How the Hormuz Crisis is reshaping Middle East construction

As economic and energy shocks from the Hormuz crisis reverberate beyond the Middle East, the consequences for the regional construction market are immediate, significant and continuing to evolve. Procurement, pricing, project timelines, and risk allocation are all being reshaped.

All project stakeholders must now take proactive steps to protect their legal and contractual positions. For contractors, “The real issue now is not whether there is disruption, but how you can actually prove its impact under the contract and subsequently claim that entitlement,” says Haroon Niazi, Partner at HKA, the global risk mitigation and dispute resolution firm.

Supply chain and site disruption

That disruption is most visible in supply chains, with shipping routes being rerouted, delivery durations extended and freight markets disrupted. Qatar and the UAE are being heavily impacted, despite government initiatives, including relaxed customs regulations, to maintain movement. Saudi Arabia has tried to ease the impact with alternative port access at Yanbu on the Red Sea. Some suppliers are delaying shipments, and insurance premiums are rising sharply.

Cost escalation is a direct and significant consequence of the crisis. Price volatility is driving sudden increases for materials – steel in particular – and imported equipment. Suppliers are cutting price validity periods, with some seeking to exit long – term pricing agreements. “Greater pricing risk is being pushed down the supply chain,” Haroon adds.

The pace of change has itself become a major challenge. Prices are moving quicker than contractual mechanisms can typically respond, shifting the risk profile of contracts.

Progress on site is also being disrupted. Late deliveries of materials and equipment lead to delays, reduced productivity, and resequencing of programmes, which is more difficult with open work fronts where teams work concurrently.

Employers, contractors and supply chain partners are responding to myriad pressures, driving behavioural change that could develop further over coming months if the conflict continues.

How project impacts vary

The impact on projects varies with their location, stage and thus, exposure to procurement risk. Offshore projects – in the UAE and Iraq, for example – have been suspended and personnel evacuated, with safety rightly prioritized. In oil and gas sites, including those inland, demobilization and sheltering in place was followed by remobilization though some stoppages have been prolonged.

For onshore projects more broadly, transport and insurability are primary concerns, says Reza Sabetnia, a Principal at HKA. Logistics have become increasingly complex, especially as oversized and overweight cargoes face limited port infrastructure and extended journeys by road. Shipments destined for UAE projects are being diverted to Khor Fakkan, Oman or Jeddah, and sometimes offloaded into storage in third countries as distant as Asia, pending eventual delivery when conditions allow.

Iraq faces an additional and primarily financial difficulty, says Zainab Saad, an Al Tamimi & Company Associate, specialising in dispute resolution. The disruption to oil exports has materially affected the government’s principal revenue stream, with oil exports down to 20% of their normal level. Payments to contractors are delayed as rising prices squeeze both public and private sector clients.

The Iraqi government has declared force majeure across the oil industry. Following missile and drone strikes, work on some projects in the south of the country has been suspended indefinitely.

Ramifications extend beyond the Strait. Along the Red Sea some projects are being affected by vessel availability, more limited insurance coverage and higher premiums. Before the tentative ceasefire, even insurance policies for ground transportation were being cancelled.

Legal and contractual implications

From a legal standpoint, most contractors can still perform but complying with contractual obligations in some projects is becoming more burdensome, says Naief Yahia, Partner and Head of Dispute Resolution at Al Tamimi & Company.

Once again, the regional construction industry is demonstrating resilience and commitment to delivery, as during the Covid pandemic.

However, as contractors mitigate their difficulties and projects continue, force majeure is generally not being invoked under contracts. Instead, the main and more applicable remedy is under the civil law principle of ‘unforeseen circumstances’. This doctrine, rooted in civil law and influenced by Sharia principles, allows courts and arbitral tribunals in certain jurisdictions to restore the economic balance between contracting parties where exceptional circumstances fundamentally alter the contractual equilibrium.

Nevertheless, contractors need to carefully examine the terms of the contract and risk allocation, Naief stresses. Most contracts for major construction projects in the Middle East are bespoke, based on FIDIC 1, but heavily amended to transfer risk to the contractor. How force majeure is defined is crucial.

The FIDIC 1999 Red Book defines force majeure as an exceptional event or circumstance which a party could not reasonably have provided against before entering into the contract. This clashes with the civil law test in most of the region’s jurisdictions, which requires that an obligation be impossible to perform. Price escalation, shipping disruption and other procurement difficulties generally do not clear that bar.

FIDIC’s 2017 standard form took a different approach, using the term “exceptional event” instead of force majeure. This allows contractors to claim an exceptional event as a contractual remedy in order to avoid the clash with the civil law definition of force majeure.

