Lawyers and consultants are seeing increased levels of contract disputes in the Middle East, as low oil prices restrict government budgets.
The lower oil revenues led governments to restrict extra payments for variations, pushing contractors to take action to recover costs.
The regional market is slowing, as government spending is cut, says David Risbridger, partner at UK-based Simmons & Simmons and head of Middle East construction and dispute resolution. Contractors are more willing to enter arbitration, and sometimes losses are so bad they are forced to.
Dutch engineering firm Arcadis found that contract disputes in the Middle East were worth on average $82m in 2015, the highest in the world. This was down to the sheer size of construction projects in the region.
Disputes take an average of 15.2 months to resolve, slightly below the global average, according to Arcadis figures.
Budget cuts drive disputes
There has been an upwards trend in the last year or 18 months, says Craig Beeson, Middle East head of contract solutions at Arcadis. One consequence of the oil price dropping has been an increase in disputes. Governments are restricting their budgets and focusing on priority projects around Dubai Expo 2020 and the Qatar 2022 Fifa World Cup there have been a number of suspensions, terminations and contract awards moved back. When contractors are terminated or suspended we inevitably see disputes.
The fall in oil prices coincided with the completion of projects awarded between 2011 and 2014, when the construction market was booming but highly competitive.
After the end of the financial crisis, a lot of contractors were hungry for work and lowballing prices it was a buyers market, says Risbridger. Some major projects were underbid, so contractors are now realising they have significant issues and we are seeing a rise in claims.
Because of the various forums parties can use and the confidential nature of arbitration, the exact number of cases is difficult to track. Contractors are increasingly thought to be resolving disputes in the region, as courts, especially in Dubai, build their reputation.
In the first half of 2016, the total value of Court of First Instance (CFI) at Dubai International Financial Centre (DIFC) Courts cases, including arbitration-related cases, counter claims and enforcement cases, handled by the commercial common law judicial system was approximately AED3.4bn ($0.9bn). This compares with AED2.3bn in the first half of 2015, a 48 per cent increase year on year.
There was also a significant increase in the number of enforcement cases before the DIFC Courts. The total number of CFI and arbitration cases grew by 35 per cent during the period, from 17 to 23, while the total number of enforcement cases grew by 194 per cent, from 17 to 50.
Contractors are also experiencing recourse to mediation and adjudication in increasing numbers, as it is a less public and costly choice, even if the contract does not include the option.
Administering contracts improperly
The main driver of disputes between clients and contractors in the region is poorly administered contracts, even when the base scope was adequately priced by contractors.
The problem is variations to works being applied in a timely way, and because of the scale and complexity of the projects there are a lot of variations, says Beeson. Most contractors are just trying to get the job completed without major cashflow problems. If they are not being paid on time for variations, it is a big issue.
Part of the problem is lack of delegation to project management consultants, who are not allowed to approve variations without oversight from the client. This leads to delays and the well-publicised cashflow problems at a number of contractors working in the region.
Qatar is an especially difficult market due to the standard contracts used.
In Qatar, you cant commence arbitration until the project is finished, explains Beeson. If you have a five-year project and a dispute arises in the second year, then you cant begin arbitration until year five. Then, with a long arbitration process, it could be five years before you get the money it is a significant cost to carry, and adds to delivery risk.
One root cause is the adversarial contract model used in the Middle East. Clients attempt to transfer all risk contractors with lump-sum turnkey projects, but end up paying more for variations, overruns and disputes.
Abu Dhabis Aldar trialled a New Engineering Contract (NEC) with Laing ORourke for its Al-Raha Beach development in 2007. However, the project was caught up in the wider real estate crisis in 2008, denting confidence in more collaborative types of contract.
Partnering-led contracts, which are less adversarial, have not got off the ground here, says Risbridger. There is a reluctance to move away from transferring all the risk onto the contractor.
For this to happen, a change in mindset is needed. This is especially important as the region considers public-private partnership (PPP) models. The long-term nature of PPP means more disputes will arise. Confidence in contracting and dispute resolution mechanisms are important to make markets attractive to PPP developers.
Risks need to be apportioned to the party best placed to mitigate them, says Beeson. Piling all the risk on the contractor feels like mitigation, but if the developer cant handle them, it puts the project in jeopardy.