Lawyers brace for surety claims and insolvencies following commercial construction delays

As the COVID-19 crisis has rocked the world and devastated the economy this year, the commercial property industry has been plagued by construction delays, contract amendments and a broad slowdown in transaction activity. 

All construction projects were suspended in Quebec as a result of the health crisis, while all but essential projects were suspended in Ontario until May. Those that have re-started are progressing more slowly and incurring greater expense due to social-distancing requirements on construction sites. 

“From a lawyer’s perspective, there has been a flurry of activity in considering the application of force majeure clauses, which is a very contract-dependent analysis,” says David Longcroft, a partner at Borden Ladner Gervais LLP. “Even if there is a force majeure clause, it’s not a get-out-of-jail-free card. Everybody is hurting as a result of the delay, so there is going to be a knock-on effect. We’re already seeing delay claims increasing, which is a strong signal of significant disputes to be resolved, so there is going to be a lot of that activity over the next few years.”

Longcroft anticipates an uptick in insolvency proceedings from lenders in the construction world, in addition to an increase in surety claims, when project security is called upon to complete the work of defaulting contractors and to pay sub-trades. Ultimately, he expects to see a continued slowdown in the commercial construction sector.

QuadReal Property Group’s ongoing construction projects have not been negatively impacted by the pandemic, but safety procedures have been ramped up on sites to protect workers. Taking care of employees is a key concern for Vancouver-based QuadReal, so the legal team has fielded questions related to measures supporting front-line employees working in buildings. 

“A lot of employees are working much harder at this time, so we need to make sure they have the resources and rest they need and they continue to be supported,” says Roger Chouinard, chief legal officer and corporate secretary at QuadReal. “That’s something we have been working on with the HR team and managers across the organization.”

RioCan REIT was also fortunate to be permitted to keep most construction projects operating during the lockdown.

“All of them are now fully ramped back up but obviously there are different safety protocols and enhanced measures on that front,” says Jennifer Suess, senior vice president, general counsel and corporate secretary at RioCan. “We’ll have to see how it plays out in the next months and years in terms of pricing, but for the time being, everything is moving as it should be.”

The legal team at RioCan has boosted engagement levels with the organization during the pandemic, scheduling daily check-ins with all business units to ensure they are aligned in terms of strategy. 

Many tenants in the retail sector are suffering so rent deferrals have become commonplace. The legal department at QuadReal is supporting the company’s business team, which has been focusing on regular communication with tenants and new initiatives to help them during the downturn, including the federal government’s Canada Emergency Commercial Rent Assistance program, which was unveiled in April to offer rent relief to small businesses.

“We have approached this from the beginning by really being close to our tenants and thinking about how we can help them,” says Chouinard. “For instance, lower occupancy levels in our office buildings has meant savings could occur in areas such as utilities. Where applicable, we have passed along these operating cost savings to tenants.”

Longcroft cautions that while programs such as the CECRA program may smooth the market, a level of uncertainty remains.

“It has a muffling impact on the level of anxiety in that market, but there is uncertainty in how it works and how it will be applied,” he says. 

Planning the re-opening of businesses and potential privacy issues have been a concern for Chouinard, as new measures to protect tenants are being considered in some buildings, such as keeping a log of visitors, so legal consideration of those initiatives was required by Chouinard and his team.

Suess is also keeping a close eye on government programs, and she and her team keep in close contact with tenants. 

“We look at every tenant on a case-by-case basis, which is very time-consuming when you are dealing with thousands of tenants,” she says. “We have looked at deferral arrangements for a number of our smaller, independent retailers, and there are different considerations when you are dealing with larger national tenants.”

Longcroft advises in-house counsel to watch closely for signs of insolvency, both within the company and in dealings with third parties.  

“Everything has a ripple effect. For every retailer that can’t keep a store open, there is a landlord that can’t make rent, so insolvency events will start happening,” he warns.

Although some landlords fear that demand for office space my decline as many employees have acclimatized to a remote working environment, Chouinard sees other compensating demand factors.

“The trend for several years has been toward a smaller and smaller space per employee, but we think that might expand again now,” he says. “We’ve had tenants tell us that they think they will need more office space in their premises to give employees more space around them. As good as technology is, the social interaction of working together in an office is still valuable and will continue to be.”

Suess agrees, commenting that while the configuring of space may change in many offices to allow for a staggered workforce and a greater distance between desks, she does not expect the demand for space to decline.

“This is something we spend a lot of time discussing in co-operation with our tenants, because they are the ones who will dictate market trends,” she says.

Longcroft says it is too early to predict whether remote working will trigger a decreased demand for office space. If this does occur, he anticipates an active sub-lease market would develop.

“Landlords are not going to let tenants simply walk away. They will want to keep them on the hook to get it sub-leased out, and there is a huge cost associated with that, so that will be an interesting dynamic to watch,” he says.