Legal and Regulatory

How to Prepare for Potential Construction Disputes Resulting From COVID-19

Stakeholders in the construction process need to prepare for potential disputes and understand their rights and responsibilities. This includes understanding applicable clauses in construction contracts and subcontractor agreements as well as business interruption clauses and other provisions in insurance contracts.
By Helga A. Zauner
July 15, 2020
Legal and Regulatory

Every industry has been affected by the COVID-19 pandemic, and construction is no exception. While construction work was deemed essential in some places, it has been limited only to pandemic-related projects in others.

In the current climate, construction companies face a myriad new challenges, including concerns about health and safety, delays resulting from employee illnesses, supply chain disruptions and increased prices for materials, as well as contract delays or cancellations by concerned contract owners. Contractors must keep their employees safe and institute what could be costly best-practice measures, while facing potential claims from employees if they get sick due to a company’s perceived lack of response to the dangers of the coronavirus.

Stakeholders in the construction process need to prepare for potential disputes and understand their rights and responsibilities. This includes understanding applicable clauses in construction contracts and subcontractor agreements as well as business interruption clauses and other provisions in insurance contracts. Stakeholders may need to seek professional counsel to help them understand their rights and responsibilities in potential disputes.

Here are some steps to take in preparing for potential disputes arising from the effects of COVID-19:

Keep records in order

Maintaining good business and financial records will be vital in determining costs incurred by builders and potential reasons behind delays or cost overruns. This includes all contracts, signed Authorization for Expenditure (AFE) forms and change orders (with supporting budgets, estimates and documentation), all invoices with supporting backup, such as material invoices and time sheets, as well as internal accounting documents such as percentage of completion schedules. Project owners must keep good records of payments to contractors and any direct payments to subcontractors. Any communications, including memoranda, letters and emails related to a potential claim, should also be preserved. Contractors also need to file and document notice of delay with the project owners in a timely manner.

Determine whether you have a claim or whether a claim may be filed against you

Owners may have the option of filing a delay claim. Their contract will specify whether liquidated damages are applicable or if they have a basis for a claim. A fundamental issue that will be resolved in COVID-19 claims is whether construction delays fall under a force majeure clause, meaning the construction delays were excusable. The nature and responsibility of delays resulting from the disruption of the supply chain also will need to be assessed.

Contractors may have the right to file breach-of-contract claims if it was the project owner who delayed or cancelled a project, outside of the provisions in their contract.

In addition, employees who are getting sick are filing claims against employers for lack of due care to protect them from the virus.

Calculate damages

The calculation of lost profit damages derived from COVID-19–related delays will be particularly complex. A classical shifting-the-curve or profits-delay approach will be insufficient. Unrelated market factors will need to be considered, such as the general downturn in the economy, industry-specific effects and even the trend in energy prices. Delays caused by different actors may need to be evaluated separately.

If project owners cancel or delay construction projects, contractors may also be able to claim losses. A lost profits calculation in this case would require a detailed analysis of the lost revenues, the cost of mitigating efforts and an assessment of whether any other factors are directly causing the contractor’s losses. It will be important to determine whether revenues are truly lost or merely delayed.

In addition, if a company benefited or may benefit from the Paycheck Protection Program (PPP) forgiveness provisions in the CARES Act, it could affect the calculation of their lost profits. The following example shows the lost profits calculation for a company that suffered a two-month delay due to COVID-19. Cases I and II show the lost profits calculation without and with the PPP loan forgiveness program, respectively. Case II assumes that the company received forgivable PPP loans, which it used to pay eligible rent and payroll costs. The forgiven loan proceeds must be used to offset the costs, or alternatively, recognized as income.

The IRS has disallowed the deduction of expenses paid using PPP loans for income tax purposes. However, Congress has alluded to the possibility of revising this rule. In any calculation of lost profits, the impact of the non-deductibility of expenses should be considered.

Note that PPP loans may or may not reduce a company’s lost profits, as they are designed to improve liquidity, rather than mitigate losses. For example, if a company retained non-essential employees to maximize forgiveness of its PPP loan, it may incur higher expenses than if the company had not taken advantage of the PPP loan.

by Helga A. Zauner
Helga A. Zauner, CVA, CFE, MAFF, is a Managing Director of Forensics & Litigation Services for Weaver, the largest independent CPA firm in the southwest. She can be reached at [email protected].

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