The Legal Ramifications of the Gulf’s Straitened Circumstances.
Contributor: Mark Fraser, founder and principal of Fraser&Co. The conflict in the Middle East, following the targeted military strikes initiated by the United States and Israel against Iranian military and nuclear facilities, has entered its eighth week with Iranian retaliation affecting airports, desalination plants, ports and energy infrastructure, not to mention residential areas, across the Gulf Cooperation Council (“GCC”). The Strait of Hormuz, through which approximately 20% of global oil and liquefied natural gas transits, has effectively been closed to commercial shipping since early March. Unsurprisingly, force majeure has been invoked in energy and commodity contracts across the region, so what is the impact on the construction sector where the consequences can be severe? In the following discussion, the contractual and regulatory frameworks in Saudi Arabia are examined.
Force Majeure and Exceptional Circumstances Distinguished
Parties operating in the oil and gas, construction, logistics and shipping arenas must consider whether the relevant contractual threshold for invoking force majeure has been met.
The key considerations are usually:
- Does the force majeure provision cover war, hostilities or government intervention?
- Has performance actually been prevented or is it simply more difficult or expensive to perform?
- What is the position regarding compliance with notice requirements?
- Has the affected party taken the requisite mitigatory steps?
- What is the remedy, extension of time, suspension, termination or cost/price adjustment?
In respect of the above, the importance of compliance with notices cannot be overstated and the distinction between force majeure (impossibility) and hardship/exceptional circumstances (excessive onerousness) involves materially different consequences.
The Contractual and Legal Framework
Most construction contracts in the Middle East are based on the FIDIC model but a notable exception is public sector contracts in Saudi Arabia which are governed by the Government Tenders and Procurement Law (“GTPL”). By way of example, under Clause 18 of the 2017 Edition of FIDIC force majeure or an Exceptional Event must satisfy four tests, namely the event must be:
- An event occurring beyond the reasonable control of the affected party
- An event which could not reasonably have been foreseen at the time of contract formation
- An event which could not reasonably have been avoided or overcome by the exercise of due diligence
- An event not substantially attributable to the acts or omissions of the other contracting party
War and hostilities are expressly specified as qualifying events, irrespective of whether war is actually declared.
In Saudi Arabia, force majeure is addressed in Article 110 of the Civil Transactions Law (“CTL”) which provides that if performance becomes impossible for a reason beyond the affected party’s control, the obligation and the corresponding obligation are extinguished and the contract is automatically terminated by operation of law. In the event of partial impossibility, it is the affected part which is extinguished.
- Article 125 of the CTL provides that a person is not liable for harm caused by events beyond its control, such as force majeure, unless otherwise agreed.
- Article 97 of the CTL addresses Exceptional Circumstances in providing that where extraordinary events, unforeseeable at the time of contracting, make performance excessively onerous to threaten heavy losses, the affected party may invite the other party to renegotiate without undue delay. If renegotiation fails, it would be open to a court to reduce the obligation to a reasonable level. Parties cannot contract out of Article 97 as it is mandatory. The affected party cannot unilaterally suspend performance while invoking this provision.
- Article 471 (3) of the CTL is particularly relevant to construction contracts. Where exceptional circumstances of a general character disrupt the contractual balance and undermine the basis of the financial estimate, a court may order restoration of the contractual balance, including an extension of the period, increasing or decreasing the contract sum or ordering termination. Unlike Article 97, this provision does not require the affected party to attempt negotiation first, but mandatory language is not incorporated so its operation can be excluded by agreement.
- Article 174 of the CTL provides that force majeure is not a mandatory rule of public policy. It is, therefore, open to the parties to agree that the effects of force majeure will be borne by the affected party. Where the contract incorporates a force majeure clause, the clause takes precedence.
As indicated above, public sector contracts in Saudi Arabia are governed by the GTPL rather than the FIDIC model. The GTPL contains its own risk allocation and force majeure framework so the parties should take time to familiarise themselves with the specific provisions of the GTPL.
Extension of Time and Liquidated Damages
If the conflict causes unavoidable delay, contractors should be entitled to an extension of time which protects against the levying of liquidated damages. As indicated above, under Article 471 (3) of the CTL, a court may order an extension of time to restore the contractual balance. Article 179 of the CTL empowers a court to reduce liquidated damages if the rate is unreasonable or if the contractual obligation has been partially fulfilled. That said, failure to comply with conditions precedent requiring timely and particulars- compliant notices could prejudice entitlement to an extension of time, leaving exposure to liquidated damages in place.
Disruption to the Supply Chain and Cost Escalation
Given the drop in shipping traffic through the Strait of Hormuz, supply and prices of critical materials such as steel, cement, concrete, aluminum and gases have been materially affected. Parties will have to revisit their terms and conditions to gauge the impact but some redress may be afforded by Article 471 (3) of the CTL which empowers a court to order an increase or decrease in the contract price where exceptional circumstances have undermined the basis of the financial estimate.
Change in Law
During and in response to hostilities, government directives such as airport closures and safety protocols may constitute a change in law with time and money entitlement for an affected party (while force majeure only provides entitlement to time). Parties should, however, be alive to restrictions in some public sector contracts which restrict change in law entitlement to legislative changes only, thereby excluding executory or regulatory measures.
Concluding Remarks
The Iran conflict is the most significant geopolitical disruption to business in the Gulf since the pandemic. Impact in terms of delay, cost, insurance, labour and financing is unprecedented. Force majeure provisions will be a first port of call but parties should not lose sight of exceptional circumstance provisions, extension of time, disruption and change in law relief. The contractual and legal framework in Saudi Arabia can provide relief but parties must comply with the contractual machinery and distinguish between impossibility and excessive onerousness.
Mark Fraser is the founder and principal of Fraser&Co., a specialist legal advisory firm focused on construction, infrastructure, energy and complex commercial projects across the Middle East. With extensive experience advising developers, contractors and international stakeholders, he regularly provides strategic counsel on contractual risk, force majeure, dispute avoidance and regulatory frameworks in the region. In this article, Mark offers insight into the legal ramifications of the current Middle East conflict and its implications for projects operating in an increasingly constrained environment.
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