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Protecting against the risk of Brexit in your construction contract

Brexit is causing and will continue to cause economic uncertainty for a while to come. It is not yet known whether the UK will agree a Brexit deal or, if there is a deal, what the transition periods will be and what the ultimate trading arrangements with both the EU and the rest of the world will be.

While so much surrounding Brexit remains unclear, it is important to understand how the construction sector will be impacted and what can be done to reduce its affects. Companies entering into construction contracts now for projects which will continue after 29 March 2019, should consider how Brexit might affect their ability to perform the contract and their costs for doing so.

Contractors, sub-contractors and suppliers are likely to be vulnerable to the possible consequences of Brexit and should be thinking about the following in particular: 

  • Border delays

  • Increased/new customs tariffs

  • Freedom of movement for workers

  • Change of currency rates

  • Changes in law

  • Force majeure

  • Frustration

  • The right to terminated due to Brexit

The industry standard JCT and NEC contracts do not contain any specific “Brexit provisions” but there are clauses or options within both suites which parties can utilise to allocate some Brexit risks. Other risks will require bespoke wording.  As with any commercial risk, parties to a contract must carefully consider what specific risks and concerns they need their contract to address in order to create a level of certainty that is acceptable to both parties.  This will mainly be done by drafting in mechanisms and triggers to deal with the “known unknowns” which, of course, is what construction contracts have always been designed to do. 

Exclusions

Please note, in light of the extent of the impact of Brexit on the construction sector and more particularly in light of the speculative nature of these considerations, we have limited the topics that we are considering to those mentioned above. As the political/legal situation develops over coming months we will publish amendments and updates to this article as well as additional articles around this subject.  Please continue to check back to the BPE website for more information.  In particular:

  • We have deliberately decided to limit this article to consideration of domestic contracts under JCT, NEC or a bespoke form of contract based largely on one of those two standard suites. In the interests of brevity we do not comment here on international work and/or the FIDIC suite of contracts.

  • Following on from that, please note that this article focuses on the jurisdiction of England and Wales and does not comment on the laws of Scotland or Northern Ireland.

  • We have not commented here on procurement regulations and OJEU notices.

  • This article does not consider insurance issues.

  • We have not commented on wider regulatory framework issues which may have a direct or indirect impact on construction, e.g., product safety and the EC safety mark etc.

Border delays

Comment

It is impossible to predict whether or not there will be significant delays to freight transit at UK ports during 2019/20, but we do know that the government has been considering the potential impact of such delays, particularly if there is a “no deal” Brexit[1].  We also know that in 2017, the UK imported over £17,072million worth of building materials and components[2].  Given that construction materials do not have the immediate impact on human life that medicines and perishable food have, it seems not unreasonable to consider that any ‘triage’ system is unlikely to put construction materials at the front of the queue. 

What should you be considering now?

If goods/materials or even parts of the works that have been constructed off-site are delayed and this has an impact on practical completion, how does your construction contract allocate the time and cost consequences?

Customs tariffs

Comment

Even once goods are able to flow freely, will they flow without cost? Many of the potential outcomes of the Brexit process include tariffs on trade between the EU countries and the UK.  Companies used to importing from outside the EU will be used to these tariffs but this will be new territory for some.  It is also important to remember that third and fourth tier suppliers may be sourcing from different locations and this may have unexpected cost consequences.

If tariffs are introduced, importers will need quickly to get to grips with the impact on costs. For example, in August 2018, the Timber Trade Federation commented on World Trade Organisation tariffs that could apply in the event of a “No Deal” Brexit and noted that many products would remain duty free but for imported European wood-based panels could incur rates of up to 10%[3]

What should you be considering now?

Contractors being asked to provide fixed prices for projects that will involve importing goods from the EU after 30 March 2019 may wish to consider factoring in a risk of tariffs being applied to those materials. Alternatively, employers and contractors may wish to agree to allocate the risk of tariff costs, potentially with a pain/gain mechanism depending on whether or not tariffs are imposed. 

Clients and their design teams could also give consideration to materials specified: it may be possible to mitigate the impact of potential border delays and customs tariffs by specifying more UK produced goods and materials. Whether or not that has an acceptable impact on time, cost and quality is clearly one for the client once the design and construction teams have reported back. 

Shortage of labour

Comment

Freedom of movement for workers has been one of the most contentious aspects of Brexit and is arguably the most important for the construction sector. Across the whole of the UK in August 2018, EU nationals accounted for 10% of all workers in the UK’s construction of buildings sub-sector, although this percentage rose to 33% in London.[4]  Anecdotal evidence suggests that there is significant variance across the particular trades which make up the construction sector.

Even if we assume that at some stage a process will be in place for EU workers to enter the UK to work, there is not yet clarity on visa costs or how long visa applications will take. As with importing goods, delays at customs are likely to affect people too.  Assuming workers are only paid for their time on site, delays in getting through customs may make the journey to/from the UK to work too time consuming for the work to appeal to some EU nationals. 

