Descoping in construction contracts in the UAE
As Heba Osman explains, in the aftermath of the 2008 global financial crisis, many employers in the UAE turned to descoping large parts of construction works as a quick exit strategy from uncompleted projects. Other employers resorted to termination.
Descoping is usually instructed by employers as a variation omitting large parts of the works. Many employers appear to believe that they are contractually entitled to descope, which in part is true. However, many employers instruct the omission of large parts of the works for one of the following reasons:
(i) Funding problems: during the life of the project, the employer becomes unable to continue funding the project. The project has simply become too expensive for the employer.
(ii) Better deals: the employer finds another contractor who can complete the remainder of the works in a faster or cheaper manner.
(iii) Contractor’s incapability: the employer has doubts as to the contractor’s capabilities, whether financial or technical, to complete the works.
(iv) Poor performance: the employer is not happy with the contractor’s performance of the works.
Most standard construction contracts entitle the employer to issue variations to the works through omission. This means that an employer does not have to go through the argument of terminating the contract when it can simply descope.
Descoping is a non-confrontational method that employers appear to turn to when they do not wish to get into the difficult situation of terminating the contract. Typically termination, whether for convenience or fault, triggers a dispute between the employer and the contractor. Many employers wish to avoid such a situation by simply omitting all or parts of the work.
The majority of construction contracts in the Gulf region maintain the principal features of the FIDIC forms of contract, yet there are also many subtle changes. These changes tend to upset the balance of risk allocation between the parties. In the UAE, many contracts appear to be drafted in one-sided language biased towards the employer. The roots of these contracts appear to have come from the Dubai Municipality construction contract, which was initially drafted for the use of the Dubai Municipality as a Governmental entity but then found its way to many of the UAE employers. In this respect, such one-sided contracts are not generally suitable for private employers, and contractors should be very careful in signing such agreements. These are not FIDIC standard contracts and thus do not contain the proper risk allocation that should be expected.
Nevertheless, most construction contracts, whether standard forms or otherwise, contain variation clauses. Without such clauses and provisions, neither the employer nor the contractor is legally entitled to deviate from the agreed scope of works. If there is no variation provision, the contractor cannot be compelled, for example, to perform additional works and the employer cannot, without being in breach of the contract, omit any works that have been agreed.
Variation clauses introduce much needed flexibility into somewhat rigid rules that otherwise govern the parties’ obligations arising under construction contracts. In other words, if there is no variation provision, the law requires the parties to the contract to perform exactly what they have agreed upon and any change to the scope of the works would have to be mutually agreed between the parties under a written amendment to the contract. The variation provisions entitle the employer unilaterally to amend the scope of the works without the need to amend the contract itself.
Clause 51 of the Red Book fourth edition, being the most widely used standard form of contract in the Middle East, defines a variation as:
“any change in form, character, kind, quality, quantity, line, level, position, alignment, or dimension of existing work or any additional work that the Engineer finds necessary, appropriate or desirable to complete works”.
This clause 51 also entitles the employer, through the Engineer, to “instruct an omission of the works, provided that the Employer does not carry out these omitted works by himself or through others”.
Clause 51 clearly states that:
“The Engineer shall make any variations of the form, quality or quantity of the Works or any part thereof that may, in his opinion, be necessary and for that purpose, or for any other reason it shall, in his opinion, be appropriate, he shall have the authority to instruct the Contractor and the Contractor shall do any of the following:
…
(b) omit any such work (but not if the omitted work is to be carried out by the Employer or another contractor).”
An engineer’s variation instruction by omission must meet the basic requirements of being in writing or given orally and subsequently confirmed in writing; be in respect of the form, quality or quantity of the works or any part of the works; and, in the engineer’s opinion, be necessary or otherwise appropriate.
Whenever variations are ordered omitting works under clause 51, and particularly if such omitted work is substantial, contractors often argue that they should be entitled to claim loss of the profit they would have earned on such works if carried out. In principle, if the variation omitting works is invalid (say, for not being in writing, or not necessary or appropriate) then this invalid omission may be construed as a breach of contract entitling the contractor not only to loss of profit, but also to damages due to breach. Where the works have been omitted and given to others to carry out, it is clearly established that this is a breach of contract and not a valid variation order.
Similarly, if the employer himself or another contractor carries out the omitted work, loss of profit and damages can be claimed, unless it can be proved that the contractor is technically or financially incapable of carrying out such omitted work. However, in many of the bespoke construction contracts drafted in the UAE, employers retain the right to omit a part of the scope and get it done by another contractor under a separate contract. In such instance, the employer becomes immune to claims for loss of profit or damages as a result of such omission.
