Introduction
Participants in construction projects, particularly in the energy field, are regular users of international arbitration. The presence of international players who are not inclined to submit their disputes to local courts, combined with the size and technical complexity of such projects and a general tendency to underestimate the costs and duration of construction, explain the large number of disputes submitted to international arbitration.
The purpose of this chapter is not to describe the issues generally encountered in construction disputes. Most construction disputes revolve around delay and disruption. Many (not to say most) projects encounter delays, and the question which then arises is whether the contractor bears the responsibility for them. The follow-up question is whether the contractual clause capping the contractor’s liability for delay to a certain amount of liquidated damages applies in the specific circumstances of the case. Allegations of defects (defects affecting the manufacture of pieces of equipment or the construction itself, as well as defective design of installations) are another frequent topic in construction disputes, and they often trigger counter-allegations of incorrect use of the concerned installations by the employer or the operator of the facilities. If these issues are clearly circumscribed in theory, they are by no means easy to answer in practice, and the recent events giving rise to force majeure claims and exceptions from contractors add another layer of complexity.
This chapter focuses on a different question, however, namely the effect (if any) of energy transition on construction projects and, in turn, on construction disputes resolved in arbitration proceedings.
An immediate answer would be that energy transition leads to new projects and, inevitably, to more disputes, as construction works will continue to be delayed and possibly defective. Although this is certainly true, the topic triggers further reflection, as the effects of energy transition may not merely be quantitative. Three factors deserve closer attention, namely (1) the financing of such projects, (2) the definition and testing of the design, and (3) considerations relating to environmental, social and governance (ESG) matters.
These factors may seriously affect the construction of renewable energy facilities, particularly the allocation of risks between the various stakeholders. We address each in turn.
Financing of projects in the field of renewable energy
States’ legislation and policies that aim to limit carbon emissions so as to reach the target of net zero emission by a near, albeit fluctuating, point in the future have boosted the development of renewable energy. The development of wind farms, hydropower plants and biomass plants, and of green hydrogen as a source of energy, requires, among other things, significant financial means. These have attracted the interest of investment banks and funds searching to diversify their portfolios by contributing to the development of decarbonised energy. The current international context, which has a direct impact on the commerce of oil and gas, may reinforce this tendency in the near future, as states will have a clear incentive to develop other sources of energy and enlarge their portfolios. In some cases, these banks and funds do not limit themselves to lending money so that owners (energy companies, for instance) can build the corresponding facilities. They take an active part in the process, from the negotiation and drafting of the engineering, procurement and construction (EPC) contract to the supervision of contract performance itself. Project finance gives a key, strategic role to the stakeholders, shareholders or lenders, financing the project via a project company created for this purpose. However, their main preoccupations may differ from those of the players directly involved in construction, who possess the know-how and the expertise required for carrying out the relevant type of work. It is not necessarily easy for a banker or an accountant to step into the shoes of an employer. Even if with the assistance of experts and consultants in various fields, ultimately, that banker or accountant will be the one having to make difficult decisions. Financiers may find themselves torn by diverging interests, which is not necessarily the best circumstance to make sound decisions. To sum up, being a seasoned employer requires more than analysing curves on graphs and spreadsheets, and the long-term interests of a project may not match the immediate financial concerns of the shareholders and sponsors.
That tension becomes even more acute when funding proves insufficient. Typically, the funding made available at the outset to a project company (which, in general, is an empty shell) is limited. It is important, therefore, to manage these funds carefully. Nevertheless, construction is full of surprises. A variety of factors may affect the initial programme as carefully drafted at the outset. Shortages of materials, price increases, strikes, bad weather or the insolvency of a supplier or subcontractor are some of the common things that can affect progress, before taking account of problems during construction, such as welding issues, corrosion or defective pieces of equipment, which may plague even the best managed of all projects. If financing is not carefully tailored to take into account these types of negative events, there is no certainty that the investors will be ready to inject more funds to cover the extra costs incurred. The logical consequence will be to turn next to the contractor. Liquidated damages then become an additional source of financing in order to allow the project to reach completion. In some cases, contractors are considered as the third layer of financing, after the shareholders and the lenders, should the project encounter delays. It may therefore be tempting to blame the contractor for the project running over budget or behind schedule, no matter the actual cause, to levy liquidated damages and, possibly, to call performance bonds, leaving it subsequently to arbitral tribunals to assess the respective liabilities, after several years of proceedings. The immediate impact of these measures cannot be ignored, however. Collection of liquidated damages and calls of performance bonds are seldom a successful means of enhancing or facilitating smooth progress on site. They may also place the contractor in a complicated financial position, jeopardising progress further.
