Real Estate and Infrastructure

Rebus sic stantibus principle in times of war and its impact on construction agreements

Published on 22nd Apr 2022

These are turbulent times. 2020 began with a global pandemic. Governments around the world pumped vast amounts of money into economies to cushion the impact of the sharp slowdown in economic growth and consumption. Two years later, in 2022 and again in March, Russia declared war on Ukraine, which have caused the prices of many of the basic raw materials used in the construction sector to rise, not to mention a high inflation as a result of delaying some of the economic consequences of the pandemic on the global economy.

The rise in construction costs is forcing contractors to review their budgets and seek solutions to mitigate the effect of the increase of the price of raw materials and energy required for construction, which has led many contractors to invoke the rebus sic stantibus clause.

The rebus sic stantibus principle was on everyone's lips during the 2020 pandemic. This principle was applied by the courts, even though there is no regulation in force. The rebus sic stantibus clause allows the parties, provided that certain requirements are met, to review their contractual obligations when there has been a fundamental change in circumstances that have altered the conditions agreed by the parties. With the pandemic at its peak, the rebus sic stantibus clause was invoked by the tenants of commercial premises who had to close their doors due to health restrictions. Many ended up in court and in most cases we are seeing that first instance courts are accepting its application to such lease agreements.

The question now is: can the rebus sic stantibus principle be applied to construction agreements that have been affected by the war in Ukraine?

In contrast to lease agreements, which are continuing-performance contracts (tracto sucesivo), construction agreements are single-performance contracts (tracto único), but with its performance deferred in time. The rebus sic stantibus doctrine is only applied in exceptional cases and, as a general rule, it is not applicable to single-performance contracts.

This is a technical issue and, therefore, it is for the courts to determine whether, based on the deferred performance – which is a particular feature of construction agreements – the rebus sic stantibus clause could be applied by the courts as an exception to the exception, in order to redress the imbalance between the parties to a construction agreement caused by the sharp increase in prices due to the conflict in Ukraine.

Furthermore, it is also worth considering whether rises in construction costs is a risk intrinsic to the construction agreement and inherent to the contractor and, although unforeseen, could have been covered, for example, by taking out an insurance policy. Yet the truth is that a construction agreement under a lump sum scheme would make no sense if a potential increase in shipping costs, employment costs, raw material costs, etc. could be reflected in the contract by an automatic adjustment in the price. In fact, in most construction agreements, this risk falls on the contractor's side. Consequently, we should analyse whether this allocation captures a risk such as the war in Ukraine, which has a global impact.

Currently, and since March 2022, the above-mentioned arguments are on the table. The first one on the contractor's side and the second one on the developer's side. Thus, it is for the courts to determine the criteria to be applied. Until that happens, the contracting parties should be flexible and try to agree on how to allocate the risk in order to avoid delays in the construction project and, on the worst case scenario, the suspension of the works.

Nevertheless, bearing in mind the precedents and taking into account that blows to society and the economy are completely unpredictable, would it be advisable to include hardship clauses in the agreements in order to make life easier for the parties and avoid potential litigation?

Developers are likely to be reluctant to include such hardship clauses in construction agreements. Non-inclusion of these clauses would imply for the developer to assume the risk that, in the event of a conflict among the parties, the rebus sic stantibus doctrine may be finally applied by the courts. However, by including specific regulation in the agreements, the risk would be limited, the framework of the potential application of the rebus sic stantibus clause would be defined and legal proceedings and possible delays in the delivery of works would be avoided.

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* This article is current as of the date of its publication and does not necessarily reflect the present state of the law or relevant regulation.

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