A long term view for Credit Crunch
by Omar Al Saadoon
Senior Associate Omar Al Saadoon.Construction & Engineering Practice – Al Tamimi & Company
This article might deter short term speculators or pessimists (so called realists) in reading further and if so no hard feelings. I too have noticed a reduction in crane activity and generally less traffic on the Sheikh Zayed Road. I also understand and appreciate the world we have lived in is rapidly changing and the credit crunch is likely to have a profound impact on global construction industries for the foreseeable future.
To those who choose to continue reading, the title does not suggest the fear of stakeholders in the construction industry in the UAE is wholly irrational, it is just I have yet to read a convincing article which deals with a local and long term perspective.
Current industry trends
The trend in Dubai is that projects which are at the foundation or ground excavation stage or where 10% or more has been paid to the contractor are more than likely to proceed to completion albeit at reduced pace and provided there is close consultation between the developer and the Real Estate Regulatory Authority (RERA) during the project.
RERA is due to implement regulations designed to bolster investor confidence by regulating developers’ ability to sell property units. For example, a subdeveloper will be restricted from receiving more than 20% of the price of a unit from a purchaser if construction has not commenced. Another measure being discussed is for subdevelopers to own title to the land where a project is situated before plots can be sold.
It’s worth noting the Emirate of Ajman has recently followed the example of the establishment of RERA by establishing its own Real Estate Regulatory Establishment.
In light of restrictions on liquidity, contracting parties who decide to complete projects may have to agree alternative forms of payment or related security. I anticipate an increase in use of letters of credit, promissory notes or even the transfer by developers of legal title to units of property to contractors (either completed or off plan).
Such forms of security should ensure cash flow to the contractor, subcontractors and suppliers is not impeded thereby facilitating credit and survival of companies affected.
It may be fortuitous for contracting parties to “dig out” their contracts and scrutinise them in light of the downturn. The following provisions below provide a general indication (based on the FIDIC standard form) of provisions which may be relevant:
1. Notice to proceed — Assuming there is a valid letter of acceptance, an employer may either negotiate a sufficient period to serve formal notice of commencement or agree an extension of time to serve a notice to commence.
2. Security — Any demand by an employer pursuant to a performance bond must be based in good faith as per requirements of UAE law. In circumstances where an employer (as sub developer) faces serious issues of liquidity or project viability, it may be the case the demand made by the employer was not bona fide (based on performance of the contractor) but with the ulterior motive of cashing on whatever funds are readily available.
Contractors should try and negotiate with employers to include certain conditions precedent before the issuing bank or the surety is obliged to pay. However, changing the nature of a performance bond may face resistance by banks seeking to improve their level of security.
3. Vetting Nominated Subcontractors – Under UAE law the main contractor remains wholly liable to the employer for performance of subcontractors. Main contractors should try (preferably during tender stage) to negotiate a contractual right to vet all proposed subcontractors from a financial and capability point to mitigate risks of insolvency or poor performance.
4. Delayed payments and overdue payments – Contractors should try to negotiate as part of its contractual entitlement for damages, financing charges it may incur as a result of delayed payment or failure to pay on the part of the employer.
5. Suspension of work – When faced with an instruction to suspend, the contractor is generally obliged to suspend part or all works. The contractor is then obliged to protect and secure suspended works from deterioration, loss or damage. It’s not mandatory for the engineer to notify the contractor the reason for the suspension.
Therefore, it seems an employer can instruct its engineer to temporarily suspend work until such time that the employer can sort out its financial arrangement or, to negotiate with the contractor regarding its financial obligations and costs payable to the contractor.
6. Termination — The conditions of the 1999 Fidic standard form entitle an employer to terminate a contract any time for its convenience. Thus, an employer may (in theory) raise an argument to terminate a contract for reasons of financial difficulties i.e. not being able to pay by virtue of circumstances not foreseeable at the time of entering into a contract. This provision may however fall foul of UAE laws and extreme caution should be taken when deciding to terminate on this basis.
7. Employer’s Finances – Some of the Fidic standard forms allow a contractor to request and obtain from the employer, reasonable evidence the employer is maintaining a financial arrangement enabling it to meet financial obligations during the project. The contractor may invoke its right to suspend work if the employer fails to supply evidence within a prescribed period from receipt of the contractor’s request. Further failure by the employer may cause the contractor to terminate the contract.