Construction Law

By Heba Osman

Descoping is usually instructed by employers as a variation omitting large parts of the works. Many employers appear to believe that they are contractually entitled to descope, which in part is true. However, many employers instruct the omission of large parts of the works for one of the following reasons:

Most standard construction contracts entitle the employer to issue variations to the works through omission. This means that an employer does not have to go through the argument of terminating the contract when it can simply descope.

Descoping is a non-confrontational method that employers appear to turn to when they do not wish to get into the difficult situation of terminating the contract. Typically termination, whether for convenience or fault, triggers a dispute between the employer and the contractor. Many employers wish to avoid such a situation by simply omitting all or parts of the work.

The majority of construction contracts in the Gulf region maintain the principal features of the FIDIC forms of contract, yet there are also many subtle changes. These changes tend to upset the balance of risk allocation between the parties. In the UAE, many contracts appear to be drafted in one-sided language biased towards the employer. The roots of these contracts appear to have come from the Dubai Municipality construction contract, which was initially drafted for the use of the Dubai Municipality as a Governmental entity but then found its way to many of the UAE employers. In this respect, such one-sided contracts are not generally suitable for private employers, and contractors should be very careful in signing such agreements. These are not FIDIC standard contracts and thus do not contain the proper risk allocation that should be expected.

Nevertheless, most construction contracts, whether standard forms or otherwise, contain variation clauses. Without such clauses and provisions, neither the employer nor the contractor is legally entitled to deviate from the agreed scope of works. If there is no variation provision, the contractor cannot be compelled, for example, to perform additional works and the employer cannot, without being in breach of the contract, omit any works that have been agreed.

Variation clauses introduce much needed flexibility into somewhat rigid rules that otherwise govern the parties’ obligations arising under construction contracts. In other words, if there is no variation provision, the law requires the parties to the contract to perform exactly what they have agreed upon and any change to the scope of the works would have to be mutually agreed between the parties under a written amendment to the contract. The variation provisions entitle the employer unilaterally to amend the scope of the works without the need to amend the contract itself.

Clause 51 of the Red Book fourth edition, being the most widely used standard form of contract in the Middle East, defines a variation as:

This clause 51 also entitles the employer, through the Engineer, to “instruct an omission of the works, provided that the Employer does not carry out these omitted works by himself or through others”.

Clause 51 clearly states that:

An engineer’s variation instruction by omission must meet the basic requirements of being in writing or given orally and subsequently confirmed in writing; be in respect of the form, quality or quantity of the works or any part of the works; and, in the engineer’s opinion, be necessary or otherwise appropriate.

Whenever variations are ordered omitting works under clause 51, and particularly if such omitted work is substantial, contractors often argue that they should be entitled to claim loss of the profit they would have earned on such works if carried out. In principle, if the variation omitting works is invalid (say, for not being in writing, or not necessary or appropriate) then this invalid omission may be construed as a breach of contract entitling the contractor not only to loss of profit, but also to damages due to breach. Where the works have been omitted and given to others to carry out, it is clearly established that this is a breach of contract and not a valid variation order.

Similarly, if the employer himself or another contractor carries out the omitted work, loss of profit and damages can be claimed, unless it can be proved that the contractor is technically or financially incapable of carrying out such omitted work. However, in many of the bespoke construction contracts drafted in the UAE, employers retain the right to omit a part of the scope and get it done by another contractor under a separate contract. In such instance, the employer becomes immune to claims for loss of profit or damages as a result of such omission.

The existence of a variation clause does not give the employer a free hand in making large-scale or significant changes to the nature and scope of the works. Clause 52.3 of the FIDIC Red Book entitles the contractor to a fair valuation of variations that increase or decrease the Contract Price by more than 15%. Such excess variations are not valued in accordance with the Bills of Quantity as other variations but are to be agreed between the contractor and the employer; if no agreement is reached then such an amount is to be determined by the engineer, having due regard to the site status and general contractor overheads.

It is also worth considering the variation provision of the new Red Book, which is really no longer that new, being issued in 1999, which provides in clause 13 that variations may include: “(d) omission of any work unless it is to be carried out by others”.

The interesting part about this provision is that when compared with the old version of the FIDIC Red Book it does not refer to whether the employer would be entitled to carry out these omitted works by itself. In the UAE, there appears to be no court decisions in this respect as this form of contract, despite being in use for over 15 years, has not found its way to the UAE.

Descoping v termination

This begs the question: why do employers turn to descoping instead of termination? As has been said, employers have a tendency to use descoping as a mechanism to avoid termination in situations where termination would be more appropriate. This is especially true when you consider that descoping may cause the employer to incur damages and immediate expenses compared with the use of termination.

As mentioned, employers tend to use descoping in one of four scenarios:

In the first scenario, if the project has become too expensive for the employer to fund, the employer has the right to descope as a matter of UAE law under Article 893 of the UAE Civil Code. This provision entitles both the employer and the contractor to terminate the contract “if any cause arises preventing the performance of the contract or the completion of the performance thereof”.

