The Effect of Contractor Insolvency on Construction Projects in the Middle East

Why are bankruptcy laws needed?

Over the past couple of years, there have been a wave of new insolvency and bankruptcy laws introduced in the GCC. With the exception of Qatar and Kuwait, all other GCC countries have now introduced new bankruptcy laws. As for Oman, its new bankruptcy law is due to come into effect on 1 July 2020.

One of the many reasons why updating the bankruptcy laws has become necessary, is the need for inward investment. Modern fit for purpose bankruptcy laws give investors confidence by providing mechanisms for distressed companies to reorganise their structure and repay creditors with the possibility of continuing to operate. As such, all of the new bankruptcy laws contain provisions allowing for restructuring.  

The risk of insolvency is present at all stages during a construction project and can have a knock-on effect on the time and costs for completing the project.

Insolvency regimes in the Middle East

The UAE was the first of the jurisdictions to implement a new bankruptcy law implementing the UAE Bankruptcy Law in 2016. It applies to all commercial companies, excluding those registered in the DIFC and ADGM as they have their own comprehensive insolvency regimes.

The UAE Bankruptcy Law has three mains parts to it:

• protective/preventative settlement;
• insolvency with restructuring; and
• insolvency with liquidation.

Protective settlement allows debtors to reach an agreement with creditors with the assistance of the court for the settlement of its debts. This is available to businesses that are not yet insolvent but are facing financial difficulties and offers a positive opportunity to enable the company to return to being profitable.

In Saudi Arabia, the KSA Bankruptcy Law was introduced in 2018. Similar to the UAE Bankruptcy Law, it also allows for protective/preventative settlement and insolvency with restructuring or liquidation.

In Bahrain, the Bahrain Bankruptcy Law, also introduced in 2018, is similar to that of both the UAE and Saudi Arabia. It was enacted to focus on modern legal mechanisms to restructure a business in distress.

Oman’s current bankruptcy law only recognises one formal mechanism, being liquidation. However, Oman issued its new Bankruptcy Law in 2019. Whilst the Law will not come into effect until 1 July 2020, the structure of the New Oman Bankruptcy Law is similar to that of the UAE. This will be an improvement and can be seen as a positive step to encourage investment.

Effect of insolvency on construction projects

Contractor insolvency is a key risk in any construction project. Whilst it is usual for a construction contract to allow an employer to terminate the contract upon insolvency, bankruptcy, liquidation, receivership, administration or similar of the main contractor, such termination may not take into account the general effects of financial difficulties (not resulting in insolvency), nor the impact on the project as a whole.

A prevalent theme in construction projects is the scenario whereby a main contractor and/or subcontractor is endeavouring to progress works while also operating within a fragile financial environment. Often this is due to late payment, non-payment and/or cash flow restrictions on other projects.

Alternatively, the main contractor and/or subcontractor may come into the project with a healthy financial backdrop only to be hindered by events arising during the contract term. All too often, parties are permitted or compelled to carry on, neither of which is commercially conducive to a successful project.

Even though employers may be aware of a main contractor’s financial difficulties, the contractor is often permitted to carry on because employers do not know how to react in these types of situations, other than through the relatively drastic step of termination of the construction contract.

One of the main considerations an employer should take into account when deciding whether to terminate the main contractor’s employment on the grounds of potential insolvency is whether the time and cost of allowing the main contractor to continue outweighs the time and cost consequences of appointing a new contractor to complete the project. This may be possible where the contactor, although in financial difficulties, is not truly insolvent, but can continue to trade. Where the contractor is insolvent, the construction contract will need to be terminated and another contractor engaged.

Formal restructuring

Once prescribed bankruptcy proceedings have been issued under the relevant bankruptcy law, one of the options is to allow for a formal restructuring of the business in distress. Given that bankruptcy legislation has recently been put into place in many GCC countries, it will be interesting to see how each of the proceedings are brought forward and dealt with by each jurisdiction. Only one firm in the UAE has successfully restructured its debt under the UAE Bankruptcy Law to date. It is therefore a relatively unknown area and it is unclear as to precisely how successful any restructuring is likely to be.  

If a main contractor is successfully restructured following such proceedings, it could potentially continue on site to work towards finishing the project. However, a restructuring process is likely to take considerable time and, as such, an employer may prefer to terminate the main contractor’s employment if there is an alternative contractor available who would be able to successfully complete the project.

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This article was written by Partner Paula Boast and  Associate Jodie Martyndale-Howard. For more information please get in touch at paula.boast@crsblaw.com or on +973 17 133212 or Jodie at jodie.martyndale-howard@crsblaw.com or on +973 17 133213.