New UAE Civil Code: the cost of walking away from construction contracts

Article 836 and employer withdrawal

Article 836 appears to be a new muqawala-specific provision dealing with employer withdrawal. It provides that the employer may withdraw from the contract and suspend performance at any time before the work is completed, provided that the contractor is compensated.

That is significant because many construction contracts already deal with termination in detailed terms. Article 836 is therefore likely to be relevant in circumstances where the contract itself contains a termination for convenience clause, as well as where the contract is silent or unclear about withdrawal.

However, the provision is equally about the contractor’s right to be compensated following the employer’s withdrawal. That is where much of the practical importance of Article 836 is likely to lie.

The compensation framework

Article 836 sets out three broad heads of compensation.

First, the contractor is entitled to be compensated for the expenses it has incurred. Secondly, the contractor is entitled to be compensated for the work it has completed. Thirdly, the contractor is entitled to be compensated for what it would have earned if it had completed the works.

The third category is particularly important because it suggests that compensation is not limited to reimbursement of costs or payment for work already performed. The contractor may also be entitled to recover the earnings it expected to make from completing the project. However, Article 836 also allows the court or arbitral tribunal to reduce the compensation payable for lost earnings where the circumstances make such a reduction fair. In particular, the court or tribunal may consider any savings the contractor has made because of the employer’s withdrawal, as well as any gains the contractor has made by using its time for another purpose.

This creates a balance. Article 836 may allow the employer to withdraw before completion, but it also seeks to ensure that the contractor is not left uncompensated for the financial consequences of that decision.

Is this termination for convenience by another route?

Article 836 resembles a termination for convenience clause; however, these are usually drafted into the contract. They are designed to give one party, often the employer, the ability to terminate the contract without needing to prove default by the other party. The contract will usually set out when the right can be exercised, what notice must be given, and what compensation is payable.

Article 836 appears to operate differently by providing a statutory mechanism for employer withdrawal and setting out the compensation consequences of that withdrawal. This may also raise questions about how statutory withdrawal rights interact with express termination provisions. For example, a contract may allow the employer to terminate for convenience but exclude loss of profit. Another contract may allow recovery of loss of profit, but only where the contractor satisfies certain notice and substantiation requirements.

It is not yet clear whether, and to what extent, parties may contract out of Article 836 or modify its compensation regime given it does not appear to be an expressly mandatory provision. However, until this has been considered by courts or arbitral tribunals, parties should be careful about assuming that it can be excluded or modified in all circumstances. That uncertainty should encourage parties to be clearer about the consequences of employer withdrawal. If parties intend a particular compensation regime to apply, or if they intend to limit particular categories of recovery, that should be addressed expressly.

The likely battleground: What would the contractor have earned?

The most difficult disputes under Article 836 are likely to concern valuation. The contractor may be able to identify the expenses it has incurred and the work it has completed. However, there may still be disputes about whether those costs were properly incurred, whether the works were properly completed, and how they should be valued particularly if the contract sum is based upon a “rules of credit” arrangement where payments are not necessarily made based upon the value of the works completed. The more difficult question may be what the contractor would have earned had it completed the works. That may require an assessment of expected profit, remaining costs, programme, resources, subcontractor costs, materials, plant, overheads and the assumptions on which the contractor priced the works.

By way of example, if an employer appoints a contractor to carry out works on a large development and later decides that the project is no longer commercially attractive, Article 836 may become relevant. The employer may wish to pause the project, redesign it, appoint a different contractor, or stop the works altogether. Article 836 appears to allow the employer to withdraw from the contract and suspend performance before completion. However, that withdrawal would not be without compensation.

The contractor may claim the expenses it has incurred, the value of the work it has completed, and the earnings it would have made had it completed the works. The employer may then argue that the amount should be reduced. If the contractor no longer needs to incur the costs of labour, materials or plant for the remainder of the project, or is able to redeploy resources to another project, this may be relevant. The contractor may argue in response that those resources could not realistically be redeployed, or that any alternative work did not replace the profit it expected to earn under the original contract.

This means that Article 836 may turn withdrawal into a detailed accounting and valuation exercise. The price of walking away may therefore become the central issue.

Practical considerations

There are a number of practical points for parties to consider.

• Employers should not assume that Article 836 provides a cost-free exit from a construction contract. The provision may provide flexibility, but that flexibility is linked to a compensation obligation.
• Employers should consider the likely financial consequences before withdrawing from a contract. This may include the value of work completed, expenses incurred and the contractor’s potential claim for expected earnings.
• Employers should also consider what evidence may be available to support any deductions from compensation. If the contractor has saved costs, avoided expenditure or redeployed resources to another project, those matters may be relevant.
• Contractors should maintain clear records of costs incurred, work completed and expected earnings. These records may be important if the employer withdraws before completion.
• Parties should review termination for convenience clauses in UAE-law construction contracts. In particular, they should consider whether the contract clearly addresses notice, valuation, loss of profit, demobilisation costs, materials, subcontracts, mitigation, savings and alternative gains.

As with many of the changes introduced by the new UAE Civil Code, the practical impact of Article 836 will depend on how it is applied by courts and arbitral tribunals. What is clear, however, is that Article 836 appears to bring the consequences of employer withdrawal into sharper focus. For employers, it may provide flexibility. For contractors, it may provide protection. For both parties, the key issue is likely to be the price of walking away.

Authored by Emerson Holmes and Jamie Phillips.