The effects of the Coronavirus in the construction industry: the biggest projects may be exposed to the greatest risk

author: Mátyás RADA

The spread of Covid-19 pandemic imposes major challenges on the construction industry and the real estate developers as well. The already experienced shortages in the sector regarding workforce and the prolonged deadlines for completion are likely to be further aggravated by the spread of the pandemic. According to Kapolyi Law Firm, construction of large office buildings, industrial buildings and hotels may be particularly exposed to risk because these investment projects usually employ a significant amount of workforce and use construction materials and equipment imported from abroad. Nevertheless, the Covid-19 crisis may qualify as force majeure, and contractor companies may be exempted from performing their contractual obligations within the agreed deadlines by referring to force majeure.

In case of larger real estate development projects, it means a significant risk for both the employer and the contractor if the concerned project has to be suspended or it cannot be completed in accordance with the agreed timetable because of the pandemic and subsequent government actions. By concluding a contract for construction and/or installation works, the contractor undertakes the basic obligation to construct the building in accordance with the building plans and within the agreed deadlines. He commits a breach of contract if he is unable to do so. In that case, he will face the consequences laid down in the contract, irrespective of the reasons underlying non-performance or late performance. However, he may be exempted from his liability for breach of contract in the event of force majeure.

In construction contracts, force majeure is usually defined as an exceptional event or circumstance, (i) which is beyond the control of the contracting parties, (ii) which could not have been foreseen by the parties prior to the conclusion of the contract, (ii) which could not reasonably have avoided by the parties and, (iv) which is not substantially attributable either of the parties. What event can constitute an extraordinary circumstance beyond the contractor’s control, which can exhaust the criteria of force majeure? Occurrence of war, terror event, natural and nuclear disaster and pandemic is usually cited as force majeure event in construction contracts. Accordingly, a contractor, who – due to the pandemic – is unable to complete the construction within the agreed time limit, may invoke to force majeure event if the above detailed criteria are met. The most important consequence of the occurrence of a force majeure event is that the defaulting party may be exempted from the liability of breach of contract, furthermore, he might be released from fulfilling his contractual obligations for the duration of force majeure event as well. This could practically mean that the contractor would not be obliged to pay penalty, furthermore, he could also extend the deadline for his performance by the actual duration of the force majeure event and the impediment thereto.

The employer – being the prospective owner of the building – usually enters into lease agreements – as a landlord – with the prospective tenants of the building, before or during the construction, in which agreements he undertakes to hand over the leased premises to the prospective tenants within the deadlines stipulated in these lease agreements. If the employer as landlord fails to meet the above deadlines, he may face penalty for breach of contract, furthermore, he may lose the rents to be paid by the tenants for the period between the deadlines and the actual handover of the leased premises. As the construction and utilization of commercial buildings are closely linked, the employer intends to mitigate his above detailed risks by stipulating penalty with high amount in the construction contracts.

However, Kapolyi Law Firm points out that in case of a force majeure event, it is not enough if the contractor refers to the pandemic as a well-known fact, he has to prove that its effects were not foreseeable at the time of conclusion of the contract and he has done everything to avoid and alleviate the consequences of it. Only if the above conditions are collectively met, the contractor might be released from the consequences of breach of contract and the performance of his contractual obligations due to the force majeure event. Construction contracts usually require  the contractor to notify the employer immediately if a force majeure event occurs or it will probably occur. It can be reasonably expected from the contractor to indicate in his notification how and to what extent the force majeure event prevents him from performing his obligations, what delay may be anticipated and what preventive measures he intends to introduce. Even if the consequences appear to be avoidable, a diligent contractor can be expected to inform the employer on the imminent danger and the preventive measures. Regarding the recent situation, it can safely be said that Covid-19 virus have been unpredictable, as there has been no example for this kind of pandemic or the limitations imposed by the governments following its outbreak, and there was no indication of its immediate detrimental effects on the economy. Accordingly, it can be stated with full certainty that Covid-19 virus may qualify as force majeure event.

Kapolyi Law Firm points out that the contractors must continue to make every possible effort to fulfil their contract, and if they are ultimately prevented from performing, they must be able to prove that they have been significantly constrained by the pandemic. Furthermore, they have to prove to what extent they were prevented and that they have done their utmost to eliminate any delays in the construction and to minimize the extent of the delays by means of possible restructuring of the work or any other emergency measures. For example, contractors importing constructing materials from countries concerned by import ban may be obliged to find alternative suppliers and transport routes. Similarly, in order to ensure and protect the workforce, the contractors may be obliged introduce health protection measures (e.g. prescribing the use of protective clothing) at the construction site to minimize the consequences of the pandemic. Based on the above, although the pandemic can be assessed as force majeure event, it does not automatically mean that the contractor is exempted from liability or released from paying penalty if he is unable to meet the agreed deadlines. At the moment, it may not be clearly seen what exact detrimental effects will the Coronavirus have on the construction industry, but it is reasonable to prepare in advance for possible scenarios on both sides. A diligent contractor in this situation draws up an action plan and a prevention protocol to eliminate/alleviate the risks posed by the pandemic and informs the employer about their contents. The present situation poses a serious risk to everyone, therefore the parties need to cooperate more closely and in good faith with each other and they need to inform each other about the appearing problems and the intended responses and they need to keep constantly discussing on crisis management regarding the pandemic.