Changing Construction Risk Regimes in Light of COVID-19

On March 11, 2020, the World Health Organization (WHO) declared the novel coronavirus disease (COVID-19) a pandemic. As governments and health care systems continue to grapple with the growing impacts of this viral disease, the construction industry is also assessing the short-term and long-term implications to its respective market. For megaprojects—which increasingly rely on the global supply chain and modularized construction—owners, contractors and lenders will all be forced to address the changing risk regime that will inevitably arise from recent events, particularly with respect to force majeure and change in law relief.

Force Majeure

Force majeure is often described via one of two definitional structures. The first structure describes general principles of relief and then sets forth a non-exclusive listing of acts and events which would typically qualify as meeting such principles. Here is an example of this “non-exclusive” structure:

“Force Majeure” means an act or event which (i) delays or renders impossible the affected party’s performance of its obligations under this agreement, (ii) is beyond the reasonable control of the affected party, was not due to its fault or negligence, and was not reasonably foreseeable, and (iii) could not have been prevented or avoided by the affected party through the exercise of due diligence, including the expenditure of any reasonable sum taking into account the contract price. Force Majeure may include catastrophic storms or floods, lightning, tornadoes, hurricanes, earthquakes and other acts of God, wars, civil disturbances, terrorist attacks, revolts, insurrections, sabotage, commercial embargoes, epidemics, fires, and explosions.

The second structure is one wherein the definition sets forth an exclusive listing of acts and events that qualify for relief, so long as such act or event complies with the general principles of force majeure. Here is an example of this “exclusive” structure:

“Force Majeure” means catastrophic storms or floods, lightning, tornadoes, hurricanes, earthquakes and other acts of God, wars, civil disturbances, terrorist attacks, revolts, insurrections, sabotage, commercial embargoes, epidemics, fires, and explosions; provided that such act or event (i) delays or renders impossible the affected party’s performance of its obligations under this agreement, (ii) is beyond the reasonable control of the affected party, was not due to its fault or negligence, and was not reasonably foreseeable, and (iii) could not have been prevented or avoided by the affected party through the exercise of due diligence, including the expenditure of any reasonable sum taking into account the contract price.

Prior to COVID-19, many megaprojects had moved towards the second structure (with some notable exceptions). We do not know if this pandemic will change that trend, but we somewhat doubt it due to a number of reasons which fall outside the scope of this article. The list of qualifying events in any “exclusive” force majeure clause are closely analyzed by both parties, with negotiations typically focusing on local weather conditions, labor issues, risks arising from differences between stick-built vs. modular built, and other key project risks which are identified during negotiations. Parties often spend significant time delving into the meanings of specific words with the goal of leveraging lessons learned, handling the stresses of current events, and above all, providing additional clarity on how and when an act or event qualifies for relief. For example, EPC contracts often provide weather relief only if a weather event is “named” or “designated” by a specific organization (i.e., a named storm) and such event occurs within a certain distance from the worksite, a fabrication yard, or other similar location. Similarly, EPC contracts often specify the types of labor actions that qualify for relief (i.e., “national and regional strikes”). Tariffs have also become a focus of additional attention, with owners, contractors, and their counsel becoming more informed on structuring risk to account for ever-changing tariff regimes, especially for those projects with leveraged supply chains in Asia. Prior to COVID-19, however, it was extremely rare to specifically negotiate the definition of “epidemic” or “pandemic.” This obviously will change in the aftermath of recent events.

Indeed, parties that are currently negotiating megaproject deals are already adding additional details and clarifications regarding epidemic/pandemic relief by, for example, utilizing the designations of WHO, including “pandemic,” “epidemic,” “Public Health Emergency of International Concern (PHEIC)” and “public health emergency,” as the foundation for a definition of “Epidemic” as exemplified below:

“Epidemic” means the occurrence of a public health emergency in a community or region which is formally declared an epidemic or a Public Health Emergency of International Concern (PHEIC) by the World Health Organization.

This definition can be modified to suit the desired risk profile of the parties. For instance, relief could be broadened by including public health emergencies declared by the WHO in any community or region regardless of whether an epidemic or PHEIC has been formally declared.