Of course termination or cancellation of a contract in the UAE would need to be agreed mutually or through the courts if there is no clear provision entitling the employer to unilaterally terminate. Employers are, therefore, advised to ensure that their contracts clearly give them the right to unilaterally terminate the agreement without the need for court intervention.

A clear provision entitling the employer to terminate for convenience is therefore quite important and it should mention in as much detail as possible the expenses or due amounts that the contractor would become entitled to in the event that the employer exercises his right to terminate for convenience.

In the second scenario, if the employer realises it has entered into a bad deal with the contractor this is indeed a risk that the employer has to bear. However, in this scenario, the employer needs to assess the cost of termination versus the cost of descoping. If there is a termination for convenience provision, then the employer is best advised to use such a provision rather than descope and hire another contractor to complete the works. If the employer opts for descoping it opens itself up to the risk of being liable to the contractor for loss of profit and damages for breach. In the event of termination for convenience, the employer’s liability will more likely be limited to loss of profit.

In the third and fourth scenarios, where there is a breach on the part of the contractor or the contractor’s ability to complete the works is questionable, then the route that should be followed by the employer is termination for breach. The FIDIC Red Book entitles the employer to terminate the employment of the contractor in the event of the contractor’s default. This is different from terminating the contract itself which continues to be valid. If the employer terminates the contractor’s employment, the employer’s liability to make any payments (if any) to the contractor does not begin until after the expiry of the defects liability period and after the engineer has assessed the cost of execution, remedy of defects, delay in execution and damages. On the other hand, in the event of descoping the works, the contractor’s right to claim loss of profit is immediate.

Moreover, as a matter of UAE law, an employer is entitled under Article 877 of the UAE Civil Code, if he is not happy with the performance of the contractor and after giving notice to the contractor to remedy his default, to request the court to authorise him to hire another contractor to complete the works at the expense of the contractor. In the UAE, this is quite a fast procedure that allows the employer to move on and hire another contractor in a fast and efficient manner.

In any event, when assessing whether to terminate or descope, it is important to have regard to Article 895 of the UAE Civil Code, which provides that a “party suffering harm by the cancellation may make a claim for compensation against the other party to the extent acknowledged by custom”.

This means that essentially the assessment of damages incurred as a result of contract termination would be considered in accordance with the custom of the construction industry as may be evidenced through experts working in this field.

Conclusion

The conclusion that employers and contractors alike should take away is that a clear drafting of contracts is paramount, and the use of the contract provisions for what they were intended would in fact save them more money in the long run. Yes, descoping appears to be a simpler approach; however, when used as a substitute for termination it will prove more costly than termination.

Fenwick Elliot

By Andrew MacCuish and Sai Dandekar

When pursuing a debt, it is common to add a claim for interest on the monies due.  However, the right to claim interest is often an area of confusion for contracting parties in the UAE, since Sharia Law prohibits the payment of interest (termed “Riba”), whether compound or simple.

The basis for this is the fact that Sharia Law, in pursuit of the objective of establishing justice and eliminating exploitation in business transactions, prohibits all sources of unjustified enrichment and all dealings in transactions that contain excessive risk or speculation.

These principles of Sharia Law, reflected in the UAE Federal Civil Code¹ and Article 409 of the UAE Penal Code², make usury between natural persons a criminal offence, with the penalty being possible imprisonment and/or a fine.

This article examines the statutory status of interest (or Riba) and the UAE Courts’ approach to it.

The UAE Civil Code

Under UAE law, the concept of Riba is addressed within the ambit of Federal Law 5 of 1985 (“UAE Civil Code”).

Article 204 of the UAE Civil Code states:

Therefore, on the face of it, there is a prohibition on any increase or decrease in the value of the money lent by way of interest.

Article 714 of the UAE Civil Code contains anti-usury provisions in respect of lending and states:

In practice, this renders void any provision in a loan contract that would provide a benefit that exceeds the “essence” – i.e. the subject matter of the contract, other than securing the lender’s right to amount lent.

However, perhaps due to concerns from the banking and financial community, the Constitutional Department of the UAE Federal Supreme Court, in its Decision No 14/9, issued on 28 June 1981, permitted the charging of simple interest in connection with banking operations, stating that this was a necessity for the economic existence of the UAE and for the wellbeing and benefit of the public.  The Court held that contractual interest received by a bank was lawful, for as long as a compelling need to maintain the system of interest remained, and would only remain lawful until such a time when the need was eliminated by a new banking system.

Commercial Code

Perhaps taking the lead from the Federal Supreme Court, the UAE Federal Law No. 18/1993 (‘Commercial Code’) was introduced to expressly permit interest on delayed payment.  It is generally accepted that the prohibition in Article 714 of the UAE Civil Code does not apply to matters governed by the Commercial Code.

