Construction projects and the impact of sanctions

In summary

The world has rarely been so unpredictable. The covid-19 pandemic and corresponding travel restrictions, geopolitical unrest and sanctions have made business deeply volatile. Construction projects have not been immune, and work around the Asia-Pacific region has been impacted by factors outside the parties’ control and beyond anything that might have reasonably been predicted. Project owners and contractors are doing what they can to address this uncertainty. In this chapter, we discuss how sanctions can disrupt the construction landscape and the tools that are available to parties when trying to address their impact.

Discussion points

• Material impact of sanctions and subsequent claims as project owners and contractors dispute liability and losses
• Doctrine of frustration and material adverse change provisions in handling disruptions for current and future projects
• Revisiting contracts to improve risk management and prevent legal issues in light of possible wider sanctions

Referenced in this article

• FIDIC suite contracts
• JCT Design and Build Contract 2016
• Thai Civil and Commercial Code
• Civil Code of the People’s Republic of China
• Civil Code of the United Arab Emirates
• Civil Code of the Russian Federation

The past few years have seen an elevated level of strife in many parts of the world, including the Asia-Pacific. At the time of writing, extensive sanctions regimes are affecting Russia, North Korea, Belarus and Myanmar, while long-term sanctions are impacting business in a range of countries, including Cuba and Iran.

In recent times, numerous projects in Asia have involved state-related civil infrastructure, such as energy, water and transportation. These projects commonly have a significant level of state funding, with the involvement of state-backed institutions, departments and multilateral development banks. As a prime example, China has developed projects in many foreign states through the Belt and Road Initiative, working as both an investor and a provider of expertise in many projects around the region.

Due to the nature of sanctions, projects involving more geopolitically volatile countries have become trickier. For instance, projects in Iran, where Chinese companies have been heavily investing in since 2015 (when international sanctions were relaxed), were again faced with concerns when sanctions were reimposed again in late 2018. The complications with working in these countries are ever present.

Importantly, the implications of sanctions go well beyond projects located in directly sanctioned countries. In recent history, sanctions have shown that the effects on logistics, and on the overall viability of projects, can be global. The use of prohibitions and embargoes have caused an increase in worldwide costs of commodities, construction materials and oil prices, as well as currency fluctuations. With many projects heavily dependent on foreign material supplies, efficient operations and cash flow, sanctions have made it increasingly difficult for projects to proceed smoothly.

In this chapter, we look at some of the key risks faced by projects, as well as some recommendations for contractors and project owners intending to mitigate their risk and improve certainty when contracting in a world where sanctions exist.

The potential impact of sanctions

In truth, unlike the covid-19 pandemic, sanctions are not a new phenomenon; they existed even in ancient Rome. However, while the concept is not new, the form sanctions take, and who will be involved, can be unpredictable and the use of sanctions is becoming more widespread. Although it is hard to quantify the level of global sanctions, the Global Sanctions Database, which is publicly available, now traces 729 multilateral, plurilateral and bilateral sanctions. They can involve any country with any form of restriction being imposed, from something as minor as admission of certain persons (such as the EU sanctions against Moldova, restricting admission on individuals in 2022), to a large-scale ban on the trade of commodities, investments and embargoes, and freezing of assets (such as the US and EU sanctions against Iran and Russia in 2022).

As a result of more severe sanctions, such as those introduced during the first quarter of 2022, the import prices of oil and metals have increased drastically worldwide, with logistics affected and the value of certain currencies fluctuating.

Force majeure

In most contracts, when an unpredicted and uncontrollable event, such as a sanction restriction, happens, the first place that parties look for relief is a contractual force majeure clause.

Force majeure operates as a defence, whereby parties can be excused from performance of obligations under the contract if the occurrence of exceptional events prevents performance. Whether a particular set of sanctions triggers the force majeure clause for a particular project will depend on the contractual provisions and applicable law of the contract.

Most standard form contracts provide for force majeure only as a defence for failing to perform obligations under the contract, and not as a ground for a claim. For instance, standard forms, such as FIDIC^[1] and JCT,^[2] contain provisions for exceptional events identified as force majeure to allow for parties to be given additional time and, possibly, a right of termination. It is relatively rare for force majeure to trigger a right to payment, although the costs incurred in addressing sanctions may be immense.

