Your questions answered:
Amid the rapidly evolving environment of the COVID-19 outbreak, at White Associates we are working with our clients to undertake risk analysis on existing and new projects, addressing questions for funders on risks that may impact the construction industry and project funding across procurement, supply chain and resourcing:
Key questions funders need to ask:
- How will COVID-19 affect my current and future projects?
- What trade components resources are affected?
- How best to manage the risks?
- Will insurance policies respond to COVID-19 delays – and what to watch out for if sites are suspended?
- Will contractors be entitled to extensions of time if COVID-19 delays a project?
- How is White Associates responding to the risks and reporting back?
Does this situation also present opportunities?
To answer these questions:
1) How will COVID-19 affect my current and future projects?
- If a project is in its early stages of procurement, the need exists to examine the supply chain to probe for any issues.
- It is also worth:
- Examining locally-sourced product options to see if a project would be de-risked from a time and cost perspective through a local supply option
- Exploring whether social distancing recommendations affect immediate supply chain availability, site resourcing
- Understanding contingency plans for key personnel in the event of illness.
- Later on in a project, supply chain constraints may not be so much of an issue, but consideration still needs to be given that you’ve looked into the supply chain to ensure that there are no significant constraints.
- Thinking about the spreading ripples of this evolving crisis, what resources, materials and stocks will run out over time and cause issues along the planned critical path for the planned project?
- This requires a thorough, rigorous risk assessment to be completed by the full project team to satisfy the funder that the borrower has considered everything, and to ensure that any risks associated with components of the project are being properly managed. For example, as much of the world appears to be shutting down, are the factories needed for the project operating – and if so, for how long? And how long will it take for a delivery backlog to unclog?
- Is the project team examining options to bulk-buy materials well ahead of time – and are their cashflows up to it in the event the contract doesn’t entitle payment for materials off site?
Potential impacts for funders:
- Increased costs for projects, unforeseen before the event
- Increased contingency expenditure
- Project is prolonged – which could affect deliverable sunset dates and interest cover provisions.
2) What trade components and resources are affected?
White Associates’ observations of construction components that may be affected include:
- Structural steel – A significant volume of steel components come from China. We understand production is once again gaining momentum. However, there may be potential supply issues until mid- to late this year.
- Lifts – some lifts are sourced from Italy and other parts of Europe, with delays associated with the current shutdown of the country borders and production.
- Reinforcing steel – is one component that no significant supply restraints are currently anticipated as most steel is refined at Glenbrook here in NZ, with only a handful of NZ reinforcing steel companies sourcing product from China. However, most reinforcing steel companies in New Zealand have Italian equipment. This could create problems if they don’t have enough spare parts to cover inevitable breakdowns, which could reduce capacity to operate.
- Glazing/ façade components – there is potential for these components, which are manufactured and shipped from China, to be delayed due to the initial closure of factories and likely border controls.
- Plumbing fittings/ electrical components – there may be shortages in supply of these items given the closure of factories and ports in China. In addition, European and American fittings will be affected.
- Kitchen components – many large-scale developments source joinery units from China. There may be a lag in being able to obtain these components in a reasonable timeframe until production catches up.
- Tiles – many wall and floor tiles are sourced from China and Italy. Supply constraints may be apparent as NZ stock runs out.
- Ripple factor: Human Resources – in the event of a COVID-19 case in an organisation associated with your development, the company could be shut down for two weeks (minimum) during the quarantine process. There will also be reduced productivity for a time until full production is reached.
There are a number of other components in construction that are 100% manufactured or assembled elsewhere in the world with components sourced in the countries which have been affected by COVID-19. As the situation develops, the risk of each of the components may increase or decrease, with the influencing factor being how long the COVID-19 crisis persists. Therefore, we recommend that:
- Additional due diligence – undertaken on existing projects and projects at the inception stage around the contractors, subcontractors and supplier procurement.
- Risk management and up-front planning – essential to ensure continuity on projects and to manage risks associated with projects becoming prolonged.
Potential impacts for funders:
- Moving to alternative suppliers may lead to increased project costs, unforeseen before the event.
- Contingency expenditure could be required.
- Prolonged projects could affect deliverables, sunset dates and additional interest and funding costs.
3) How best to manage the risks?
Engagement with the contractor is key – to fully and comprehensively understand their procurement and supply chain, and any inherent risks within it. This is fundamental.
