COVID-19 and major infrastructure projects: managing the impact

Like every other part of the economy, the coronavirus (COVID-19) pandemic is having a significant impact on major infrastructure projects.

These impacts vary by asset type, stage of the project and the role of a party involved. All stakeholders should take steps to understand and manage the issues relevant to them.

This will require a ‘whole of project’ assessment and an integrated approach across the full range of inter-related government contracting, construction, operations, financing and equity arrangements relevant to major infrastructure projects.

Informed positions can facilitate proactive and constructive engagement among stakeholders. They can also assist in reaching commercial agreement where there is insufficient time to strictly follow contractual processes.

Managing the impact

Infrastructure, and the works and services to develop and support it, will be affected in different ways. The objectives, requirements and concerns of stakeholders will vary, for example:

• A hospital operator may require additional works or services to respond to the increasing strain on health services.
• Existing facilities may need to be repurposed to support the medical response.
• Convention centres have cancelled events or closed to the public.
• Contractors are affected by restrictions on movement and impacts on supply chains.
• Transport infrastructure will experience reduced patronage.
• Student accommodation facilities may suffer reduced occupancy, while universities and operators manage the wellbeing of students that are in residence.
• Electricity generation is still required, but contractors may be affected in service delivery and broader ‘market stresses’ are still relevant.

How a stakeholder – be it government, sponsor/investor, contractor, lender or other participant – should respond will be informed by its particular circumstances.

We set out below some observations on key themes relevant to major infrastructure projects and how the impacts on stakeholders can be managed in these challenging times.

Contractual relief

Force majeure

While determination of whether the current circumstances can constitute a force majeure event – whether as a pandemic or other basis – is the first question in the force majeure analysis, there are a number of subsidiary questions which determine the entitlement to contractual relief and the nature of it.

Force majeure event regimes often require that the force majeure event occurs at, or in the vicinity of, the site of the infrastructure, and that a party be prevented or affected (wording differs) in performing obligations. This may not obviously be the case, even in circumstances where the construction or operation of infrastructure is affected by the impacts of COVID-19.

Turning to the nature of the relief, while it may include relief from performance and/or an extension of time to a date for completion, the financial consequences are often more important. For example:

• who bears the cost of debt service, impact on equity return and additional site overheads in the case of a delay to completion?; and
• how can unavoidable fixed costs and debt service continue to be paid in circumstances where revenue stops or is materially reduced?

The answers will vary from project to project and will depend, in part, on the stage in the project lifecycle and whether it is a public private partnership (PPP), where the State may meet certain unavoidable costs.

Finally on force majeure, a contract may include a right for a party to terminate for a prolonged force majeure event (say one that has continued for six months). Given COVID-19 has the potential for a long-term impact, it will be important for parties to discuss the potential for termination early and make medium and long-term arrangements for the project, in addition to the immediate questions of relief and funding.

Change in law, policy or standards

With increasing government intervention to attempt to stem the spread of COVID-19, attention is shifting to an assessment of whether government action gives rise to an entitlement to compensation, or relief as a change in law or change in policy or standards.

Much will depend on the nature of the government action. Restrictions on mass gatherings may mandate the closure of a facility; travel restrictions may deprive a project of resources to progress work or affect patronage; and new cleaning standards may require additional resources.

Relief will depend on the terms of the contract. Relief may not be granted, may be subject to a sharing arrangement or depend on the stage in the project lifecycle (it is common in PPPs for example for the State to not provide relief for general changes in law during the construction phase).

As an alternative to providing relief for a change in policy or standard, a party may be able to elect that a non-mandatory policy or standard not be complied with.

Other action

Parties should be vigilant as to whether other grounds of claim may be triggered by their, or the other party’s, action.

Instructing a party to act in a particular way to respond to COVID-19 may simply be to require a party to comply with its existing contractual obligations. In other cases it may amount to a ‘deemed variation’ which must be compensated.

It may be the case that the action needs to be taken regardless of the contractual outcome. There may be public health or safety imperatives, for example. But, where circumstances permit, it is preferable for decisions to be made with an appreciation of the contractual consequences.

Managing claims

Contracts often contain conditions to an entitlement to claim relief, and timeframes within which claims must be brought. These should be observed, with claims as complete as possible on the information available.

‘Linked claims’ regimes also need to be considered where they exist so that, if applicable, the claim is preserved and can be pursued (for the benefit of the contractor) and the protection afforded by the regime is not lost (for the benefit of the ‘project company’).

Responding to the circumstances

Variations

Project owners may require additional services from contractors (such as additional cleaning or increased security for public facilities) or a change in the way existing services are performed. Works may be required to repurpose areas for a new use.

The variation (or modifications) regime in a contract will typically detail how such changes can be implemented, how cost and time impacts should be determined and whether they need to be agreed or determined before the change can be implemented. Alternatively, a project owner may be able to direct that the change be made with the cost and time consequences to be worked out later.

Reduction in scope and suspension

In other cases, a party may not require works or services (either at all or to the same extent) or may wish to reduce works or service provision to manage costs.

This may be achieved through a variation or suspension right. The discussion is likely to be easier where works or services are not required or cannot practically be performed, or where there is a mutual interest in managing outgoings.

Step-in rights and alternative contractor regimes

An existing contractor may, quite legitimately, not have the capacity or expertise to undertake required work or manage unfolding circumstances, particularly within tight timeframes.

Step-in rights (which may be triggered by an emergency or public safety incident), and the ability to appoint another contractor to undertake work or perform services, can provide a means for a project owner to take back responsibility for certain tasks or engage others to undertake them.