The civil law’s alternative remedy of unforeseen circumstances may be more feasible, but there are two notable parameters. First, contractors must demonstrate exposure to a severe loss. Second, they must not attempt to allocate the entire loss to the employer. Both requirements are essential when a judge intervenes to restore the economic balance between parties. Other factors, such as the original risk allocation, will also be taken into account.

The Saudi requirement for renegotiation

Saudi law sets a high threshold for eligible losses due to unforeseen circumstances – requiring significant and exceptional increases in cost – and the burden of proof is on the claimant, explains Dr Ahmed Basraw, Partner and Head of Office – Jeddah at Al Tamimi & Company. The judge or tribunal will also want to be satisfied that a claimant is not trying to escape a bad bargain. “The law’s function is not to protect businesspeople from their decisions.”

Significantly, Saudi law – through Article 97 – imposes a specific obligation not found elsewhere in the region: when an exceptional event occurs, the affected party must invite the other to renegotiate terms, and both must act in good faith. Throughout this process, the claimant must continue to perform its obligations under the contract.

The nearest equivalent to this duty to seek agreement on revised terms is the standalone provision in FIDIC Red Book for advance warning when contract prices change due to exceptional circumstances, Naief points out. This clause 1 FIDIC – International Federation of Consulting Engineers standard forms of contract offers a potential remedy to the contractor through renegotiation that is not linked to FIDIC’s clauses on force majeure or exceptional events.

As a Sharia – based fairness principle, parties cannot contract out of this provision for unforeseen circumstances. However, Naief cautions contractors against defaulting to English law as the governing framework. In a construction market where contract term s tend to be heavily weighted in favour of employers, the civil law’s fairness provisions can offer valuable protection not available under common law’s strict adherence to contract terms.

The mitigation obligation: a common misunderstanding

One of the most pressing and complex questions confronting contractors in the current environment is the duty to mitigate delay and disruption. Contrary to common belief in the regional construction market, civil law in most Middle Eastern countries does impose an obligation to mitigate, Naief says.

In the UAE, Article 32 of the civil code states that whatever is required for the completion of a wajib (or obligation) is itself an obligation to the contracting party
– a Sharia principle reflected across other jurisdictions. Article 246 further requires that a debtor (or contractor) acts in good faith and complies with standard customary practice and the law. The duty to mitigate, in other words, goes beyond what is written in the contract.

Meanwhile, standard contracts forms, including both 1999 and 2017 FIDIC Red Books, also require both parties to take reasonable steps to minimize the impact of delay events. Even where an employer does not agree, the contractor should proceed with mitigation measures. However, if the costs are significant, the contractor may defer action on the grounds that the employer is acting in bad faith, or seek recompense for severe loss under civil law. Article 287 of the UAE Civil Code, alongside broader civil law principles across the region, may also provide some protection against compensation claims or liquidated damages where delay arises from causes outside the contractor’s control or from acts attributable to the employer.

The claims landscape: grounds for optimism and caution

Both the HKA and Al Tamimi experts paint a largely positive picture of the current claims landscape. Employers and contractors are, in the main, having open discussions in good faith, although there is pushback on costs – and inevitable resistance to agreeing mitigation costs upfront.

A notable behavioural change is that contractors are increasingly “on the front foot”, says Haroon, issuing contractual notices promptly – “which is very different to what we used to see in the region many years ago”.

With claims for extensions of time, the first stage is unpacking disruption events into project – relevant parts, Reza explains. “Is it a shipment blockage, custom hold, export control, site suspension? How is it causing delay on the critical path of the
project?” – and what are the supporting contemporaneous records?

Shipping costs for standard container movements have increased dramatically in some cases. Contractors who fail to establish baseline mitigation costs will find their contractual risk grows as costs mount. Many UAE employers have supported record – keeping or requested documentation that will help contractors build claims for mitigation costs.

Claims strategy – from award to completion

Contractors who tendered before the crisis and are now due to begin works face a particularly complicated set of questions, Naief warns. Where it is not subject to agreement on contract terms, a letter of award or letter of intent may be binding (with the exception of administrative contracts in Saudi Arabia and some other jurisdictions in the region). Civil law also requires that contractual obligations are fulfilled even in the absence of detailed terms. However, the parties do have recourse to the law’s fairness principles.

Amid live negotiations post – award, notably on some large EPC 2 contracts employers are pushing contractors’ concerns on supply chain pricing towards a formal claims process. As this happens, contractors’ risks around notification, proving losses, and claims management all increase, Haroon cautions.

Across the board – from record -keeping and interactions with the employer to disclosing sensitive tender details to demonstrate increased costs – having a clear legal understanding and contractual strategy in place now is essential, whether for time or cost claims.