Difficult by design: Why disputes emerge from energy construction projects
Locations
Large energy projects are notorious for difficult designs. Often, the energy generation solutions are innovative, the materials and technologies involved are new and the local geography is challenging.
In many cases, the technology earmarked for the project moves on during the construction phase, necessitating changes to the project plan.
The specialist equipment needed to complete projects is also particularly vulnerable to supply chain disruption, caused by events such as international conflicts, natural disasters, sanctions and pandemics.
Energy projects also have numerous interfaces, including grid connections, water supply and waste disposal that have to be managed as separate moving parts to the main project.
The potential for things to go wrong in major energy projects is therefore higher than in other areas of the construction market and, due to the eye-watering sums and the weight of vested interests involved, when problems occur, disputes tend to follow.
In this article, we look at some of the most common causes of disputes in energy project construction and consider how these can be avoided or resolved.
Contractor claim clauses
There are a number of key clauses in construction contracts that commonly lead to disputes – these so-called "contractor claim clauses" relate to variations, extensions of time and loss and expense provisions.
Almost all the standard construction contracts (FIDIC, NEC, JCT, etc.) require variations to be instructed, or confirmed, in writing. This gives rise to requirements for the contractor to tell the employer, or engineer, about the programme and cost implications of the variations, within a period of time specified in the contract.
Experience suggests that employers will generally look to shorten the standard time periods and set prescriptive requirements for how a variation must be notified (for example, some employers may insist on being notified by post, while others expect to be notified via tools in the project management system).
These obligations are then flowed down from the main contract to the subcontract level, meaning that already tight notification periods are generally reduced further to allow the contractor to pass them up to the employer within the time limit set by the main contract.
There is an understandable need to control variations in construction projects in this way, as this prevents contractors from making wide and unlimited changes, with the employer oblivious to the cost consequences until the end.
Loss and expense provisions and extensions of time usually involve time periods that are similar to, or tighter than, those required for variations.
Disputes tend to arise when project managers accept contractor claim clauses without reviewing them carefully, and then departing from the agreed process once the works have begun.
The bases for disputes in these circumstances tend to fall into one or more of three categories:
- That parties were not aware, or did not fully understand what they had signed up to.
- The parties are unable to comply either with the complexity of the clause covering the variation, or with the sheer volume of instructions they receive from the other side.
- Sometimes in combination with the above, the process for notifying variations agreed at the outset is too rigid and time-consuming to allow the project to proceed as it should.
When these situations arise, the parties will often agree to disregard the contract and proceed on a mutually collaborative basis – adding a further layer of complication to any resulting dispute.
The lesson from experience is that parties who spend a significant amount of time negotiating complicated contractor claim clauses are advised to comply with them; alternatively, they have the option to spend less time negotiating simpler clauses, which in theory will result in fewer procedural problems if they are ultimately ignored.
Investment treaties
Contractors investing in another country may wish to take advantage of relevant investment treaty provisions when setting out their contracts, to ensure they have the desired protections throughout the performance of the contract.
Practice shows that this is an area where opportunities are often missed, as parties commonly fail to establish whether there is a BIT between the host country and their home jurisdiction, or whether the project in question qualifies as an 'investment' under the relevant BIT.
Parties should investigate treaty possibilities when setting out the contract and, if necessary, consider setting up a company in another jurisdiction that benefits from stronger BIT protection with the host country.
BITs are by no means a panacea for resolving construction disputes, however, and there are some countries where relying on BITs will not protect the contractor. It is also an expensive process perceived as a 'last resort' for struggling parties.
Another area worth exploring is whether a contractor can benefit from the Most Favoured Nation clause of another international treaty that would allow it to add standard protections to the contract.
A commonly overlooked point is that, in order to rely on investment treaty arbitration, a party has to show that there has been a breach of international law, or else that the breach is covered by the relevant umbrella clause.
Contradictions in terms
In large construction projects, contracts are accompanied by a series of schedules and technical documentation, which may sometimes give rise to conflicting terms.
A frequent source of problems is when contradictory provisions exist within technical specifications, as these are not always picked up by construction lawyers who are not generally technical experts.
Sometimes, the unavoidable truth is that the technical specifications in contracts cannot be 100% complied with. In these cases, a contractor may fulfil the specifications to the best of its ability and deliver a result that functions as required by the contract, however the employer may argue the contract has not been complied with.
Most contracts now have hierarchy of documents, clauses and provisions that are meant to deal with conflicting terms, however courts and tribunals are generally reluctant to invoke this hierarchy until parties have tried to resolve the issue by looking at the terms independently.
Parties sometimes assume they are restricting their liability under a main contract by including a cap on liability, or relying on a reasonable skill and care obligation. If there is a service life or fitness for purpose obligation hidden in the technical documents, these attempts to avoid liability will generally fail.
A more successful approach is to carefully review an employer's technical requirements, as opposed to focusing too closely on the legal requirements at the expense of the technical information.
Where technical specifications are likely to cause problems, contractors should try to negotiate them where necessary, to get to a position where all parties know what is expected.