No contractor can claim that it is not aware of the possibility of liquidated damages being levied. It is part of the risk assessment to be made when determining the contract price. However, the risk may increase for contractors to be held liable by employers, when the financing defined at the outset already includes them as an additional source of funds. To sum up, strictly constrained funding and lack of appropriate expertise and experience in construction on the side of employers, who must meet the expectations of their stakeholders, are compounding factors rendering project performance more challenging. The situation becomes even more complicated when contractors underestimate the duration of a project, and implement demanding construction programmes that then prove difficult to achieve.
Proven versus novel design
Technical specifications often require that installations should be built according to “proven design” (or an equivalent formulation). In that situation, the employer and the future contractor may spend a great deal of time, sometimes spanning several years, combining their efforts to design the future facility. The employer, who is often already operating similar facilities and is therefore experienced in their complexity, may be even more knowledgeable than the contractor in some respects. In any event, the employer and the contractor both have adequate command of the technology used and can assess which improvements are worth making and to what effect. The risk of the unexpected is thus limited, because the design used has been proven over time.
The same may not be true when the project concerns renewable energy. Technology is developing fast under the pressure of various stakeholders and the persistent need to achieve carbon neutrality in the near future. There may therefore not be sufficient opportunities or time to test a given technology before it is used in a particular project. The design of a specific piece of equipment may seem adequate in laboratory experimentation yet behave in a wholly unexpected way once installed in a real unit, where a variety of other parameters come into play. Similarly, a previously reliable piece of equipment may have unexpected results when used with renewable fuel, presenting different characteristics in comparison with fossil fuel. The production of energy ultimately achieved may also differ from the theoretical calculation, on which an assessment of the profitability of the project is based. The driver of an electric car knows the difference between the battery autonomy displayed on the screen when starting the engine and the actual autonomy of the same battery, leaving the driver with no option but to drive through a snowstorm without heating to conserve enough power to complete a journey. When a power plant does not reach the expected level of production, the consequences may be more problematic, especially when subsidies depend on performance.
Implementing a design that is still experimental in certain respects is probably unavoidable to move energy transition forward at a fast pace; however, it means that the time needed to build a facility and the costs of correcting any unforeseen shortcomings may be more significant than expected. The question then becomes one of liability, and who will bear the consequences of the risks. A relatively easy answer – applying the contractual defect regime – may not be satisfactory, particularly when the installation at issue abides by the contractual design, which was accepted by the employer beforehand. Careful contractual drafting may prove decisive here. In particular, the parties should pay attention to the wording of any clause allocating responsibility for aspects of design. This is important if the design provided by the employer is not fully developed when the contractor starts to perform its own obligations. A recent English case reminds parties of the importance of proper drafting. In short, it may be useful to determine up front, to the extent possible, whether any difficulty relating to untested design will be taken care of by the contractor at its own cost, or whether any change to the design will give rise to a variation entitling the contractor to additional payment.
Another tempting avenue for employers may be to rely on general contractual requirements for the contractor to act in a diligent fashion during contract performance. Combined with a general contractual obligation to indemnify, such clauses (which focus on the conduct rather than on the result) are sometimes relied on by employers to try to obtain compensation for allegedly defective work, when the contractual defect regime is not available. Whether this approach can be successful is rather uncertain, as it would be tantamount to circumventing the defect regime set out by the parties in their contract. Nonetheless, it may not prevent employers from trying this route to obtain compensation, which in turn triggers additional costs in the event of a dispute.
In any event, beyond the liability issue, the fact remains that such projects present an enhanced degree of uncertainty, which needs to be taken into consideration up front and does not necessarily sit well with narrow financing constraints, such as those addressed in the previous section.
Considerations relating to environmental, social and governance matters
The infrastructure and construction industry is responsible for a significant amount of carbon dioxide emissions worldwide. For instance, according to United Nations reports, the building and construction sector accounted for 39% of energy and process-related carbon dioxide emissions in 2018. The percentage did not vary much during the following year and reached 37% in 2021.
Energy transition requires the construction of new facilities, and building a power plant using renewable energy is not, in and of itself, less polluting than building a traditional refinery. Hence, it is important also to consider emissions during construction, and not merely energy consumption once the completed plant is in operation.
