Potential Disputes Under Common Construction Contract (2)

7 Areas of Potential Disputes

Previously on Potential Disputes Under Common Construction Contract (1), we have mentioned 3 areas of Potential Disputes in the construction project: project-related disputes, disputes from the scope of work, and disputes related to the project’s schedule. Here are the other areas of potential disputes that need to be noted, and how to avoid the disputes.

4. Contract related

Ambiguities in Contract

Ambiguities in a contract can put the parties at disputes. Therefore, it is highly advised that all parties must carefully read and clearly understand each provision before agreeing to it. Most importantly, the parties involved must understand the provisions related to resolving ambiguities.

Ambiguous contract provisions are those that are reasonably subject to more than one interpretation. For example, the word “day” could be both interpreted as “calendar day” or “working day”.

To avoid this issue, before signing off the contract, the Parties to the construction contract should understand all the effects and consequences of all provisions in the contract as fully intended, known, and understood by the parties.

Risk Allocation

Common risks in construction projects include weather, unexpected job conditions, personnel problems, errors in cost estimating and scheduling, delays, financial difficulties, strikes, faulty materials, faulty workmanship, operational problems, inadequate plans and specifications, and natural disasters. A construction contract includes a set of rights and obligations between the parties by which the parties pre-allocate responsibilities between themselves in respect of certain risks. An effective and fair risk allocation can be an incentive for a construction contract to produce its best effects.

However, in the event of the COVID-19 outbreak, Article 1244 and 1245 of the Civil Code provide that parties are covered or protected in case of force majeure.

Parties are released from their obligations if such an event happens. Since those rules are not mandatory, parties can still decide which party bears the risk. A dispute may happen because one of the parties takes advantage of the other party. For example, the Project Owner tends to allocate more risks to the Contractor and accept as little risk as possible. In this instance, the Contractor considers the contractual allocations of risk as intolerable or unsustainable. The Contractor is unlikely to bear the risk, and this may lead to legal disputes as the result of the irrational implementation of construction projects for the Contractor.

5. Manpower

Amidst the pandemic, the Minister of Public Works and Housing (MPWH) has issued Instruction No 02/IN/M/2020 on Protocol to Prevent the Spread of Corona Virus Disease 2019 (Covid-19) in Construction Service Works (“MPWH Instruction“) to mitigate the COVID-19 risks in relation to construction service works. The MPWH Instruction provides that in the event a construction contract is suspended due to force majeure, the following conditions shall apply:

Establishing the mechanism for work suspension;
Establishing the mechanism for changes in contract specifications; and
Compensation in the form of fulfilling (i) the payroll of the construction workers during the suspension period, and (ii) the payment obligation to sub-contractor, producer, and supplier during the suspension period.

If the parties have included a pandemic or disease outbreak as a type of force majeure in the contract, then the existence of Covid-19 has been strengthened by MPWH Instruction, which makes it clear that it can be used as a basis for the Contractor to delay the implementation of their obligations.

However, if a disease or pandemic is not categorized as force majeure, the Contractor cannot automatically neglect its obligations to carry out construction activities. Construction disputes are inevitable as the Contractor cannot perform the work on site during the pandemic. In that case, the Project Owner may sue the Contractor due to a breach of contract.

6. Claim and payment

Liquidated damages

Liquidated damages are damages stated in the construction contract, the funds of which are chargeable to the Contractor for each day the Contractor fails to complete the project beyond the contract completion date. In the contract, the Project Owner cannot only set a completion date but is also required to set the completion of portions of the work by interim dates. These interim dates, commonly known as “milestones”, require the Contractor to schedule and perform the work in a manner that meets the milestones. In addition to the contract completion date, a liquidated damage provision may also apply to milestone dates. Under these circumstances, the damage assessment liquidated due to failure to meet multiple milestone dates would then be cumulative. The contract milestone or completion dates can be changed, and these changes can be agreed upon between the Project Owner and the Contractor, usually resulting in a “change order” to the contract. The construction disputes may arise as the Project Owner and the Contractor have different opinions as to whether a contract has been constructively changed, and if so, the contract change adjustment must be fair and balanced.