In our experience, force majeure clauses tend not to be heavily negotiated and are often included without particular attention, amendment or negotiation, and without parties’ full consideration of their effects. A narrow lesson was learned from the covid-19 pandemic and many forms have been reviewed so that their force majeure clauses properly address epidemics and, most particularly, travel restrictions, port closures and lockdowns that may be introduced. The same cannot be said for sanctions.

Many standard forms of contract list events that constitute force majeure, either by exclusive lists or (more normally) in lists that set out a series of examples. While war and hostilities are frequently set out expressly in such lists (eg, clause 19.1 in the FIDIC 1999 Red, Yellow and Silver Books), sanctions and embargoes are not normally so listed. Nonetheless, sanctions will often fall within broad words and in the definition of force majeure as they are likely to be beyond either party’s control, unavoidable and not something which could have been provided against in advance. However, while sanctions are likely to fall within most standard form definitions of force majeure, the consequences of the sanctions may not trigger the operative force majeure clause. Such clauses often require a party to be ‘prevented’ from performing its obligations and, while sanctions may impose additional hurdles on the performance of a contract, performance may not be prevented, particularly where the project is not in a directly affected country and the impact of sanctions is on logistics, material supply or costs.

Outside the contract, force majeure is also recognised in the general law of certain jurisdictions. For example:

• Article 8 of the Thai Civil and Commercial Code allows for force majeure during ‘any event the happening or pernicious results of which could not be prevented even though a person whom it happened or threatened to happen were to take such appropriate care as might be expected’.
• Articles 180 and 563 of the Civil Code of the People’s Republic of China provides that no civil liability will be borne for parties that are unable to perform obligations due to force majeure, and that termination can be effected if the purpose of the contract is rendered impossible.
• Articles 273 and 287 of the Civil Code of the United Arab Emirates (the UAE Civil Code) provides that contractual obligations will be discharged where performance of the contract (or part thereof) becomes impossible, and any losses arising out of an extraneous cause, such as force majeure, shall not bind the other party to make good the losses.

All of these laws set out their own definitions of force majeure and specify the reliefs that follow.

The result of this is that force majeure provides an inadequate remedy for sanctions in the international projects market. The remedy available at law will, obviously, depend on the law applicable to the contract. The remedy available under the contract is unlikely to carry payment with it and may not be triggered at all if the consequence of the sanction is merely to cause a material problem, rather than to prevent work.

Frustration

In addition to force majeure, parties can also consider the applicability of the doctrine of frustration to the contract. Have sanctions caused the contract to be frustrated?

Frustration is applicable where a contract has become impossible, illegal or drastically different to perform from the original agreement. It is a commonly recognised remedy in common law jurisdictions and is effected by operation of law, regardless of whether specific references were made to ‘frustration’ in the contract. Where frustration is invoked and established, the contract will be brought to an end and will be seen as discharged. While the concept of frustration is widely recognised, it is only rarely available in practice.

For a party to establish frustration, it must prove that (1) the supervening event occurred after the contract was entered into, (2) the event was not caused by the fault of either party, and (3) the event caused performance to become impossible, illegal or radically different.

While a change in law or subsequently illegality can be considered as frustrating events, common law principles generally uphold parties’ intention to contract and, thus, there is a general reluctance to hold that a contract should be discharged, unless truly exceptional circumstances exist. As a result, there is a high bar to overcome for parties seeking to claim frustration.

Most importantly, the doctrine of frustration is generally not extended to situations of impracticability, where performance could only be rendered with extreme and unreasonable difficulty, expense, injury or losses. It is not available where the obligations simply become difficult or onerous to perform. So long as performance is possible, whether through alternatives or otherwise, frustration would rarely be allowed. In the context of sanctions, this means that unless the project or the parties are in a state directly impacted by the sanctions, frustration is unlikely to be relevant.

As an example, in the old and well-known case of Tsakiroglou & Co Ltd v Noblee Thorl,^[3] a Sudanese supplier was contracted to provide commodities to Germany. During the course of the contract, the customary shipment route through the Suez Canal was closed due to military operations, and while an alternative route round the Cape of Good Hope was available, it was far longer and more expensive. However, as the contract did not mandate shipment via the Suez Canal, the supplier was obliged to deliver the shipment even if it resulted in vastly higher costs. The relevance of this to cases where sanctions have impacted logistics and costs are obvious.

