Conflict bites when money is tight
Legal insight relating to upstream projects.
Oil&Gas Middle East delivers monthly legal insight relating to upstream projects. This month conflict resolution is on the rise as contractors and principals feel the pinch.
Clyde & Co’s infrastructure and construction specialists David McElveney, and Mark Blanksby digest the topical issues which are dominating the upstream legal scene.
What’s dominating the legal landscape in the energy and construction sector?
MB: As construction and infrastructure lawyers we are beginning to see quite an upsurge in inquiries in relation to dispute related work.
That’s manifesting itself as payment disputes where contractors have carried out work, in some cases quite a number of months ago, and are having difficulty getting payment for that work. Usually this is because either the developer hasn’t got the money or can’t afford to pay.
Also there’s a noticeable upsurge in terminations of projects, and we’re seeing contractors coming to us with those sorts of problems, but we’re also seeing employers coming to us asking for ways to reduce their expenditure.
The more mature end of the market and the more forward thinking employers are restructuring their debt and payment plans to match their cash flows. The less established and more speculative developers are looking of ways of reducing their payments altogether by descoping the work. This has been building for the last four months.
Is this all related to the credit crunch?
DE: All of the above are being driven by the economic downturn, but the principal drivers are three fold. Most obviously it’s the lack of funds in the market. It’s fairly obvious from discussions with clients that funds that were available in terms of finance, aren’t there any longer.
Also, there are questions now about the financial viability of some projects, which just a few months ago might have been seen as lucrative in terms of end products. Therefore projects are being put on hold whilst developers re-examine that viability.
Probably the third, and most recent driver, is that construction costs are going down.
The cost of steel and concrete is dropping, and there are more contractors in the market looking for work, so developers or principals in the oil and gas business, who thought they were going to proceed with a particular project, are seeing that by putting it on hold they may be able to get a cheaper price by re-entering.
Are these situations arising in energy projects?
MB: It’s rampant in the residential property sector, but when you look at public infrastructure works and the oil and gas contract business it’s nowhere near as apparent. The Purple Line on the Dubai Metro has been shelved for the moment, so there is already some scaling back, but a lot of that work is absolutely essential for the day to day business of Dubai and Abu Dhabi, so will have to press on.
If an upstream project has already commenced, is there a legal mechanism for re-evaluating that contract?
MB: Normally if the parties have entered into a binding contract then they are, on the face of it, required to fulfill those obligations on both sides. If a contractor has a healthy price and a healthy margin, then the principal is obliged to continue with that, he can’t just exit because he can get a better price in the market.
What we may begin to see is the employer looking for reasons to exert some commercial leverage on the contractor for a reduced price. For example, if he can demonstrate that he has reasons to suspend work such as contractor non-performance. We haven’t seen much of that yet, and to be honest that’s a very difficult game to play.
What you gain on the one hand with lower prices, you may lose on the other with the cost of the delay whilst the project is in a state of flux. On the oil and gas side we’re not seeing much of this at all yet.
DE: A while back we were seeing contractors asking for rise and fall clause provisions in their contracts to deal with the increasing costs of steel and construction commodities. We’re actually seeing those contracts working the other way around now, where a principal may look to get the project cost revised down as commodities fall, and that’s within the mechanism of the contract itself.
These clauses haven’t been industry standard for a long time, and the inclusion was initially driven by the soaring steel prices over the past few years, where contractors were looking to protect their interests in a rapidly rising price environment.
Essentially these clauses enable principals to leverage the benefits of a drop in commodity prices. This would be preferential to putting projects on hold.
Why are some Middle Eastern contracts drawn up with a foreign legal code stipulated, or an international arbitrator appointed, and others not?
MB: In some cases, such as Yemen, it is not uncommon for the legal framework to be adopted from elsewhere, such as in an international arbitration jursdiction.
That framework reduces the uncertainty that may come with working in unfamiliar territory, and means that the best EPC contractors will happily tender for the work. Qatar and the UAE generally call for the operation of local law, but that’s no barrier to the international firms because the courts and legal framework are known quantities. There’s nothing to be afraid of.
Companies just need to make sure they are fully aware of the differences between the common law in their home jurisdiction and the one they are working in.
DE: Dispute resolution clauses are very important parts of the contract understand. In these changing economic times people are cautiously aware that these are an important part of the contract, even in situation where you don’t anticipate a dispute.
How will this play out in the energy sector?
MB: The drying up of finance and the nervousness in the market isn’t really something that will apply to the national oil companies in the region. Whilst these companies may not have any difficulties attracting finance, they are more likely now to be looking at projects and having a rethink about whether they really want to go ahead with those developments or not. It may not be as financially viable as it was before.
With gas projects there are cases where the principle has to evaluate the implications of reduced output as demand dries up, and quite quickly those projects look less appealing than they once did.
DE: These projects may not be coming on stream for two to three years, but there is still caution in the market. The shrewd owners and developers out there will actually see that they are building something to come onstream a few years down the line, and now may in fact be just the right time to and get it built.
There’s a lot of hungry contractors out there willing to reduce their margin, and commodity prices are low. The project could come onstream just as the oil price is $100+ per barrel.
When did these impacts of the financial crises hit in the Gulf?
DE: By Autumn it was realised that the credit crunch was a global problem, and suddenly the brakes were thrown on everything. At the moment we’re still in that period of reflection as people figure out what to do.
Are you busier now because of conflict resolution cases?
MB: We’ve always been busy as infrastructure lawyers in this region, but whereas in the past the split may have been 50:50 between contact drafting, and conflict resolution, that’s shifted more towards 25:75 ratio.
DE: The cyclical nature of construction law dictates that when the boom times are here, companies are focused on moving from project to project, so don’t want to divert resources to disputes.
It is not surprising that when times are hard people tend to look at where they have to pay money, and then only in order of priority, and also people examine how they can get revenue in. These two opposing forces cause friction, and that’s what leads to disputes.
From a legal perspective, is this region behaving any differently to other industrialised regions?
MB: The market here may be a little different. I don’t think the period of huge growth followed by a downturn has really happened before in the UAE. Times have been so good for so long that people haven’t really examined in such detail what their full rights and obligations are. It’s been common in cyclical industries in the western world, and I think now we’re seeing it emerging here too.
DE: In Abu Dhabi there isn’t the same developed culture of entering into disputes, particularly with government entities. That is something that hasn’t been a feature of business in the GCC before. However, with people faced with the economic reality of survival, we will probably see more companies turning towards that.
Meet the Panel
Partner, Construction &
Engineering, Clyde & Co.
• 19 years experience of advising on the legal aspects of construction projects, and since 2004 has been based in Dubai.
• Advises main contractors, employers, subcontractors and suppliers in the construction, engineering and oil & gas sectors. He has advised clients in relation to projects in the UAE, Kuwait, Qatar, Saudi Arabia, Bahrain and Oman.
• Provided legal advice on a number of issues to the pipe laying contractor engaged on the Dolphin Energy Pipeline project.
Partner, Construction &
Engineering, Clyde & Co.
• 22 years experience working on contentious and non-contentious matters.
• Recently acted for a consortium in relation to the procurement of sewerage amd water infrastructure works, and on behalf of a consortium in relation to the design and build of power facilities and electricity distribution lines.
• Also acted for the developers of data centres in the UAE and process plants in Australia and the UAE.