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Conflict in Ukraine - What does it mean for the UK Construction Sector

25 March 2022

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    Introduction

    The conflict in Ukraine is having immediate, significant and far-reaching economic consequences. This is partly due to the swift international response triggered by the conflict, with the US, EU and UK (among a number of others) imposing a series of significant sanctions (many joint and coordinated) against Russia. These are increasing daily.

    Broadly speaking, the sanctions imposed to date target a number of areas of the Russian economy and particular military and political leaders in Russia and Belarus, and restrict the importation of certain Russian exports. To keep up to date on these sanctions, visit our Russia sanctions tracker.

    Implications for the construction sector

    The Ukrainian conflict and the related sanctions are already having an impact on the price and supply of materials and equipment critical for projects in the construction sector. In the UK, this sector typically operates on small profit margins but requires significant resources for works to be progressed. Accordingly, any impact on supply chains quickly gives rise to financial pressures. The conflict will further exacerbate an already turbulent market, hit by Brexit, COVID-19, shipping disruption, inflation and rising energy and fuel costs.

    In particular, Russia is a key global supplier of steel, iron, nickel, chemical products and wood. Critical exports from Ukraine also include steel, iron, nickel and chemical products as well as machinery and transport equipment. Disruption to these supplies caused by the conflict and the sanctions that have followed will add to the increased price volatility in the commodities market putting pressure on supply chains. 

    The conflict has also had an impact on the cost of fuel, given the high European dependency on the supply of gas and oil from Russia, with prices for both increasing significantly. These prices may remain high and could increase further, meaning that the cost of materials used in projects that require intensive energy input to manufacture and produce such as steel, bricks, plastics and ceramics will likely increase. Transportation costs for equipment, plant and materials used in construction are also likely to go up. 

    In this article, we consider the potential impact on current projects by reference to three common standard form contracts: the JCT Design & Build Contract 2016 (JCT), the NEC4 Engineering and Construction Contract (NEC) and the FIDIC Red Book (2017) (FIDIC).  We also consider the potential impact of these factors on future projects and how these may be procured.

    What does the conflict mean for current projects?

    The possible impact of the Ukrainian conflict on existing projects will vary and the factual position will need to be considered carefully on a project by project basis. Impacts may include delay and disruption caused by materials and goods shortages affecting deliveries; cost overruns; changes in the scope or nature of the works (variations); and, possibly, arguments around the triggering of suspension or even termination rights. 

    Understanding the contractual position and the position under the governing law of the contract, is therefore essential. We set out below how time and cost issues are dealt with under the standard form contracts under English law before addressing two general ways that non-performance risk is allocated – force majeure and frustration.

    It's also important to remember that parties are obliged at law, and often pursuant to the express contractual terms, to mitigate their loss where possible and such efforts, for example, to source materials from elsewhere, will need to be considered carefully as part of any assessment of entitlement. Questions of causation should also be carefully considered, including pre-existing issues, which mean the impact of the conflict is not the main problem.

    Another factor to bear in mind is that each of the contractual clauses referred to below is subject to a notice requirement and parties risk losing their contractual entitlements if notice provisions are not complied with in terms of timing and/or content. 

    Potential grounds for an extensions of time and additional costs/price adjustments under the standard form contracts

    ContractAdditional Time?Additional Money?
    JCT

    Grounds for an EoT might include:

    • Clause 2.26.14 (Force Majeure): force majeure is undefined in the JCT contract but broadly refers to an event causing delay to completion that is not reasonably contemplated by the parties when the contract is signed, and which is beyond the reasonable control of the party seeking to rely on the provision.
    • Clause 2.26.12 (Change in Law): "….the exercise after the Base Date by the United Kingdom Government… of any statutory power…which directly affects the execution of the Works". This would include the imposition of sanctions by the UK government and therefore may constitute a ground for an EoT.

    Neither change in law nor force majeure are listed as "Relevant Matters" so the contractor would not be able to claim for additional loss and expense.