In reality, however, the imbalance of power between employers and contractors and the commercial pressures on contractors to secure work mean that negotiating contract terms can be extremely difficult.
Compatible contracts
Large construction contracts tend to involve a large number of parties operating at different levels, and a common cause of disputes is the lack of attention paid to the compatibility of all the contracts involved.
Typically, when a dispute arises, parties will find that dispute resolution clauses provide for different seats, different arbitration institutions, different rules on tribunal composition and even different languages.
In these instances, often the only option is to settle, unless the parties agree to derogate from terms of the divergent contracts.
To anticipate and avoid this situation arising, parties have the option to draft a separate arbitration agreement that sits on top of all the project contracts and uses one set of rules, one procedure and one arbitral tribunal.
Getting what you pay for
Another common area for disputes is when the use of value engineering processes are not reflected in the risk profile of contracts.
Employers may request value engineering or the use of novel materials to reduce the project budget, but fail to accept the risks associated with lower-cost activities. Sometimes, an employer will expect the result it originally signed up for, despite having agreed to a value engineering approach, which generally leads to disagreement.
A related cost-cutting measure is the removal of roles for external experts, such as engineers and project managers, with employers trying to bring these functions in house and consequently ending up with project problems due to a lack of expertise and/or a truly independent approach.
This squeeze on costs accounts for an increasing number of disputes, as competitive pressures result in a race to the bottom among contractors, who frequently take on enormous liabilities with insufficient remuneration for the risks incurred.
Sometimes, the time frames specified in the standard form contracts are not suitable for the projects involved, particularly in the energy sector, where designs often take longer to deliver than the contracts cater for.
When this results in disputes, professional experts are needed to assess whether the time frame specified in the contract was realistic in the first place.
Extensions of time and additional costs
Typically, contractors have to ask for extensions of time and/or additional costs due to one or more of four main factors, namely: geological risk; natural risk; financial risk; and political risk. Slightly less common, but no less disruptive when they emerge, are regulatory risk and technological risk.
Geological risk tends to arise when a contractor finds the geological information given to it by the employer turns out to be different to the actual geology of the construction site. In geologically risky areas, therefore, it is important to allocate the risk of geological information being inaccurate before work begins.
Natural risk is elevated when projects are located in difficult geographical areas, and compounded by climate change and the increasing frequency of extreme weather conditions.
Financial risk, is particularly prevalent in developing countries, where financial institutions typically finance most of the project and expect to be involved in all project negotiations.
Political risk is almost always present where the project involves infrastructure, and the employer is a state, or a state-backed entity. This can be particularly problematic if the ruling government changes part way through the project, or when an extension of time is needed that jeopardises a political promise.
Alternatives to litigation
While energy construction projects very often give rise to disputes, in most cases parties will seek to avoid full-blown litigation.
Litigation represents a level of uncertainty and risk that is difficult to budget for. Some of the standard form contracts attempt to provide alternatives, such as the multi-chair clause proposed by FIDIC.
Dispute Adjudication Boards (DABs) have proved a useful way to resolve claims without going to arbitration, however there is a reluctance to use this option due to (generally unfounded) doubts that adjudicators will be able to reach a better solution than the parties can achieve through direct negotiation.
Adjudications can resolve disputes relatively quickly (usually within 28 days) and their decisions are temporarily binding on parties and enforced by the courts. Although not always to everyone's satisfaction, generally parties will accept adjudicators' decisions in the interest of progressing the project.
The efficiency of adjudication is being compromised, however, as parties expect DABs to deal with increasingly large, complicated disputes where once they were solely used to for relatively minor issues such as interim applications and notices.
Mediation is also an option for resolving disputes that works in a different way to commercial negotiation and is cheaper and more efficient than some of the alternatives.
While mediation is not widely used, it is often successful in resolving at least some of the issues in dispute, meaning the parties have less to argue over if the issue escalates to full blown litigation.
On the flip side, mediation can have the unintended consequence of entrenching parties in their positions and ultimately make it more difficult to resolve the dispute.
Where arbitration is considered inevitable, having a standing arbitration panel constituted at the beginning of the project, comprised of arbitrators that know the contract and can be on standby to deal with ad hoc issues, can prevent disputes from mushrooming and causing delays.
Whatever route parties decide on to resolve them, disputes should be considered as a normal part of a large, complicated construction project, such as those found in the energy sector.
For this reason, parties need to think about implementing contract structures that anticipate disputes and can deal with them immediately.
This article was authored by Marily Paralika, International Arbitration Partner at Fieldfisher Paris, and Dan Preston, Construction Partner at Fieldfisher in London. Panellists participating in the round-table discussion organised by Fieldfisher and Kroll as part of Paris Arbitration Week – Construction energy disputes: what went wrong? included Maria Irene Perruccio, Legal Counsel, Head of International Affairs Europe and Americas at Webuild Group; Françoise Lefèvre, Partner at Lefevre Arbitration SRL; and Louk Korovesis, Senior Director at Kroll.