Additionally, many force majeure definitions contain express exclusions for relief, even if such events would otherwise qualify as a force majeure event. Here’s an example of such structure:

For the avoidance of doubt, Force Majeure shall not include any of the following: (a) economic hardship, (b) changes in market conditions, (c) late delivery of construction equipment, materials, or other items not included as equipment, (d) failure of equipment, construction equipment, materials, or other items, (e) strikes or other similar labor actions, (f) unavailability of laborers or subcontractors; or (g) climatic conditions (including rain, snow, wind, temperature, and other weather conditions, but excluding catastrophic named storms or floods, tornadoes, or hurricanes), tides, and seasons, regardless of the magnitude, severity, duration or frequency of such climatic conditions, tides or seasons.

Owners, contractors and lenders should expect COVID-19 to result in additional negotiations regarding such exclusions. While it is premature to speculate regarding how the market will shift, from the perspective of owners and lenders, these exclusions have become even more important when a lump sum, risk-off contracting strategy is desired by stakeholders. From the contractor’s perspective, this pandemic has likely caused impacts far beyond those traditionally encountered for traditional force majeure events, and thus contractors will likely re-think whether traditional exclusions for relief are acceptable when taking on lump sum megaprojects. Reducing the number of force majeure exclusions may be a primary way contractors are able to continue to offer lump sum contract prices when required while mitigating risk in this new world. Of course, time will tell, and the market is certainly still in flux.

Changes in Law

With communities across the world essentially shut down by their federal, state, and/or local governments, relief for “shelter in place” and other similar restrictions imposed by government officials has become a key issue in numerous EPC projects nearly overnight. Depending on specific language of the applicable contract, force majeure may or may not provide contractors relief from such scenario. If it does not, change in law relief represents the logical next step in evaluating the rights of the parties. Like force majeure, however, change in law language comes in many forms, all providing differing degrees of relief. Here is an example of a more simplistic structure:

“Changes in Law” means any amendment, modification, superseding act, deletion, addition or change in or to applicable law that occurs and takes effect after the effective date.

Without further addressing the scope of “applicable law”, contractual clauses similar to the one above will likely result in friction between owners and contractors. On one hand, owners will be inclined to interpret “applicable law” more narrowly to limit relief to changes to statutes, regulations, and permits, which would ostensibly eliminate relief for the impacts associated with current shutdown orders. On the other hand, contractors will be inclined to interpret “applicable law” more broadly to include governmental decrees, injunctions, or any other legislative, administrative, or executive action that impact their work.

Moving forward, we expect virtually all EPC contracts will take the additional step of defining “applicable law” to, among other things, clarify the parties’ agreement regarding scope of change in law relief similar to the sample definition below:

“Applicable Law” means all laws, statutes, ordinances, certifications, orders, decrees, injunctions, licenses, permits, approvals, agreements, rules and regulations, including any conditions thereto, of any governmental instrumentality having jurisdiction over any party, all or any portion of the site or performance of all or any portion of the work, or a final decree, judgment or order of a court which relates to the performance of work hereunder.

Under this definition, “orders,” “decrees,” and “injunctions” would represent the most logical basis for change in law relief due to governmental shutdown orders. Additionally, definitions of “Applicable Law” often times include broad, overarching descriptions (such as “any other legislative or administrative action of a governmental instrumentality”) which would most likely encompass such orders.

Finally, bright-line distinctions between change in law and force majeure relief may not exist in certain EPC contracts. For example, changes in law can be specifically designated as force majeure events or can be otherwise encompassed by broad force majeure clauses that provide relief for “any actions or events outside of the control of the parties.” In short, both owners and contractors should conduct a careful evaluation of their respective change in law and force majeure clauses in evaluating claims arising from the recent pandemic-related government shutdown orders.

Outlook

Looking forward, we expect COVID-19 to have a significant impact on EPC megaproject force majeure and change in law negotiations as the fallout of force majeure cost impacts and governmental shutdown orders are better understood throughout the construction industry. While the current focus of the world’s attention is (correctly) on the global health impacts of COVID-19, the associated short- and long-term impacts to construction risk regimes also merits consideration given the significant cost and schedule impacts that have arisen, and will continue to arise, from this global outbreak.

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