    However the contractor may gain relief under other contractual provisions including:

    • Clause 5.1: if the change in law necessitates an amendment to the Employer's Requirements, this would be treated as a "Change".
    • Clause 2.2.1: the contractor is only required to use materials and goods of the kinds and standards described in the Contract Documents "so far as [they are] procurable", suggesting that if they are not procurable, this could be grounds for a "Change".
    • Contract Particulars 4,2, 4.12 and 4.13: incorporation of optional price fluctuation provisions which may allow Contract Sum adjustments to account for inflation.
    NEC

    Additional time and money are assessed together to the extent they are caused by a qualifying "compensation event". Grounds include:

    • Clause 60.1(19): an event which stops the contractor completing the works entirely or by the date for planned completion and which "neither Party could prevent, an experienced contractor would have judged at the Contract Date to have such a small chance of occurring that it would have been unreasonable to have allowed for it".
    • Option X2 (Changes in law): a change in the law of the country in which the site is located will be a compensation event if it occurs after the date of the contract.
    • Clause 60.1(1): if the Scope requirements are 'impossible' to perform, the Project Manager must give an instruction under clause 17.2 changing the Scope as necessary, with such an instruction being a compensation event under clause 60.1(1). However, 'impossibility' is a high threshold and performance simply being more difficult or costly will not be enough.

    Same as entitlement to additional time. Other points to bear in mind include:

    • Clause 10.2: contractors may highlight the parties' obligation to "act in a spirit of mutual trust and co-operation" as a way of encouraging the Project Manager and/or the client to work with the contractor to overcome the issues and fairly compensate it for any losses genuinely sustained.
    • Option X1 (Price Adjustment for Inflation): this can be used with some NEC pricing options and gives the contractor scope to claim adjustments to the Prices for market volatility/price increases relating to goods and materials.

     

    FIDIC

    The contractor is entitled to an EoT for delays caused by:

    • Sub-clause 8.5(d) and 8.6: "Unforeseeable shortages in… personnel or Goods… caused by … governmental actions", as well as Unforeseeable delays or disruption caused by public authorities of the country in which the site is located.
    • Sub-clause 18.1: an "Exceptional Event" (in other words, force majeure) which "(i) is beyond [the contractor's] control; (ii) [the contractor] could not reasonably have provided against before entering into the Contract; (iii) having arisen, [the contractor] could not reasonably have avoided or overcome; and (iv) is not substantially attributable to the [Employer]". Such events are expressly said to comprise "war, hostilities (whether war be declared or not), invasion, act of foreign enemies" (whether in the country in which the works are being carried out or not).
    • Sub-clause 13.6: changes in law of the country in which the works are carried out (including changes to permits and licenses).

    The contractor is entitled to additional cost incurred as a result of:

    • Sub-clause 18.4(b): an 'Exceptional Event' if the particular event relied on is "war, hostilities (whether war be declared or not), invasion, act of foreign enemies".
    • Sub-clause 13.6: changes in law of the country in which the works are carried out (including changes to permits and licenses).

    Other points to bear in mind include:

    • Sub-clauses 13.1-13.3 : "Variations" and "Value Engineering" proposals may be submitted by the parties to change the works if unforeseen circumstances arise.
    • Sub-clause 13.7: parties may elect to include Schedule(s) of cost indexation in the contract. If they do, the amounts payable to the contractor will be adjusted for rises (or falls) in the cost of labour, Goods and other inputs to the Works by adding or deducting amounts calculated in accordance with such schedules.

    What about rights to suspend or terminate?

    On some projects, entire contracts or certain obligations may not be able to be performed at all, or for a certain period of time, and suspension and termination rights on the basis of force majeure will be under scrutiny.

    To determine the parties' rights under English law will be a question of looking at the contract (and, of course, there may be other contractual grounds for suspension or termination that are relevant aside from force majeure, for example, the NEC contains an optional clause giving the Client the right to terminate at will (Option X11)).