A contract will usually address the consequences of this sort of action, including impact on payments, potential compensation and obligations for contractors to co-operate.

Service payments, abatements and availability

Calculation of service payments

Some of the matters identified above will track through to payment arrangements.

In addition, for some facilities, the consequences of COVID-19 may have a material impact on the calculation of ‘regular’ service payments.

While some will be based on fixed amounts for services provided over a period of time, others will include variables based on usage – such as volume rates for certain activities and adjustments based on energy consumption relative to target consumption levels.

Abatement and availability regimes

Service payments may be reduced for poor or non-performance of a service. Abatements above permitted levels may also trigger defaults.

Availability damages may be payable for failure to maintain the availability of assets at agreed levels.

However, the strict calculations in an abatement or availability regime may not recognise the reality of circumstances ‘on the ground’ and the impacts of COVID-19 on service delivery.

Relief may be available on the basis of force majeure, a change in law or other grounds.

Where it is available, the nature of the relief will vary by contract, the ground of relief and availability of insurance. Under some contracts, the service provider will remain entitled to full payment or will not be liable for availability damages. Under others, service payments may be reduced but not to the extent that certain unavoidable costs (such as debt service and fixed costs) would go unpaid. An abatement may also be disregarded in determining whether a default threshold has been reached.

Financing and equity arrangements

Managing financing arrangements

In financed transactions, all parties should be aware of obligations and restrictions under finance documents.

While most relevant for the borrower group, other parties such as contractors, off-takers and government bodies should be aware of the terms of lender tripartite agreements (or consent, direct or side deeds) that they are party to. These may require the other parties to give copies of notices or other information to the lenders, and restrict how these other parties respond to circumstances (such as through restrictions on amendments to documents and the exercise of suspension rights).

Returning to the borrower group, it should carefully manage the relationship with lenders. Copies of material contractual notices should usually be shared with lenders. Lender consent processes should be factored into timeframes. Circumstances in which lender consents are required on an expedited basis should be clearly identified.

Key terms of financing arrangements

Borrowers and lenders should also carefully consider sources of funds to meet ongoing debt service obligations on stressed projects, potential drawstops, material adverse effect (MAE) provisions, the potential for increased cost of funds to be passed through to the borrower through market disruption clauses, and the potential impact on financial covenants.

Borrowers should be particularly mindful of financial covenants – such as debt service cover ratio (DSCR) – and the level at which default, cash sweep, lock up and drawing of debt service reserve facilities are triggered.

While some facility agreements will include a formal regime to ‘cure’ a DSCR default, the absence of one does not preclude discussion.

Deferred equity commitments

Investors who agree to provide equity on a deferred basis are usually required to contribute it in fixed amounts on fixed dates. This is generally expressed as an absolute obligation (supported by a letter of credit) with no relief for intervening events.

Potential market stress

Refinancing

Investors should identify timeframes for required re-financings and commence discussions with potential lenders early to gauge appetite to lend and possible terms in the current environment.

As part of this, investors should consider whether they can ‘split’ the refinancing task so that only facilities or tranches with a looming maturity date are refinanced. This is more than simply a question of maturity dates. In practice, do the documents and current swap positions facilitate a ‘partial refinancing’, so that existing lenders can be replaced in relation to the maturing debt only?

Depending on anticipated lending appetite, investors should also consider parallel extension discussions with existing lenders, though extension without a competitive process is unlikely to be optimal – in terms of pricing and, in the case of a short term extension, unbudgeted upfront and transaction costs.

Credit rating downgrades

Performance security for contractor performance and letters of credit in respect of deferred equity commitments must typically be provided by an issuer with a minimum credit rating.

While it remains to be seen, the current circumstances may put pressure on the credit ratings of some issuers, with a downgrade triggering a requirement for the contractor or equity investor to source a replacement issuer with an acceptable rating. Failure to provide a replacement when required will entitle the beneficiary to call on it.

Contractors and equity investors should be alive to this and consider alternative credit lines where there is a concern about an existing issuer (noting that credit lines may dry up as the impact of COVID-19 continues to evolve).

Solvency

As projects and stakeholders continue to be affected, solvency positions are likely to come under pressure.

While it is of course prudent to prepare for this – to understand rights and obligations, access to security and the availability and cost associated with replacement contractors – early identification of potential issues and good lines of communication are key.

Agreement on ways to manage points of tension, rather than strict enforcement of contractual rights, may ultimately produce a better outcome than insolvency and the work out that follows.

In any enforcement scenario, the application of ipso facto laws need to be considered.

Other practical issues

‘Business days’

Many contractual obligations are defined by reference to ‘business days’. Definitions vary but, generally, they are days other than Saturday, Sunday and public holidays. In some cases, they are expressed as days on which banks are generally open for business in a particular place.

While it has not happened in Australia as yet, days may be declared as public holidays (it has happened elsewhere) or there may be days when banks are not generally open for business.

At one level, this should afford more time to perform obligations that are based on a business day count. But, as definitions vary, disconnects between documents and jurisdictions may emerge and unintended consequences may arise (for example, performance security with a fixed expiry date compared with a contractual obligation to maintain it by reference to a business day count).

This is a discrete point and one to keep an eye on.

Non-contractual issues

COVID-19 is also giving rise to a range of other concerns that sit outside contractual provisions and may be relevant to major infrastructure projects. These include:

• occupational health and safety;
• industrial relations;
• directors and officers duties; and
• insolvency, which Corrs has separately commented on as part of our insight series, COVID-19: Navigating the implications for business in Australia and beyond.