Pausing here, it is useful to remember the role of the Commercial Code.  The Commercial Code takes precedence over the Civil Code, in respect of the commercial transactions that fall within the former’s ambit – i.e., a ‘trader’ transaction where at least one of the parties is a trader and/or the transaction concerns ‘commercial activities’.  One consequence of this is the possibility that certain construction contracts are governed by the Commercial Code.

Article 76 of the Commercial Code states, in respect of commercial transactions:

Further, Article 77 of the Commercial Code states:

“Where the contract stipulates the rate of interest and the debtor delays payment, the delay interest shall be calculated on basis of the agreed rate until full settlement.”

Thus, the Commercial Code is clear that, if contractually agreed, a debtor is obliged to pay interest as compensation for the delayed payment, on the rate agreed to by the parties.

Similarly, Article 88 of the Commercial Code states:

In this context, it is worth noting that the Abu Dhabi Court of Cassation has set out certain criteria, which must be met if Article 88 of Commercial Code is to be applicable³.  These are: the subject matter of the obligation must be a sum of money; at the time of demand for payment, the sum must be an ascertained amount; and, the obligor (i.e. the debtor) must have delayed payment.

In addition, Article 90 of the Commercial Transaction Code states:

This position is confirmed further in Article 409(3) of the Commercial Code which states:

The Dubai Court of Cassation in its judgment of 17 March 2009 in case 266/2008 held:

Therefore, it is clear that such interest is categorised as damages, and is not regarded as an ‘unjust gain’ under the contract.  Interestingly, it is not necessary for a party to prove “damage” in order to claim interest, as Article 89 of the Commercial Code states:

Furthermore, under Article 91(1) of the Commercial Code, a creditor may claim damages in addition to delay interest and it will not be mandatory nor necessary for a creditor to prove that such damages resulted from fault or cheating on the part of the debtor.

Abu Dhabi

The situation in Abu Dhabi differs slightly because Abu Dhabi has enacted specific legislation, in addition to the UAE laws mentioned above, which provides for the amount of interest that may be awarded by a Court in both Civil and Commercial cases⁴.

In Abu Dhabi, Articles 61⁵ and 62⁶ of Civil Court Procedure Law No. (3) of 1970 (“Abu Dhabi Civil Court Procedure Law”) are applicable.  While the Civil Procedure Law No. 11 of 1992 (“the UAE Civil Procedure Code”) repealed all laws concerning civil procedure, provisions on interest such as the Abu Dhabi Civil Court Procedure, were specifically excluded and continue to be effective⁷.

Therefore, if parties conclude a contract which is subject to the laws of Abu Dhabi, parties should keep in mind that Abu Dhabi has the aforementioned Emirate specific law which entitles the Courts in Abu Dhabi to award interest in contracts which are governed by the Civil Code and the Commercial Code.

DIFC

Interest can be claimed under DIFC law.  Article 39 of the DIFC Law No 10 of 2004 specifically allows for interest to be recovered on a judgment for damages and interest will start to run from the date of the judgment.  The interest rate shall be fixed as per the rules of the DIFC Court or as determined appropriate by the DIFC Court.

Similarly, there are no restrictions on claiming interest under the DIFC Arbitration Law, nor are there any mandatory or customary rates. In practice, arbitral tribunals tend to award interest at between 9 and 12 per cent per annum, but this is matter specific.

Conclusion

In summary,  courts and legislators in the UAE have provided for a well-balanced and measured application of interest, meeting the needs of the economy, but in doing so have endeavored to recognize and walk within Sharia.

The UAE courts will give effect to contractual provisions for the payment of interest, provided these provisions are within the boundaries prescribed by the Commercial Code.  If contractual provisions are silent on the right to claim interest, the Court will follow applicable laws and determine whether the parties are entitled to interest, taking into account the facts of each individual case.

In practice, if contracting parties wish to include the right to interest for delayed payment, it is advisable that they ensure that their contract contains well defined interest clauses that comply with relevant laws.

Footnotes

[1] Federal Law No: 5 of 1985 as amended by Federal law 1 of 1987

[2] UAE federal law no (3) of 1987

[3] Decision dated 12 June 2008 of 212/Judicial Year 2

[4]  The interest rate will be fixed as agreed between the parties or if the parties did not agree on the interest rate, then at the rate not exceeding 12% for commercial transactions and 9% for non-commercial transactions.

[5] Article 61 of the Abu Dhabi Civil Court Procedure Law authorises the Abu Dhabi Courts to award interest from the date the debt falls due:

“The Court may in determining the interest on an adjudged amount order the calculation of the interest from the date such amount fell due or any later date until the date of payment or any prior date. It may further charge interest on the costs of the claim or any part thereof.”

[6] Article 62 of the Abu Dhabi Civil Court Procedure Law gives guidance to the Court on the rate of interest to be applied:

[7] Article 1 of the UAE Civil Procedure Code states:

“The attached law concerning civil procedures before the courts shall take effect, and all laws, decrees, orders, measures and directives in force pertaining to civil procedures are repealed, with the exception of provisions relating to interest on commercial transactions, which shall remain in force until they are regulated by law;”

 

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