A common amendment to the JCT suite of contracts clarifies that “a mere shortage of labour will not in itself constitute a Relevant Event”. Contractors working under a contract with this wording should therefore note that they will be afforded neither additional time nor extra money if visa issues lead to staffing issues. On a tight programme, even delays of a few weeks while visa issues are resolved could be extremely costly. 

In addition to the programming implications, a shortage of labour could create wage inflation which, ordinarily, is a cost borne by the contractor.

If the employer is risk averse, they may be accepting of the higher cost and longer programme as a fair price to pay for certainty. Where the works are urgent and/or the employer is more risk loving, the parties may agree to a lower price and shorter programme, but with a mechanism to compensate the contractor if labour issues arise as a direct result of Brexit. 

What should you be considering now?

Where is your work force coming from over the coming months? Are any particular trades more affected than others?  How will you allocate the risk of increased wages?  How would you decide who is “worth” a visa and who isn’t?

Force Majeure/Frustration

Comment

Force Majeure clauses are included in most construction contracts. Although the term has no strict definition in English law, whether the clause can be invoked will depend on its interpretation.

The underlying principle of force majeure is that on the occurrence of certain events which are outside a party's control, that party is excused from, or entitled to suspend performance of all or part of its obligations. That party will not be liable for its failure to perform the obligations, in accordance with the clause.

Force majeure may, therefore, be a legitimate excuse for non-compliance with a particular contractual obligation. In the JCT suite, “force majeure” is a Relevant Event entitling the contractor to time but not money, although force majeure itself is not a defined term.  The NEC goes further, with “force majeure” being a compensation event giving rise to time and money for the contractor.

Given the broad interpretation of “force majeure” at common law, some lawyers like given a written definition of “Force Majeure” in contracts. Generally speaking, a written definition will narrow the scope of force majeure from the common law position and so is unlikely to be preferred by the contracting party expecting to rely on force majeure/Force Majeure to avoid culpability for delay.  That said, the NEC ECC Clause 19 (on prevention) is much wider than the common law and so clients often seek to delete it to revert to the common law.   

Consideration of force majeure can be taken a step further to consider ‘frustration’: where the event in question has such an impact on the whole of the contract so as to render performance impossible.

Although it has not yet been tested in the context of Brexit, it is likely that a change in economic or market circumstances, affecting the profitability of a contract or the ease with which the parties’ obligation can be performed, is not regarded as being a force majeure event. The courts are cautious of parties terminating a contract by way of frustration when economic conditions mean that it is more expensive to perform and less commercially attractive, rather than rendering obligations impossible to perform.

That being said, contracts are already starting to be challenged in relation to the impact of Brexit. In January, the Business and Property Courts in London heard a claim whereby a tenant wished to move its practice to the Netherlands but was bound by a 25 year lease which was entered into 5 years before the Brexit referendum[5]. It was argued that the lease was frustrated by Brexit on the grounds that Brexit could not have been reasonably foreseen by the parties when it was signed, and it would be unjust to hold to parties to the terms of the contract. At the time of writing, judgement is awaited.  This is likely to be a key Brexit decision and it is hoped that the decision will be available in the next few weeks.

What should you be doing now?

At this stage it is difficult to predict how the courts will deal with Brexit as a frustration and/or force majeure event. We believe that in any event, cases will be highly specific and it will be difficult for the Courts to hand down judgments that will have wide application in later cases.

To avoid lengthy disputes and to provide clarification, it maybe that force majeure clause are amended to further define how Brexit outcomes are to be addressed. However, we would recommend exercising caution in this regard as it may be that the existing common law position gives greater protection.

In terms of frustration the usual guidance applies: it is important to use the recitals/background paragraphs of a contract to set out the intentions of the parties and the purpose of the contract. Whilst these introductory paragraphs may not have the same weight as the substantive clauses of the contract, the background information can be hugely helpful to the courts on the matter of interpretation. 

Fluctuation provisions

Comment

We know that Brexit is likely to have an impact on inflation and on the value of Pound Sterling. What we don’t know, is what effect. 

Both JCT and NEC contracts contain fluctuation provisions which provide a mechanism for dealing with the affects of inflation. The current trend for most domestic projects, is that the contractor will be expected to take inflation into account when calculating their tender price and fluctuation provisions will be struck out. Parties to the contract, especially contractors, may want to utilise fluctuation provisions in their contract. They can allow for changes in the cost of labour, transport and materials so it could provide a contractor with suitable protection should Brexit make these more expensive. Bespoke fluctuation provisions can also be drafted, this would provide flexibility and can be as simple or complex are the parties desire. Well drafted amendments could provide mechanisms to deal with many of the issues discussed in this article.

The recent propensity not to utilise fluctuations provisions has been driven by employers wanting price certainty. That client desire is likely to remain.  However, if increased costs of labour and materials is a significant risk and that risk continues to sit squarely with the contractor, then a prudent contractor will price that risk into their tender price and thus the employer pays for the risk even if they don’t take it. 

