no material adverse effect on the project. As outlined above, the party in receipt of the pre-force majeure notice should clarify the sender’s intent if needed, and having regard to the scale and scope of the contract, assess the potential for a materially adverse outcome should the pre-force majeure notice become an actual force majeure event. Borrowers should consider the potential impacts and how they can be mitigated, including contingency plans to replace suppliers or service providers if it becomes necessary, and having the independent engineer be on standby to evaluate any proposed schedule changes and knock-on effects for the lenders.
Outside of the technical requirements of the various agreements, communication continues to be one of the most important factors in these uncertain times. Borrowers should be prepared to give their project lenders comfort that they are enforcing their contractual rights, communicating often with key contractual counterparties, evaluating any potential changes to project schedules or material deliveries, and, as always, being prepared with a “Plan B.” Lenders have a key role to play in holding the market steady by being in touch, by listening and considering borrowers’ mitigation strategies. Lenders should also be working to understand the minutia of any delays and the effects along with how those can be recovered throughout the life of the project.
The situation is rapidly changing – over the course of the last few weeks alone, the impact of COVID-19 on construction projects has evolved considerably and is expected to continue to evolve. The Canadian Construction Association (CCA) has urged the Government of Canada to issue a clear statement and commit to a future legislation on how it will treat delays, project disruptions and other COVID-19-related costs under federal contracts and have a dialogue with the provincial authorities to maintain a consistent approach to these issues. Meanwhile, parties that have not recently reviewed their contract terms should refresh themselves on their rights and obligations: in the event of a force majeure event; on other potentially relevant contract clauses such as what to do upon the occurrence of a material adverse event or knowledge of a potential claim; and whether there are any other relevant rights in the contract that may be applicable in the future, such as the right to suspend work. Construction industry stakeholders should also familiarize themselves with the mandatory shutdown orders for non-essential workplaces, and if in doubt as to their application, seek advice.