Frustration will also not be found in instances where the parties have expressly provided for the event. These can include events that have been stipulated in other contractual provisions such as force majeure clauses. So, if the force majeure clause does address sanctions, the parties must apply that clause and cannot also apply the doctrine of frustration.

Therefore, the remedy of a frustration claim is likely to be inadequate. Frustration is difficult to establish and brings a contract to an end rather than providing an appropriate mechanism to address the consequences of an intervening event.

Material adverse change and hardship

Less widely incorporated than force majeure clauses, and not existing as a matter of common law like the concept of frustration, a third and far better answer can be found in material adverse change (MAC) or hardship provisions.

MAC clauses, sometimes known as hardship clauses, are common in some forms of contracts but are not widely used in construction projects outside the common law world. Some jurisdictions recognise changed circumstances as part of the law of contracts. For example, the doctrine for change of circumstances exists in China;^[4] article 249 of the UAE Civil Code contains provisions relating to the doctrine of changed circumstances;^[5] and article 451 of the Civil Code of the Russian Federation also has provisions for changed circumstances. Certain civil law jurisdictions, such as Switzerland, Austria and Spain, also recognise changed circumstances as a matter of law.

Considering the contractual position, perhaps the most significant difference between MAC and force majeure provisions is that MAC provisions do not require performance of the contract to become impossible. Instead, they are effective where circumstances have made the contract onerous or impractical to perform.

Of course, a MAC clause will spell out preconditions to the rights. As the name suggests, the impact of the event (eg, sanctions) must be material. However, if there is a material impact on the project caused by the introduction of sanctions, even though that impact falls well short of preventing performance, a MAC clause allows the parties to continue with their contract, with the project and with the commercial deal. The risk of sanctions can be shared and the parties incentivised to work together, rather than incentivising the contractor to say that performance is altogether prevented as force majeure and frustration do. This is likely to be a good thing for the parties in almost every case.

Parties may then agree that, in the event that the precondition of a MAC clause is met, specific contractual mechanisms and outcomes will be triggered. Examples of the structure and drafting of simple MAC clauses are:

• if supplier A closes, parties shall agree to the appointment of an alternative supplier from the alternative supplier list, and any increase in costs will be shared equally between the parties; and
• if there is an increase of 30 per cent in the cost of construction materials by reason of any sanctions imposed, parties shall discuss whether to continue with the completion of the project. If either party elects to continue with the project, any additional costs resulting from the increase in material costs shall be borne equally by the parties until such period where the increased material costs have fallen below 30 per cent or where any related sanctions cease to be in force.

As seen above, the advantage of having a MAC clause is that the clause can be customised to suit parties’ specific needs and can be used by project owners and contractors to mitigate risk and ensure stable project management.

While most construction contracts do not contain MAC clauses, the concept is not alien to the construction industry. For instance, finance documents will often contain MAC clauses. Indeed, it is common to address certain specific material changes, for example change-in-law clauses, in construction contracts. Indeed, change-in-law clauses could give relief in cases of sanctions, but they are typically restricted to the law of the place of the project (so will not cover foreign sanctions) and are often excluded in private sector contracts.

The way forward

Sanctions are increasingly impacting international construction projects. Standard construction contract provisions for force majeure offer little relief. Common law concepts, such as frustration, are unlikely to apply, and if they do, they will bring the contract to an end.

A market dominated by fixed-price engineering, procurement and construction contract models will encourage contractors to price for these substantial and unpredictable supply-chain disruption risks, and the increased prices that may be caused by sanctions. We believe, however, that the time is right in international projects for the more widespread adoption of MAC protection.

We do not envisage that MAC clauses should be used to protect contractors from the risk of fluctuations in the market for commodities. Contractors are best placed to manage this risk and, indeed, are experts in doing so. However, geopolitical risk is something different. Where markets are distorted by the sudden imposition of sanctions, a properly drafted MAC clause allows a way for risk to be allocated between the parties and for the project to continue. We believe that project owners and contractors will be far better served by addressing the risk through a MAC clause, rather than asking the contractor to price for that risk in every contract.

Footnotes