Linked to this is but contractually distinct is the issue of currency fluctuation. Usually one thinks of currency fluctuation clauses as relating to where at least one of the parties is based in a different jurisdiction to where the works take place.  However, where materials are being imported and/or entire elements of the works are constructed off-site, significant changes in the value of the pound may present a risk.  This may require bespoke drafting once the parties have considered where the risk will lie. 

What should you be doing now?

These are more risks which need to be discussed between contracting parties before documentation is signed. Consider where materials are coming from and whether or not this could have a realistic impact and then the parties need to carry out the usual exercise in balancing risk and certainty before recording the agreement carefully in the terms of the contract. 

Changes in law

Comment

Many construction contracts include a provision which deals with changes in law. The JCT require contractors to comply with ‘Statutory Requirements’ and that a change to the Statutory Requirements after the Base Date will constitute a variation. The NEC Option X2 has a similar affect.

Under JCT, where a schedule of amendments is used, the ‘Statutory Requirements’ clause is usually amended so that the contractor can only claim for changes in law which are reasonably foreseeable. At present, it seems fair to say that the fact that a law may change due to Brexit is in itself foreseeable, but what that change could be is probably not foreseeable.

Included in changes to the law would be things like product regulations and health and safety law, some of which may have statutory links back to EU law and/or EU bodies. The extent of these regulations makes detailed comment beyond the scope of this article but we will be providing updates on the impact of Brexit on construction over coming months and will provide more information at the appropriate time. 

What should you be doing now?

As usual, we remind contracting parties not to assume that a particular risk is dealt with in their chosen form of contract. Changes in the law is something to bear in mind when agreeing contract terms: the amendment to the JCT mentioned above maybe a compromise which means the parties share a degree of risk. Although with Brexit at the forefront of a lot of minds, it will probably be difficult for contractors to argue that any consequences of Brexit are not foreseeable.

Termination rights

Comment

Notwithstanding the comments above regarding frustration, parties will need to bear in mind the implications if they cannot agree on how to deal with the affects of Brexit. If a contract’s termination clause gives a party the right to terminate at will (i.e,. even if the other party is not in breach), particularly if on relatively short notice, then an amendment/further amendment may not be necessary.

It may be possible to agree certain triggers which allow for renegotiation and/or termination. These triggers could include changes in law, the imposition of tariffs and loss of licences. A contract could then provide a clause allowing for renegotiation due to a ‘Brexit trigger event’ and, if that fails, termination of the contract.

Amongst the key considerations for such a clause would be:

  • How would you define a “Brexit trigger event”?

  • Would a list work or could that be deemed exhaustive and accidentally miss something?

  • How remote from Brexit could the event be and still deemed a “Brexit trigger event”

  • How would you word the renegotiation clause to avoid an “agreement to agree” which is not allowed under English law?

  • What would the consequences be of termination? Would it depend on who triggered the termination?

What should you be doing now?

Our considered view is that “Brexit termination clauses” have the potential to be fraught with difficulty and would be subject to interpretation in any event. Having a Brexit termination clause could lead to a two-part dispute: first agreeing on whether or not the clause applied and then considering its effect.  It is important to remember that parties to a contract are always free to agree a variation to the terms of that contract, so long as the variation is agreed and recorded in accordance with any existing restrictions within the contract.  We would recommend that any post-contract negotiations and amendments to deal with Brexit (or any other issue) must be recorded carefully if they are to be binding. 

Conclusion

We are living in a time of great ambiguity and planning for uncertain events is very difficult. If you are negotiating a new contract now, you may wish to consider specific contractual provisions dealing with Brexit-related risks.

Contractors are going to find that Brexit uncertainty increases the ever-present challenge of balancing catering for possible financial risks and the need to win work. As ever, clients will need to choose between the cost of price certainty and taking on more risk.  The key is to assess the potential risks and create mechanisms which avoid a completely fixed contract so that the cost and time implications can be assessed as they occur.

We recommend that contracting parties continue regular dialogue and work through risks together. Clearly, as with any risk allocation process there is a need to be proportionate with the time dedicated to creating mechanisms for “what if” scenarios.  

Brexit Clauses Checklist

Here is a list of Brexit-related risks which we recommend parties consider discussing pre-contract. Each box in the following table can be completed with an E(mployer) or a C(ontractor) to reflect who will bear the risk.  Needless to say this can be flowed down to Sub-contractors and suppliers as necessary.

 

Risk

Time Risk

Cost Risk

Shortage of labour

 

 

Increased labour costs

 

 

Increased cost of materials (including tariffs excluding currency)

 

 

Delay in supply of materials

 

 

Inflation

 

 

Currency fluctuation

 

 

Changes in law

 

 

The co-authors of this article are Anna Wood and Katie Pickering. 

[1] Brexit: Holyhead lorry backlog plan in case of no-deal

[2] ONS Construction statistics: Number 19, 2018 edition

[3] No-deal Brexit papers released. Here's what that means for the timber trade

[4] ONS Migrant labour force within the UK's construction industry: August 2018

[5] The "Frustration" of Brexit

 

These notes have been prepared for the purpose of an article only. They should not be regarded as a substitute for taking legal advice.