Does COVID-19 allow builders’ clients to change their minds?

By Commerical lawyer, Geoff Hardy.

At the time I wrote this, we were a week into Alert Level 3 and we were preparing for the transition to Level 2.

Building firms had returned to work but they were having to observe all the social distancing, personal protection equipment, hygiene, contract tracing, and other precautions that applied to both those levels.

They were also facing backlogs in the supply of building materials. That meant they were going slow and incurring additional cost. On top of that, they had returned to projects where the structure or the site may have deteriorated during the lockdown, and plant and equipment such as scaffolding and hired generators had been lying idle and running up wasted charges. The discussion about who was going to pay for all of this was probably still to come.

But perhaps the worst of all, was that their clients the property owners were staring at an uncertain economic future and were having second thoughts about whether their building project was such a good idea after all.

In those circumstances, it is natural that many owners would want to do one of two things – suspend work, or suspend payment.

And for those projects which had already been signed up but not commenced, it was just as likely that they would want to call them off.

Many builders are going to be confronted with this and they are going to want to know whether they have to go along with it. The purpose of this article is to provide some guidance on that.

I suspect most property owners who are already part-way through a building project are going to want to see it finished, or at least completed to a stage where it is usable, weathertight, and secure. After all, they probably had their project finance in place, and a half-finished structure isn’t any use to anyone.

However, if their incomes have taken a hit then they might want to soften the blow of the accumulating costs, and that means slowing up payment.

I have heard of many cases, for example, where the owners have told the building company that the security deposit it was holding was going to have to be applied towards payment of the outstanding invoices instead of being retained for a rainy day.

Now whether the owners want to change the payment terms, put the project on hold for a while, or even bring it to an end, the starting point is that neither party can force changes on the other without their consent.

A deal is a deal, and there is nothing about COVID-19 that alters that deal.

If the parties didn’t anticipate a pandemic and didn’t cater for it in the contract, then they have got to carry on as though it didn’t happen.

So just as the building company has to keep working, so the owners have to keep paying.

That doesn’t mean that the building company can ignore the Government and keep working as normal right through lockdown. But it does mean that it could be in breach of contract by complying with that directive, regardless of the fact that it had no choice.

Fortunately, most sophisticated building contracts do cater for this situation to some extent. Some of them contain force majeure provisions that excuse a party from complying with its obligations when they are prevented from doing so for reasons beyond their reasonable control.

And most contracts entitle the contractor to an extension of time (thereby avoiding having to pay damages for delay) for similar reasons. The only catch is that the building company has to try to get around the interruption and must resume work as soon as reasonably possible. And in some contracts there is a deadline for applying for the extension.

What about the owners’ obligations to pay the building company and not hold it up? Can the owners rely on force majeure, assuming the contract has such a clause in it, to get around those obligations?

Well to do so they would have to point to a cause beyond their reasonable control that prevents them from complying with their obligations. And it’s doubtful whether COVID-19 prevents them from paying the building company and allowing it to continue uninterrupted.

Fortunately for the owners, some building contracts such as NZS 3910:2013 allow the engineer to suspend part or all of the work indefinitely, if it “becomes necessary”.

It is debatable whether a looming depression makes suspension “necessary”, but the consolation for the building company is that it can treat the suspension as a variation, and submit claims for the resulting costs and an extension of time.

If the suspension continues for more than three months the building company can ask that the suspension be lifted, and if it isn’t lifted within a further month, the building company can get out of having to do the affected work at all.

As an alternative, can the owners change the rules by ordering a negative variation?

Most building contracts allow owners to order variations, including removing portions of work from the building company’s scope of work. Technically they could remove all remaining work from the project, and call it to a halt. But the law forbids them from doing so, because that would be a termination in disguise.

The final thing the owners might contemplate doing is terminating the building contract. That is more likely to happen with projects that have been signed up but not commenced, but it could equally happen to projects that are already underway.

The important point for both parties to remember is that it’s not that easy to cancel a building contract. Normally both parties must see it through to the end.

There are some exceptions to the rule, of course, and those exceptions are either spelled out in the building contract itself, or they are found in the Contract and Commercial Law Act 2017.

Precisely which ones apply depends on the building contract that you use, but they typically include situations where the other party goes bust, or is seriously in default of its obligations, or it abandons the project or becomes incapable of carrying it out, or for some reason it becomes impossible for the parties to carry the project out.

None of those situations necessarily occurs just because of COVID-19. That is because COVID-19 is hopefully only a temporary phenomenon.

Although building companies were prohibited from working during Alert Level 4 unless they were providing essential services, and they were technically in default for not working continuously, most of them could rely on force majeure as an excuse, or claim an extension of time.

And the fact that they returned to work during Level 3 demonstrated that they hadn’t abandoned the project, they hadn’t gone bust, and they were capable of seeing it through to the end.

So where does that leave the building company?

Although it might have to accept a suspension of work (depending on the contract), it will be compensated for that.

More importantly the building company does not necessarily have to accept a termination, or a change in the payment terms for that matter.

Admittedly, the building company would normally be realistic and would accommodate a good client’s reasonable requests. But the important point is that it should be on the building company’s terms, not on the owners’ whim.

Geoff Hardy has 45 years’ experience as a commercial lawyer and is a partner in the Auckland firm Martelli McKegg. He guarantees personal attention to new clients at competitive rates. His phone number is (09)-379-0700, fax (09) 309 4112, and e-mail geoff@martellimckegg.co.nz. This article is not intended to be relied upon as legal advice.