Real Estate, Construction and Hotels & Leisure Focus
Euan Lloyd Senior Counsel, Construction & Infrastructure
Many hotel projects are being developed across the GCC (particularly in KSA), while many existing hotels are (or have recently been) refurbished.
In the hotel and hospitality industry, quality and appearance (including small details) are of the utmost importance, particularly as the expectations of guests are becoming increasingly sophisticated and positive guest reviews are often key for enticing future patronage.
Defects (and their disruptive rectification) can therefore be very damaging to the reputation and profitability of a hotel.
In this article, we briefly consider why defects arise and what can be done to ensure that they are addressed in the most efficient way.
Defects emanate from a variety of sources in respect of which the contractor’s lack of the necessary skill, resources and experience to satisfy the specification (that typically incorporates the hotel operator’s requirements) can be a factor.
To address this risk, it is important that the employer invests time in undertaking a thorough tender process to ensure that the contractor that is ultimately engaged is well positioned to properly perform the works (i.e. having previously undertaken works of a similar nature) and has the resources to properly fulfil its obligations.
However, this is only part of the jigsaw as, during the construction phase, it is vital that the works are closely supervised to ensure that aspects of non-compliant works are identified from the outset and corrected by the contractor (and works certainly should not be covered up without having been approved).
In terms of further underlying causes, lack of liquidity can severely impact on quality (and also cause delays). It is therefore vital that employer comply with their payment obligations.
Even if an employer pays its contractor on time for a particular project, the contractor can still experience financial difficulties on account of residual and legacy issues.
This is likely to be problematic as a contractor’s financial constraints may encourage the contractor to use of lower quality materials than those that are prescribed (although such instances should be identified during the supervision process) and also result in subcontractors not being paid their dues. Failure to pay subcontractors is likely to result in the unpaid subcontractors producing shoddy workmanship, suspending performance outright or electing to ‘go slow’.
Options to alleviate a contractor’s lack of liquidity need to be carefully considered on a case by case basis. However, typical approaches include adjusting the payment structure (including by making on-account payments (that should be secured)) as well the employer making direct payments to the subcontractors (although this can be a dangerous proposition for the employer unless this solution has been expressly agreed with the contractor).
As hotel projects are invariably time critical (including in order to comply with the hotel operator agreement), we are aware of instances of hotel projects being taken-over upon receipt of the necessary authority approvals to commercially operate the hotel, even though the project may not fully satisfy the contractually agreed (and more prescriptive) taking over criteria.
If a pragmatic (and understandable) approach of this nature is adopted, the employer would nevertheless be well advised to defer taking over the works at least until all activities that are likely to impact on the operation of the hotel to the desired standard have been addressed.
Defects in any construction project are inevitable, but this reality does not sit well with the exacting standards that are typically demanded by leading hotel brands.
Once a hotel has been taken-over, it becomes a revenue generating asset and the defects liability period commences.
The presence of paying guests means that defects (including items of incomplete works) need to be corrected as quickly and as discretely as possible.
Defects identified at take-over should be set out in the taking-over certificate (together with the timeframe within which such defects are to be remedied), while the employer should have the express right to instruct the contractor to correct any subsequently identified defects. Further, the employer may wish to have the ability to extend (i.e. for a further 12 months) the defects liability period for any defects rectified during the defects liability period.
In our experience, it is not unusual for the contractor to fail to comply with its obligations during the defects liability period (usually by failing to correct defects within the prescribed timeframes).
To address this situation, it is important that the employer has the contractual right to correct the defect itself (or engage others to do so on the employer’s behalf) and to recover the cost of so doing directly from the contractor.
In order for this right to be meaningful, the employer needs to ensure that it has in place sufficient security to cover the cost of rectifying defects that that the contractor failed to remedy.
In practice, this means that the employer should either retain the performance bond or the retention until the expiry of the defects liability (as may be extended). Without this, the employer would otherwise be compelled to bring formal proceedings against the contractor in order to recover the cost incurred in rectifying the defects itself. However, this may not be an effective or practical approach in light of the cost and time involved compared with the likely value of an action arising out of the contractor’s failure to comply with its obligations during the defects liability period.
Notwithstanding the fact that performance security will invariably be released upon the expiry of the defects liability period, it is important that this milestone does not release the contractor from liability. The employer should therefore ensure that the contractor remains liability for residual and latent breaches, even the relevance of this protection will dissipate over time.
To provide additional protection, the employer may wish to obtain collateral warranties form key subcontractors (i.e. in respect of the MEP package) as well as key manufacturer warranties (i.e. in respect of elevators, water-proofing and cladding).
This approach allows the employer to by-pass the employer (i.e. in the event of its insolvency) and seek redress directly from the relevant subcontractors and suppliers (although the lack of invariable performance security from such parties is an obvious downside).
It is also important to stress that liability for the performance of defective works does not exclusively lie with the contractor as the certifier is responsible for erroneously certifying defective works, while designers should equally be held to account for design defects.
As is customary, the basis upon which and the extent to which a claim can be brought against the certifier (or any other consultant) will be primarily determined by the provisions of the certifier’s appointment.
In our experience however, it is not unusual for certifiers to be engaged on either terms of engagement that do not prescribe the certifier’s obligations in detail and/or are on favourable terms from the certifier’s perspective. For instance, liability for indirect and consequential loss (such as loss of profit, which is clearly very important in the context of an hotel) may be excluded while the certifier’s liability may be capped at a relatively low amount, even though the certifier may have professional indemnity insurance in place that would provide the employer with adequate redress.
We therefore recommend that the terms of engagement of the professional team are carefully considered.
Defects in any construction project are inevitable, but this reality does not sit well with the exacting standards that are typically demanded by leading hotel brands. From a construction perspective, it is therefore vital this disconnect is bridged by ensuring that the consultants, the contractor and subcontractor are engaged on robust terms so that defects can be expeditiously and fully addressed.
For further information, please contact Euan Lloyd.
Published in July 2022