Insurance

A project owner may just figure out that its insurance does not cover problems that are resulted from the pandemic. Generally, liability insurance policies will usually cover a broad range of damages, including:

Construction insurance, such as building materials, foundations, and property.
Worker’s compensation, such as bodily injury, occupational illness or disease, or death of Contractor’s employees
Financial failure

Construction Companies are likely to experience dramatic reductions in cash flow and working capital as a result of the recent global economic shutdown. Insolvency is on the rise, as is bankruptcy. Whilst some losses incurred during this period will occur, the Project Owner and the Contractor are likely to give rise to disputes. They both will attempt to manage claims in a way that benefits themselves financially. Generally, the Project Owner is responsible for paying the Contractor, and the Contractor is responsible for paying the subcontractor, but during the pandemic, they will opportunistically seek a financial gain at the expense of the other party to the contract. The dispute arises as the Parties responsible for paying may be slowing down the payment, or may attempt to pursue claims to justify not having to pay.

Overhead cost

Any construction project consists of two types of overhead costs. The first is direct costs, and the second is indirect costs. Direct costs are the costs incurred on labor, material and equipment expenses needed to physically do the work. Indirect costs (also called field office or jobsite overhead costs) are costs that increase due to a critical and compensable delay. Compensable delay is commonly described as delays caused by the Project Owner, but also includes delays caused by events or circumstances for which the Project Owner has assumed liability under the terms of the contract. In this instance, the Project Owner must assume the liabilities leading to delays, including different site conditions or delays in delivery of equipment or materials furnished by the project owner. In such cases, the Project Owner is usually entitled to recover an amount of damages equal to the number of days of delay multiplied by the amount of liquidated damages.

However, disputes may happen if the Project Owner finds that the Contractor is subsequently at fault for a delay in the project construction. Because the delay is caused by the Contractor, the Contractor is entitled to recover the overhead costs.

7. External factors

Government Policies

MPWH Instruction elaborates on the implications by highlighting the mechanisms of (i) temporarily suspending works, (ii) changes in specifications and (iii) compensation. With this instruction, however, delays and extension of time in construction service works may be expected due to the Covid-19 situation.

Unforeseen Changes (e.g. pandemic, weather, riot, etc.)

Unforeseen changes create substantial risk for the construction sector, especially with respect to schedules, costs, quality and, in some instances, terminations of parties or the entire projects. It is important for the Parties to mitigate those impacts to the maximum extent as possible. Under this event of uncertainty, the Parties are expected to continue to carry out the construction in this environment. Some of these considerations include:

Specifying where equipment and materials come from when some manufacturing locations may be shut down while others are not;
Examining partnership, joint venture, participation and loan documents that address project ownership, risk-sharing and financing;
Studying insurance policies, bonds, guarantees or security agreements that could allow risks of a large-scale construction project to be offloaded to a third-party surety or insurance carrier.

How to Avoid Disputes

Here are some tips for avoiding construction disputes:

Good management

As we are certain that every construction project will face impacts, it is highly recommended to create a comprehensive risk management plan at the beginning of the project. A comprehensive risk management plan requires a high level of expertise and a very thorough project analysis because the most successful risk management plans cover a complete lifecycle of the project. The Project Owner should create a plan on recognizing the risk, assessing the risk, and planning for the Risk: The lesson here is that the more planning is done ahead of time, the easier it will be to manage the risk.

Clear contract documentation

When construction documentation is being discussed, we would think of time logs, budget, bids, design, drawings, and minutes of meeting as the only documentation required in the field. Additionally, thorough and organized documentation is needed throughout the project so that it will be easier to look through the files needed in times of assessment with the Contractor or when litigation arises

Partnering and alliancing

Partnering recognizes that there are two parts to every construction project contract. The first part is a written contract, which establishes each party’s legal requirements. The second part is the working relationship, which describes how the parties communicate with each other, how they resolve disputes, and how they execute the contract to fulfill the needs of each party

Good project management

When managing a project, the Parties should avoid issues relating to financial conditions, schedules and major risks during the project. A construction project can easily go millions and even billions over budget. Some Project Owners may request a project cost audit as part of usual due diligence. The audit report should be helpful for determining a quantitative measurement of the issue including its monetary impact on the project, and whether a perceived problem is truly an issue according to the contract.

On scheduling, the Project Owner’s review and acceptance of the baseline schedule help ensure that all parties are aware of the activities and work sequences that need to take place to complete the project on time. Timely and accurate schedule updates allow the parties to identify and possibly mitigate delays.

The Project Owner and the Contractor should determine what risks have the highest probability of occurring in the project. The most common risks in construction projects are related to labor issues, unsafe working conditions at construction sites, poor documentation, and disputes.

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Dendi Adisuryo
dendi.adisuryo@adcolaw.com

Liza Mashita
liza@adcolaw.com

@2020 ADCO Law. All rights reserved.
This publication has been prepared by Nursanti Savitri Kireina for general informational purposes only to provide clients with information on recent legal developments and is not intended as legal advice or opinion.