Construction law experts across Europe, the Middle East and Africa have discussed how the sector is adapting to high inflation and significant supply challenges through contractual, legal and other remedies.
Hosting a debate at the Official FIDIC Regional Contract Users’ Conference on 10 May 2023, FIDIC contracts committee chair Vincent Leloup made the point that inflation feels like a “blast from the past” in many countries, as he asked a panel of experts how things are being handled in different areas of the Europe, Middle East and Africa region.
How big a challenge is inflation?
Adriana Spassova, a partner at EQE Control OOD, told the international audience at the conference that on megaprojects in particular, it had become harder for contractors to provide materials and goods in sufficient quantities and that this had been exacerbated by extensive inflation.
To overcome this, she said that contractors needed to find ways to claim escalation or seek relief from employers through their contracts. That might include specific clauses allowing for adjustments with inflation, though she said that some projects had seen attempts to terminate contracts to avoid escalating losses and this was very bad for countries, clients and contractors.
Refki El-Mujtahed, senior legal counsel at Besix Construct Group, painted a tough picture in the Middle East, saying that pandemic shutdowns saw restrictions on contractors sourcing labour and constraints on supply of materials. The global ramp-up after pandemic shutdowns then saw new shortages, with companies having to seek wider sources from around the world. Then there were serious shipping challenges, with costs rising dramatically. Finally, from 2022, he said there had been hyper-inflation of fuel, steel and other metal products.
While there was a view among clients that Covid was over and no longer required adjustments, El-Mujtahed said that by mid-2021 some clients were willing to mitigate exposure to higher prices through greater advanced payment to help secure materials, along with increased fees to cover the cost of importing, often from non-typical countries.
International construction lawyer at 3PB and member of the FIDIC contracts committee Peter Collie said that in the UK there had been lockdowns with obvious contractual and delay implications. However, he noted that not many contracts in the country had inflation clauses anymore. These were common in the 1980s but became rare this century, so, he said the majority of construction contracts in the UK offered little direct remedy for those struggling with inflation.
In contrast, he noted that his experience in Africa was rather diverse, with some contractors locking themselves on site to just get on with things, while others had walked away and paused work in the hope that inflation and supply challenges might ease over time.
Rob Morson, partner at Pinsent Masons, said that risk was always there and that as lawyers, they shouldn’t be scared of addressing the fact that prices don’t hold still. He explained that across Ghana, Tanzania and South Africa, projects lasting ten to 12 years used indexed product schedules running to 3,000 to 4,000 items with very sophisticated ways of dealing with inflation.
Over the past 36 months, Morson said there had been high inflation around steel, copper and most metals but people had to remember that prices might fall too. So, he warned that companies might presently be procuring at the top of the market and needed to be aware of that.
FIDIC Contracts clauses and legal provisions that can help
Peter Collie turned to solutions to these challenges, saying that international FIDIC contracts do include optional clauses to provide for inflation. Using them was a decision for the employer and he suggested that enlightened employers do account for inflation this way. Such clauses allow for the scheduling of materials and the indices they will be tied to. However, he warned that such adjustment mechanisms were not an assurance that the employer would carry all inflation costs. It just meant they agreed to adjust fees in accordance with the schedule agreed, which provided some relief for contractors.
Adriana Spassova, operating in south east Europe, highlighted another challenge and the solution found. The Ukraine war had created many difficult problems for contractors and in one such situation, two regional companies had a branch in Ukraine to provide equipment. They had to find alternative sources of that equipment which risked delays and higher costs. The same had happened with companies who depend on a Ukrainian supplier of highly specialist skills. These very direct supply and inflationary pressure led to a different approach in Bulgaria.
Spassova said that with infrastructure and public procurement projects in the country, the biggest issues had been resolved thanks to the contractors chamber working with government to develop an amendment for public procurement. That change has allowed for possible relief for the works contractors via a new and easy-to-apply methodology when faced with high inflation or supply problems of that sort.
Refki El-Mujtahed explained the very different situation in the Middle East, where clients tend to prefer fixed lump-sum contracts. He said contractors were seeking to promote a cost-plus model through contracts to ease the implications of lump-sum contracts offering no adjustment for changes to legislation or changes to costs through high inflation.
To resolve problems caused by inflation and supply challenges right now, he said they looked at how the law reflected good faith. Contracts were not restricted to their own clauses. So he said firms argued that they went into contracts in good faith, not able to predict the pandemic, Ukraine war and hyper-inflation, and in some instances employers ended up accommodating some relief for those events.
Additionally, he said that while contracts tended to be lump-sum, there was an article of the Civil Code that requires contractors to inform the employer of changes to cost quickly or lose their ability to reclaim those higher costs. This is something he said they looked at because on giga-projects, the rise of the price of so much steel can go further than wiping out a company’s margins.
Rob Morson drew attention back to the options available through FIDIC contracts and the optional clause for schedules of costs. He said people needed to understand that clause properly to make best use of it and avoid problems. For example, he said the assumption in the clause is that the period of price adjustment is one month, which made sense for monthly balance sheet payments, but had implications where payments are made upon milestones.
Additionally, he said that the FIDIC contract approach tends to put the base date at the time of tender, which seemed sensible but some other approaches might place it at different points in the contract – another thing to be aware of. With any such schedules he said that localised in-country indices can be useful for employment, labour, resources, fuel, steel and cement, etc. These formulas are often created for particular types of work and are weighted for that type of work. But with mechanical processes, he said things got more difficult, with manufacturing in one country, using steel from another and being operated by someone in another. So, Morson said that such things needed an index that tracks its specific parts proportionally.
Vincent Leloup concluded the discussion highlighting that FIDIC Contracts proved to be particularly robust in dealing with these troubled times over the recent years, with key relevant provisions proving to be highly useful in the circumstances, such as change in laws, adjustments for changes in costs, Exceptional Events, providing time and cost relief to various degrees and often to an extent not otherwise contemplated at national level. However, users should be mindful of also considering any additional relief the law may provide beyond the contract terms, in particular in civil law jurisdictions which benefit from hardship provisions.