In the first of a series on the legal implications of the economic downturn, we run through the options for limiting your exposure to risky projects
In recent months demand for new properties has plummeted and banks have become increasingly keen to limit their exposure to risk. For projects that are nearly complete, it would be sensible to build them and hope for better times, but banks will be tempted to mothball or withdraw from schemes that require significant expenditure to complete.
In most cases it will be in the interests of the funder and the developer to work together to retreat with minimum expenditure. Either way, though, it is up to the employer to take the necessary action. Here are a number of options.
Some standard forms – including NEC/ECC and GC/Works – allow employers to terminate without cause, but do entitle contractors to compensation.
Even if such a clause exists, the employer should check if a default on the contractor’s part entitles it to terminate at no cost. On most jobs, though, such a breach is likely to have been addressed already.
There is also a need for care owing to the obligations of good faith in many standard forms. The NEC/ECC, for example, calls for mutual trust and co-operation and JCT requires termination not to be applied frivolously. If the developer falls foul of such a provision, it could be exposed to a damages claim.
Another option is to omit works that can be left to a later date. There will generally be a part of the contract that assesses the value of such omissions. This will, of course, not always be feasible. The stage the work has reached may not lend itself to omissions. Also, if the aim of omission is to enable the employer to get the work done at a lower cost, this may lead to claims of loss of profit.
Suspend or postpone
Arguments based on the economic downturn are unlikely to amount to force majeure
A right to suspend or postpone work is a feature of many contracts. This may be a sensible solution to gain short-term breathing space. On the other hand the contractor may be entitled to an extension of time and additional costs. It may also have the right to terminate if the works remain on hold for some time. This would generate extra costs and put the contractor in the driving seat.
Any other options?
In some circumstances an event beyond the control of one of the parties may entitle it to argue that performance should be suspended or the contract brought to an end without exposure to a claim. There are two ways in which this can happen. First, the contract, such as the JCT forms, may provide for suspension or termination for force majeure. This is an event beyond the party’s control that prevents all or most of the contract being performed.
Second, the common law doctrine of frustration arises when an event after the formation of the contract makes it impossible to fulfil it or transforms the obligation into one that is radically different from that initially thought.
As you might expect, most frustration cases turn on their own facts. Some events such as the outbreak of war or the expropriation of an oil concession are classic cases where a court has decided that the contract concerned has been frustrated. On the other hand, in a leading construction case where unexpected delays in the post-war demobilisation of troops caused labour shortages, the resultant cost increases and delays were held not to amount to frustration as there was no radical change in the obligation.
Recent cases have confirmed that arguments based on the economic downturn and the resultant scarcity of funds are unlikely to amount to force majeure or frustration. The view of the courts is that the seller or employer bears the risk of the availability of supply or payment and if that obligation has not changed, it will be held to its bargain. Unless the contract specifies the source of payment, the argument is likely to fail.
In short, neither contract nor general law is likely to allow the employer to stage a Houdini–style escape from its obligations if its funding dries up. Any slowdown, suspension or termination of the contract will almost certainly trigger additional costs. It would, therefore, make sense for a developer to think carefully through the implications of the options discussed above before taking action.
Henry Sherman is a partner at CMS Cameron McKenna