The existence of a variation clause does not give the employer a free hand in making large-scale or significant changes to the nature and scope of the works. Clause 52.3 of the FIDIC Red Book entitles the contractor to a fair valuation of variations that increase or decrease the Contract Price by more than 15%. Such excess variations are not valued in accordance with the Bills of Quantity as other variations but are to be agreed between the contractor and the employer; if no agreement is reached then such an amount is to be determined by the engineer, having due regard to the site status and general contractor overheads.
It is also worth considering the variation provision of the new Red Book, which is really no longer that new, being issued in 1999, which provides in clause 13 that variations may include: “(d) omission of any work unless it is to be carried out by others”.
The interesting part about this provision is that when compared with the old version of the FIDIC Red Book it does not refer to whether the employer would be entitled to carry out these omitted works by itself. In the UAE, there appears to be no court decisions in this respect as this form of contract, despite being in use for over 15 years, has not found its way to the UAE.
Descoping v termination
This begs the question: why do employers turn to descoping instead of termination? As has been said, employers have a tendency to use descoping as a mechanism to avoid termination in situations where termination would be more appropriate. This is especially true when you consider that descoping may cause the employer to incur damages and immediate expenses compared with the use of termination.
As mentioned, employers tend to use descoping in one of four scenarios:
(i) The project has become too expensive for the employer to fund.
(ii) The employer wishes to escape a bad deal, especially when there are other contractors who can do the remaining works cheaper or faster.
(iii) The employer has doubts as to the contractor’s capabilities to complete the works.
(iv) The employer is dissatisfied with the contractor’s performance generally.
In the first scenario, if the project has become too expensive for the employer to fund, the employer has the right to descope as a matter of UAE law under Article 893 of the UAE Civil Code. This provision entitles both the employer and the contractor to terminate the contract “if any cause arises preventing the performance of the contract or the completion of the performance thereof”.
Of course termination or cancellation of a contract in the UAE would need to be agreed mutually or through the courts if there is no clear provision entitling the employer to unilaterally terminate. Employers are, therefore, advised to ensure that their contracts clearly give them the right to unilaterally terminate the agreement without the need for court intervention.
A clear provision entitling the employer to terminate for convenience is therefore quite important and it should mention in as much detail as possible the expenses or due amounts that the contractor would become entitled to in the event that the employer exercises his right to terminate for convenience.
In the second scenario, if the employer realises it has entered into a bad deal with the contractor this is indeed a risk that the employer has to bear. However, in this scenario, the employer needs to assess the cost of termination versus the cost of descoping. If there is a termination for convenience provision, then the employer is best advised to use such a provision rather than descope and hire another contractor to complete the works. If the employer opts for descoping it opens itself up to the risk of being liable to the contractor for loss of profit and damages for breach. In the event of termination for convenience, the employer’s liability will more likely be limited to loss of profit.
In the third and fourth scenarios, where there is a breach on the part of the contractor or the contractor’s ability to complete the works is questionable, then the route that should be followed by the employer is termination for breach. The FIDIC Red Book entitles the employer to terminate the employment of the contractor in the event of the contractor’s default. This is different from terminating the contract itself which continues to be valid. If the employer terminates the contractor’s employment, the employer’s liability to make any payments (if any) to the contractor does not begin until after the expiry of the defects liability period and after the engineer has assessed the cost of execution, remedy of defects, delay in execution and damages. On the other hand, in the event of descoping the works, the contractor’s right to claim loss of profit is immediate.
Moreover, as a matter of UAE law, an employer is entitled under Article 877 of the UAE Civil Code, if he is not happy with the performance of the contractor and after giving notice to the contractor to remedy his default, to request the court to authorise him to hire another contractor to complete the works at the expense of the contractor. In the UAE, this is quite a fast procedure that allows the employer to move on and hire another contractor in a fast and efficient manner.
In any event, when assessing whether to terminate or descope, it is important to have regard to Article 895 of the UAE Civil Code, which provides that a “party suffering harm by the cancellation may make a claim for compensation against the other party to the extent acknowledged by custom”.
This means that essentially the assessment of damages incurred as a result of contract termination would be considered in accordance with the custom of the construction industry as may be evidenced through experts working in this field.
Conclusion
The conclusion that employers and contractors alike should take away is that a clear drafting of contracts is paramount, and the use of the contract provisions for what they were intended would in fact save them more money in the long run. Yes, descoping appears to be a simpler approach; however, when used as a substitute for termination it will prove more costly than termination.