This issue is taken seriously by the construction industry. By way of illustration, the International Federation of Consulting Engineers (FIDIC) issued a Climate Change Charter in 2021. Through this charter, FIDIC aims at leading the industry to reduce the level of carbon emissions linked to buildings, infrastructure and projects. Some standard-form construction contracts provide for clauses to protect the environment.
Protecting the environment, both on-site and off-site, has been a matter of concern for more than 20 years. It has notably been addressed in sub-clause 4.18 of the FIDIC contract forms published in 1999 (Red, Yellow and Silver Books). This clause requires contractors to take “all reasonable steps to protect the environment (both on and off the Site)”. The same clause also provides that the contractor shall limit damage and nuisance to people and property caused by the construction works. Breach of this clause may lead to the obligation to pay indemnities pursuant to sub-clause 17.1. In the 2017 editions of the Red, Yellow and Silver Books, sub-clause 4.18 was updated, reinforcing the contractor’s obligations in that regard. It particularly requires the contractor to “take all necessary measures to protect the environment [and] comply with the environmental impact statement for the Works (if any)”. The scope of this sub-clause is broad, and the drafting is somewhat imprecise. For instance, the contractor must take all necessary measures to “protect the environment (both on and off the Site)” and “limit damage and nuisance to people and property resulting from pollution, noise and other results of the Contractor’s operations and/or activities”. According to Christopher Seppälä’s commentary on the clause, “it should presumably be interpreted more narrowly as meaning that in performing the Contract the Contractor shall take all necessary measures to do the things provided for by this Sub-Clause”. This statement triggers further comments. First, specifying that the scope of the sub-clause must be limited to the performance of the contract is not necessarily helpful. The performance of an EPC contract involves various activities, not limited to construction work on site. It suffices to think about the procurement of all materials and pieces of equipment to have an idea of the broad significance that the words “in performing the Contract” may have. Similarly, the words “all necessary measures” are rather stringent and a priori do not leave much room for manoeuvre.
It is not within the scope of this chapter to discuss the appropriate reading of such a clause. The fact is that, rightly or wrongly, the wording used may be construed in a less restrictive manner than suggested and, as such, it is susceptible to creating uncertainty as to the limits of the contractor’s responsibility. Second, even if in 2017 this provision was intended to be construed narrowly, the approach may change as circumstances evolve and favour a more demanding understanding of contractors’ and employers’ obligations in considering ESG matters in general and the net zero emissions target in particular.
FIDIC is not the only body that has decided to tackle carbon dioxide emissions and social governance in the construction field. Several organisations have developed standard clauses or guidelines with the aim of improving practices. As noted in Practical Law Construction, “there is some evidence that the adoption of radical climate change drafting is driven by funders that have expressly committed to environmental initiatives and whose lending may be conditional on achieving such objectives”.
Various standard contractual clauses have been proposed, for instance in the Joint Contracts Tribunal’s 2016 and 2024 edition contracts or the New Engineering Contract, setting out additional obligations, essentially for the contractor, as well as mechanisms aiming at sanctioning failure to meet certain targets and rewarding good performance. Efforts are also being made to try to reduce construction waste, over-ordering and over-specification of materials and, in turn, to limit the impact of transport.
In addition, the Chancery Lane Project, an initiative launched by legal and industry professionals in 113 countries, has issued contractual model clauses to deliver climate change solutions. Some of these clauses may be applied in the construction sector. Among other things, their aim is to enhance sustainable on-site working practices and transparency in supply chains for renewable energy generating assets, limiting carbon dioxide emissions during construction, reducing waste, providing more sustainable construction solutions, benchmarking the contractor’s carbon footprint in comparison to what is otherwise done in the market or setting a carbon budget for a project.
By way of example, one of these clauses, known as Rose’s Clause, introduces requirements for a greenhouse gas emissions management plan into a facility agreement for projects financed by development finance institutions and export credit agencies. Rose’s Clause imposes obligations on the borrower (ie, the project company), which are then passed down to the EPC contractor. Failure to abide by these requirements (if they are considered as not capable of being remedied) may lead to the rejection of the works and termination of the contract. It is not difficult to work out what difficulties the implementation of such a clause may cause in practice, particularly if the contractor’s obligations in that regard have not been precisely defined. The level of discretion given to the project company, particularly the lenders, to decide whether a failure to comply with the emissions plan can be remedied may not be acceptable for the EPC contractor. Whether such a risk can be covered by insurance is also questionable. Furthermore, it is difficult to know how rejecting the works, especially at an advanced stage of the project, may lead to a positive result, even from an environmental point of view. One may thus assume that this ultimate sanction would seldom apply.
