Engineering Agreements

In the first half of 2020, due to the Covid-19 pandemic - characterized as such per the World Health Organization – Brazil’s GDP shrank 1.5% compared to the previous period in 2019 and the engineering sector suffered major losses despite some sparse signs of recovery after five years of economic recession

Outcomes

The lockdown brought most construction projects to a halt because the execution pace was severely affected by reduced working hours and problems with the supply chain, which was itself severely impacted by the lack of manufacture of specific products and the logistical limitations at the time.

During lockdown, there was an input shortage (ceramics, cement, PVC, aluminum and glass) that, combined with the increase in the prices of international commodities (e.g. iron ore, copper) and the devaluation of the Brazilian Real, led inflation to its highest peak in 28 years, fluctuating from 40 to 70%, according to the IGP-10/FGV index.

A new series of costs began affecting operations in the sector in light of new safety protocols required by the health authorities: aseptic measures within construction sites from access and tools, PPE replacement, individual distancing in transportation and accommodation, manpower disinfection and periodic testing, among others, also with the incorporation of acquisition costs, due to less practicality.

The mobility sector - particularly airport, road and passenger transport concessions - was seriously impacted by demand reductions

The rule of law

Timetables and the disproportionate price hike in materials and equipment would cause a potential imbalance in the legal settlement of engineering contracts, being administrative or private deals.

When raised from unpredictable facts, their charges are not contained in the business risk and then budgeted in the proposal that gave origin to such a contract, creating extraordinary economic risks.

The Covid-19 pandemic can be understood as a period of force majeure, which demonstrates the impossibility of completing projects without accounting for unforeseen circumstances and relying on engineering expertise alone.

But for the proper compensation to be characterized, it is also essential to determine whether, in the contractual instrument, the clauses providing for these events of force majeure and overstretching are written.

Contractual rebalancing

An expert examination will rebuild the work occurrences in a timeline, correlating events and its impacts through “causality analysis”, aiming at the adequate economic-financial reorder of the original conditions then agreed upon in the contract.

Careful assessment of justifiable factors, responsibilities and effects on the critical path should be carried out.

Finally, the expertise is responsible for making sure that everything is supported by records proving the related costs and delays as well.

Concession contracts

Mobility related segments, especially road, airport, urban and intercity passenger transport concessions were also strongly affected by the circulation restrictions imposed by health authorities.

In the first half of 2020, due to the Covid-19 pandemic, Brazil’s GDP shrank 1.5% compared to the previous period in 2019

Outcomes

Taking the State of São Paulo road system as an example, recent studies by the Brazilian Association of Road Concessioners (ABCR) have shown a decrease of 14% in driving and a 21% in revenues, interfering with dealerships' cash flow management.

The rule of law

Although the demand risk could fall back upon the concessioner when drafting concession contracts, which would release the regulatory agency (ARTESP – Agência de Transporte do Estado de São Paulo) from admitting their adequate economic-financial reordering in case of amounts below expectations, there is a firm understanding that this provision does not fit when the problem arises from events of force majeure and overstretching.

The decrease in the road demand is a force majeure clause since travel restrictions were adopted precisely to contain the spread of the virus.

And in the opinion of the State Attorney General's Office: “The global pandemic scenario creates a hypothesis of force majeure, as that is completely far-off the parties’ will and absolutely unavoidable, even if abstractly unpredictable. With this, the required assumption to feature the impossibility of the concessioner to prevent the occurrence of that event or that resulting in impacts on the services provided is hereby recognized.”

Contractual rebalancing

The expert must analyze the scope of measures and the impact on each concession contract.

The assessment includes a demanding task, such as measuring the pandemic extraordinary effects when revenues are unfulfilled, as well as considering its level change - whether in relation to the expected revenues or those observed in the previous period.

Urban passenger transport companies also had significant imbalances related to the loss of passengers because of circulation restrictions. In many cases, the demand risk is assumed by the conceding authority. In addition to the loss of revenue, they had to bear limitations on passengers per bus, and obligations such as providing PPE, hand sanitizer and vehicle disinfection.

The National Association of Urban Transport Companies (NTU) estimated losses of R$ 16.7 billion between March 2020 and June 2021. These companies have been suffering losses and, today, there are many discussions on rebalancing being observed countrywide.

We should experience several actions in the near future claiming economic and financial imbalances due to excessive burdens characterized by extraordinary and unpredictable events, as observed in the pandemic.

Conclusion

The mobility sector - airport, road and passenger transport concessions - was seriously impacted by demand reductions, while the impact on construction was caused by the issue of costs and material and the limitation of materials, in addition to other charges resulting from the pandemic. These imbalances contribute to the impossibility of providing the service agreed on.

Events such as these, that affect the economic-financial equation of the contracts, must be analyzed and proven for each situation, demonstrating the effects of the pandemic in relation to the premises in the original contract and establishing the effective causal link.

It is then possible to request the revision of contracts signed with construction companies and governments, as well as with other individuals, in order to re-establish the balance between the parties in unpredictable cases, such as the global situation we have been experiencing since early 2020. Measuring and verifying imbalances for each contract is the challenge.

About the Author:

OSÓRIO ACCIOLY GATTO is a founding partner of Mercatto Assessoria e Avaliações, an engineer and a Master of Economics, postgraduate in Engineering Expertise and Evaluations, with an expressive institutional and academic career and a certified expert (AAA level) by IBAPE Nacional (Instituto Brasileiro de Avaliações e Perícias de Engenharia). He is a former president of IBAPE Nacional and IBAPE São Paulo, and former vice-president of União Pan-Americana de Associações de Avaliação (UPAV). He is a highly sought out expert witness, having worked in several arbitration proceedings and built up over 30 years of experience acting in cases involving economic-financial imbalances of heavy construction contracts and concession contracts.

E-mail: mercatto@uol.com.br
Phone: +55 (11) 5090-6020