Then we recommend working proactively together to understand (and ensure) that:
- A full risk assessment has been made.
- Detailed contingency plans have been put in place.
- Any associated costs and time implications are known, quantified and accommodated within the project plan.
4) Will insurance policies respond to COVID-19 delays – and what to watch out for if sites are suspended?
A number of insurers have been quick to issue guidance to the market in light of the COVID-19 outbreak. One of them is AON, which has offered a number of useful pointers in its Know the Drill | March 2020, Coronavirus Virus/COVID-19 | Policy Wordings vs Schedules bulletin, which includes:
- Most insurance policies in the construction sector will not cover losses arising from COVID-19. Property policies require physical damage and liability policies require negligence. Focus should be on the impact of the situation on your policies.
- Does the contract works policy have a cessation clause in it? This means if there is no work onsite for a specific number of days (as per the policy) the contract works policy automatically lapses. This could unexpectedly leave the contact works uninsured.
- What are the lead times to order/source supplies? Do you need to be ordering more/holding stock yourselves?
What to watch out for if sites are suspended?
- In the event that a site is suspended it will be imperative to notify your broker or insurer to ensure continuity of your policy during the suspension period.
In any event, we recommend that:
- You talk with a specialist broker or advisor if you have any concerns about either of these points or any wider concerns.
- As AON says: You should always carefully check any policy documentation where your expectation is that you will have the benefit of the insurance coverage procured by a third party (be it a Principal or a Head Contractor). If in any doubt, seek advice from your insurance broker as the downside can be considerable.
Potential impact for funders:
– A project could become uninsured if a site is shut down for a period of time.
5) Will contractors be entitled to extensions of time if COVID-19 delays a project?
They may be. Simpson Grierson, in its recently published guidance note, says that in some cases contractors may be entitled to extensions of time for such delays. We concur with these guidelines.
The type of contract in place is important. Clause 10.3.1(f) of the General Conditions of The most commonly used contract version, NZS3910:2013, provides that the Engineer shall grant an extension of time if the Contractor is fairly entitled to an extension by reason of “any circumstances not reasonably foreseeable by an experienced contractor at the time of tendering and not due to the fault of the Contractor”. This provision is replicated in NZS3916:2013.
‘Provided tendering took place prior to the outbreak of the virus, the spread of COVID-19 and its impact on production and supply chains could not have been reasonably foreseeable to a Contractor.’
We recommend that:
- The borrower and their representatives review their contracts to ascertain the contractor’s entitlement and establish potential time and cost impacts on their projects.
Potential impacts for funders:
- The role of the Engineer – and the term ‘fairly entitled’ – are in the spotlight here. The Engineer’s determination that the Contractor is (or is not) ‘fairly entitled’ to an extension will be key. Simpson Grierson’s view is that relevant factors to this determination could include ‘the Contractor’s ability to re-sequence works to avoid any critical delay and the particular circumstances of procurement of the delayed materials.’
- Even if entitled to an extension of time and relief from liquidated damages for late completion, the contractor may not be compensated for time-related construction costs.
- Prolonged projects could affect deliverables, sunset dates, facility expiry dates which could create additional interest and other time-related development costs.
6) How is White Associates responding to the risks and reporting back?
At White Associates, we are working with our clients to undertake risk analysis on existing and new projects with regard to procurement. Our actions include:
- On every project we are involved in we are asking:
- Thorough questioning of the project team on their procurement and supply chain
- For information on all/any risks
- Management plans are in place to reduce the risks.
- We are also providing alternative supplier options where possible (such as an alternative, locally-based lifts supplier in the example given above).
- Full risk assessment – a major part of our precondition report information will include a section on supply chain risks associated with a project and COVID-19, with commentary and in-depth analysis.
Does this situation also present project opportunities?
Amid this global threat it may seem odd to consider it, but the current situation does provide opportunities in various sectors – such as retail and hospitality – to bring forward / undertake required maintenance or significant renovations or upgrades while visitor and occupancy levels are low.
Undertaking projects of this sort at this time:
- Would cause reduced disturbance to the public and to the organisation’s customer base
- Could be undertaken without a requirement for staging, which could also reduce time and cost.
Should you have any concerns about your existing project, or if you’d like to discuss the items noted in this bulletin further, please feel free to contact Darin Bayer to discuss.