It is for the parties to contracts to determine whether to include such clauses and, if they do, how to adapt the wording to their needs and reduce the degree of uncertainty they often convey. There is nonetheless a trend towards placing new and broader responsibilities on contractual parties, particularly on contractors. Given the number and size of projects in the renewable energy sector and the various challenges they entail, we are likely to see contractual mechanisms for fostering ESG matters during the procurement and construction phase (in the EPC contracts, but also in contracts with various suppliers and subcontractors). This warrants some further comments.
It is well known that margins in the construction sector are currently very thin. Simply levying delay liquidated damages can quickly result in the contractor losing money on a project, even without considering factors such as prolongation of the works, higher prices of materials or the necessity to redo some activities, all of which can cause significant cost increases. Hence, the application of additional mechanisms to sanction the failure to meet specific targets may disincentivise construction companies from undertaking these projects, unless the price takes account of such risks. Furthermore, a reward in the project’s final accounting for having achieved the expected targets may be of little practical interest if the project is not completed. Depending on the parties’ contractual arrangements or the applicable law, a plant may operate commercially without completion having been formally reached. For instance, it is sufficient for the parties to disagree as to whether items on a punch list remain unresolved to conclude that completion has not been reached (unless the remaining items are de minimis). Hence, rewards may never materialise in practice.
It is largely assumed that environmental, social and health considerations are consistent and that favouring one will also favour the others. This starting point may prove overly simplistic. Moreover, the fostering of such concerns may also create practical difficulties when faced with delay and cost issues, which have shown no sign of decreasing in recent years.
A few examples may help illustrate some of the particular problems that players in the sector may encounter. Safety is a major concern, during works as well as when operating a facility. It is often said that there cannot be any compromise regarding safety. It is also well known that increased consumption of materials for construction works is one of the important sources of carbon dioxide emissions and other types of pollution. In theory, it would be logical to change design techniques to limit over-specification of materials, to the extent that it does not jeopardise safety. In practice, however, it might not be easy to draw a firm line and different players may have differing views. Similarly, suggesting design improvements may be adequate from an environmental standpoint but it may be difficult to reconcile with a contractual requirement to only use proven design. If ultimately the performance of the concerned installation fails to meet the expected target, the contractor or the manufacturer will be held liable for having delivered a facility that does not operate in accordance with the contractual specifications. Even the idea of rewarding the contractor for implementing new solutions in carrying out the works to foster improvements in environmental performance may not incentivise the contractor, if those solutions cause delay or increase costs. Again, in theory, such improvements would only be implemented if they constitute a variation for which the contractor will be paid (and will not be held liable for any ensuing delay). In practice though, the contractor may well face first liability for delays before being able to justify the delay by demonstrating that it was caused by approved changes.
As to determining emission plans at the outset and the possibility for the employer to terminate the contract if the plans are not respected during the construction phase, one might wonder whether this would not be a strong deterrent and de facto hinder, rather than foster, energy transition.
Hell is often paved with good intentions. Mechanisms that are too stringent and punitive may prove to be an obstacle to change instead of encouraging change. Ultimately, charging liquidated damages to contractors that cannot pay them is of little help, and terminating contracts is seldom a means of fostering progress and limiting costs.
Incentives are certainly more attractive, to the extent that employers can actually afford them. Strategies for avoiding such outlay would be counterproductive, for instance if sanctions were to be applied during construction, while rewards only become due at the stage of final accounting.
In any event, incentives or punitive mechanisms cannot be designed in the abstract. If the need for new projects in this field increases under the current circumstances, employers, lenders and contractors will have to find a common ground allowing them to reach the objective set out in the various contracts at issue.
Conclusion
As things stand, the construction sector is likely to face increased pressure to build new facilities, using new technologies, in a more ecological fashion, while also being aware of social well-being along the whole production chain, from the first pipe to handing the key to the plant to its owner. To say that it will not be easy is an understatement. At the least, these projects (at least initially) will be more risky and more costly than traditional projects. Taken separately, each of the factors identified in this chapter carries its own set of issues. In practice, these factors are frequently combined, which raises additional challenges. To conclude, even if, ultimately, the question boils down to determining liability and the compensation due, the path for players, counsel and arbitral tribunals to take to achieve this result may prove even more tortuous and full of thorns than it has been to date.