    Generally, whether the Ukrainian conflict and/or any resulting unavailability or restriction of particular goods or materials constitute a force majeure event will need to be assessed on the particular facts in each case against the relevant contractual wording. However, the fact that contract performance has simply become more onerous or expensive is unlikely on its own be sufficient, meaning that force majeure (that entirely prevents performance) is harder to argue in situations where materials are more challenging to source or prices have increased. Mitigation will also be relevant in this context.

    Termination rights under the standard form contracts for force majeure1

    ContractTermination Right
    JCTClause 8.11.1.1: Either party may terminate the contract on notice if a suspension for force majeure continues for more than two months.
    NECClause 91.7: Client has option to terminate the contractor's obligation to provide the works if the force majeure event will prevent completion of the works or is forecast to delay it by more than 13 weeks.
    FIDIC

    Sub-clause 18.5: Either party may terminate the contract if an "Exceptional Event" causes a delay of 84 continuous days or multiple delays which total more than 140 days.

    Sub-clause 18.6: Either party is also entitled to serve a termination notice if any event arises outside the control of the parties which makes it impossible or unlawful to perform their contractual obligations, and the parties are unable to agree an amendment to the contract. This might be relevant but 'impossibility' of performance is a high threshold.

    If a contract becomes physically or commercially impossible to perform, the common law doctrine of frustration may apply to automatically discharge the parties from their obligations. However, the threshold for frustration at common law will ordinarily be significantly higher than the threshold for force majeure. 

    Frustration is also less likely to be successfully invoked where contracts contain a force majeure clause which addresses the scenarios that may arise as a result of the conflict. In practice, the doctrine of frustration is likely to only be invoked in the most extreme circumstances and when the relevant construction contract does not have the ordinary mechanisms to deal with those circumstances.

    What is the impact on future construction contracts and the sector generally?

    The applicability of a force majeure provision will depend on whether a particular circumstance was unforeseeable at the time the contract was entered into. Some, although arguably not all, future impacts of the conflict are now foreseeable, such that a claim for force majeure will no longer be possible in respect of contracts currently under negotiation. Equally, change in law provisions typically apply to changes after the contract has been entered into, so wouldn’t apply to current sanctions or restrictions.

    It follows that parties will want to mitigate against future uncertainties by addressing them upfront. Potential ways of doing this might include:

    • Drafting works specifications more widely to give contractors more flexibility when procuring materials in terms of the identity of the supplier and/or type of material;
    • Re-reviewing the validity and appropriateness of prices and/or work programmes included in bids for projects currently being tendered;
    • Using provisional sums for certain works, if appropriate, to allow for greater price flexibility;
    • Shifting the supply strategy for certain goods or materials from just-in-time delivery to stockpiling – which, in turn, will require more upfront payments from employers (and accompanying security in relation to such payments);
    • Contractors may look to de-risk their project portfolio by seeking cost reimbursable contracts. Employers, on the other hand, will be looking for fixed price tenders to limit their exposure but may find that the appetite amongst contractors to take this risk on is limited without a significant price hike; and
    • Inclusion of cost fluctuation provisions (including those set out in the table above) to safeguard against cost increases of materials flowing from the conflict or sanctions being imposed.

    Final thoughts

    Russia's invasion of Ukraine, and its devastating impact on the Ukrainian people and their homeland, is having far reaching and unprecedented consequences. For the UK construction sector, the conflict has added to a number of other major challenges the industry is currently facing. In this update we have attempted to shed some light on how construction contracts will respond.

    1. It's worth noting that, over the course of the Covid-19 pandemic, parties have often agreed to temper these strict obligations in recognition of the difficulties that have been widely experienced. Similar negotiations may occur as a result of difficulties stemming from the war in Ukraine.

    Authors: Sadia McEvoy, Stefan Jammes and Carrie Leader

    The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
    Readers should take legal advice before applying it to specific issues or transactions.

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