The energy sector is one of the biggest sources of construction disputes thanks to the size and complexity of the projects involved. Here, we look at how common practices tend to lead to disputes and consider what can be done to avoid them.
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.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
