This interview was first published on 27 July 2018.
Construction analysis: Hamish Lal, partner at Akin Gump, Martin Potter, legal counsel at Canary Wharf Group and Sarah Schütte, of Schutte Consulting Limited, examine the ongoing impact of Brexit on the construction industry.
How is Brexit currently affecting the UK construction industry?
Hamish Lal (HL): Brexit has caused significant uncertainty, and a natural consequence of uncertainty is a contraction in both public sector spending and private sector development. The contraction has a direct and derivative impact on the complete construction industry, including:
A contraction with a duration of several months can take a number of years to be corrected.
Martin Potter (MP): There is a downturn in activity due to uncertainty arising out of Brexit, and withdrawal or decision deferment of potential tenants/purchasers and therefore occupiers of construction projects until uncertainty is resolved. There is also a reluctance of European contractors to commit to the UK market, as well as a reduction in skilled operatives (plumbers, bricklayers etc) to service potential developments. Additionally, there is a potential slowdown of development lending.
Sarah Schütte (SS): Brexit is causing an abundance of caution in the market. There is simply no clear line of policy and therefore industry cannot plan. In or out, whatever your political leaning, there needs be more certainty. Lack of certainty creates risk.
In our industry, you need to be able to plan work systematically to accurately analyse project risks. You can’t just start a project, nor just stop one. The most successful projects take foresight and stamina.
Are some sectors more affected than others?
HL: The commercial real estate sector is perhaps more affected than others. The PFI/PPP sectors
are also significantly lagging expected levels.
MP: Commercial and residential building. Infrastructure less so due to government stated intentions.
SS: Firstly, sectors which rely heavily on the skills of EU nationals are particularly vulnerable. Resource planning in these areas is difficult and the market for services has changed. Projects, which are currently well underway, and therefore procured pre-June 2016, are costing more as the buyer-seller negotiation (price point) has shifted. Typically, this means main contractors find themselves at risk of bearing the cost, since it was not a term they sought to negotiate with their clients at the time. Previously, the labour market at second-tier and below had been buoyant, reasonably balanced and, moreover, stable—now it is more unstable and more of a seller market.
Are there any provisions which contractors/consultants are seeking to include/amend in contracts as a result of Brexit?
HL: The key terms that contractors/consultants want to include in contracts and appointments are:
a term that allows an extension of time (EoT) if there is a manpower shortage
a term that allows an increase in labour costs should the UK government or the EU
impose additional visa/working/regulatory requirements
a term that allows an EoT if there are customs delays in respect of key components
a term that allows cost increase if certain material costs increase (beyond, say, a 7 %
limit) due to import/export tariffs
a term that seeks to impose a requirement that British standards/design codes will prevail over European and/or international standards
SS: During the past 18 months, I have seen risks, which were not high on the priority list, being more aggressively negotiated. These include
inflation risk (eg under NEC4 Option X1 or the JCT fluctuations options)
currency (eg under NEC4 Option X3 or bespoke amendments to JCT)
retention (eg under NEC4 Option X16 or JCT Contract Particulars 4.17-4.18)
I have also spent more time with technical teams to carve up a single completion or practical completion date into smaller chunks, and I have used this successfully on several projects. It is another way, in my view, of sharing risk.
In addition, I have seen more attention paid to the entirety of the contract, in a holistic sense, so that it becomes more balanced. This is something I feel strongly about, to get the best out of the project team and to maximise the project’s value and benefits. By the same token, I have also seen more aggression on the part of funders who are investing in projects which perhaps are more vulnerable to currency markets or overseas investment. Their return on investment is at risk.
But, I have to say, pushing down risk unevenly into the delivery market will not solve the problem and can be a crude way to attempt to do so. More government-backing is required without creating undue risk to the taxpayer. That means paying more attention to flexible sources of investment in publicly-oriented projects, which will produce assured long term benefits, not just consumer-led short term ones which peak then fizzle out. Creative strategies look to create self-perpetuating on-benefits, based on solid strategy, critiqued earned benefits and short and long term value. Some of the most exciting projects I have been involved in since the Brexit vote have adopted this slightly-leftfield thinking and they are working.
Are there any provisions which employers are seeking to include/amend? How receptive are contractors/consultants?
HL: Some employers want to say that Brexit a neutral event and so the risks should remain on whoever they fall. Put another way, employers don’t want to give time or money as a consequence
force majeure events (but employers are unreceptive to this)
currency fluctuations (if the employer is unreceptive to this, it is likely to have an effect on
the quoted price)
risk allocation of materials and labour being unavailable (likely to have an effect on price
if risk allocated to contractor, or the putting forward of fluctuation provisions as an alternative) of Brexit. In effect this is the opposite of what the contractor or consultant is looking for. The considered view, however, is that the consequences of Brexit are an employer risk and so, while employers can seek to limit the relief, the tariffs/visa costs/free movement and related issues will lead to increased costs and an EoT.
MP: Extension of compliance with ‘statutory requirements’, as finally amended when Brexit is complete.
SS: I have seen some clients/employers in NEC trying to use Option A (lump sum) to try to fix their risk. If a lump sum is insisted upon, I prefer Option B as it more balanced. Similarly, Option C and Option D (target cost) can be tussled over.
Has Brexit had an impact on the types of claims/disputes we are seeing?
HL: No—not yet. There is no evidence of real claims being made on this basis. As the government’s
position crystallises one would expect to see such claims emerge.MP: Not yet, but this can be anticipated.
SS: I have noticed a few changes:
more aggressive pursuance of claims
an increased number in EoT claims where labour resource risk is on the employer
an increased number in claims for non-payment of sums due, probably as a result of
contractor pressure on cashflow, and also pressure from above to join forces and press
employers for quicker resolution
more hanging on to cash by employers, whether legally justifiable or not, which then
results in lower settlements by contractors or, conversely, aggressively pursued claims, depending on appetite for the fight and desperation
This is notwithstanding recent-ish moves by standard construction contracts NEC and JCT to encourage collaboration (eg the JCT 2016 and NEC4 contracts).
What is the outlook for the next 12 months?
HL: The outlook depends entirely on the agreed/negotiated position with the EU and the consequences on free movement/tariffs/trade/steel prices. The current uncertainty created a desire to seek certain protections in the contracts and appointments. The details will lead to a refinement in the risk allocation in contracts and appointments. It may also improve the commercial position.
MP: More of the same until final shape of Brexit package known. Shortage of specialist labour and materials probably going to increase. Prices likely to increase as shortages arise and possibly tariffs are imposed. More commercial space likely to become available as companies/organisations move elsewhere within Europe thus reducing demand for new builds. Possible downturn in demand for residential property until final Brexit deal is known and other worldwide trade problems are resolved.
SS: The outlook looks very cautious. There are many fascinating projects but many are at break- even point. Don’t be fooled by the big shiny ones. The markets are responding—there is likely to be more consolidation in the market and more cost-cutting measures. The Construction (Retention Deposits) Bill (known as the ‘Aldous’ Bill) may be whizzed through Parliament to create some stability but it is far from clear whether it will have any real impact.
For me, paying more and better attention to contract packages is the key. My approach is to focus on agreeing an appropriate ‘basket’ of incentives and penalties, and being more creative in drafting with terms, risk-sharing and sensible carve-outs. There is much work to be done to bring contracts into the real world and make them be useful live tools which people actually read and use.
Interviewed by Max Aitchison.