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The Root Cause of Evil!

Vijay Bange and Tanya Chadha
August 2021
Construction Law

The Root Cause of Evil!

Vijay Bange and Tanya Chadha
August 2021
Construction Law

Read below

Practitioners and professionals involved with construction, engineering and energy sectors will no doubt after completion of
each project engage in an exercise of what could be done better and more efficiently. As part of the learning process it is important to delve deeper so as to appreciate the real root cause(s) of disputes and any emerging trends.

We are grateful for HKA sharing with us their 2020 CRUX Data[1].

When examining trends in energy disputes, it is initially helpful to distinguish between (i) power and utility projects and (ii) renewable energy projects. Whilst collectively both categories fall under the general ‘energy’ umbrella, recent data from HKA shows that at project stage, traditional power and utility projects have very different characteristics to renewable projects. In the disputes arena, those differences are less marked and the root causes of disputes are more aligned across both sectors.

Power and Utilities

In the energy sector, power and utility disputes heavily dominate the marketplace across all jurisdictions. Most of these disputes arise under bespoke contracts. Given the size and complexity and specialist nature of power and utility projects, and the notable absence of energy specific standard forms, this is perhaps unsurprising.

Where standard form contracts are used, globally, the most common of those is FIDIC with various projects in the UK, Middle East, Caribbean and Latin America all adopting these terms, likely with energy specific bespoke amendments. NEC, IChemE and IMechE are standard form contracts produced by English professional associations, so their use is predictably more localised for energy projects in the UK. That said, for general construction projects, we are now seeing some foreign governments appoint contractors on NEC terms so we may see this trend continue in the energy sector. An example is the Peruvian reconstruction of infrastructure damaged by the El Nino, where the NEC form of contract will be used for this G2G agreement with the UK. Whilst some UK and Middle Eastern projects have adopted the JCT standard form contracts, we expect those are few and far between given the generality of the JCT’s approach and style of drafting. Notably, government contracts are in place for some power and utility disputes in both the US and Caribbean / Latin America regions. For obvious reasons, The American Institute of Architects (AIA) form of contract is certainly US centric.

Renewables

The UK leads the charge with renewable projects with around 28% of all energy projects being in the renewables sector. Whilst the US is not far behind with almost 20% of energy projects focused on renewable sources, emerging markets still have some way to go. Predominantly bespoke contracts are most commonly used for renewable energy projects across all jurisdictions.

Causes of Claims and Disputes

HKA’s data examines the primary and secondary causes of energy claims and disputes. In the power and utilities sector, the most notable trend that emerges is that failures in contract management and/or contract administration form the basis of the majority of energy claims across the globe. This finding is not at all surprising. Contract administration is often overlooked by parties. Contracts are often thrown in a drawer and forgotten about. Parties may manage and administer contracts according to what they think the contract should say, rather than in accordance with what it actually says. When things go wrong, and the contract re-emerges, it is not uncommon to discover deadlines have been missed, requisite notices have not been served and condition precedents have not been complied with. The adoption of procedures that depart from what was prescribed in the contract may then give rise to variation, albeit inadvertently, of the contract terms.

As previously mentioned energy projects by their nature tend to be mega state backed but with the contractors and professional teams being global. All of this creates a breeding ground for potential disputes.

Disputes over contractual interpretation are also very common across all jurisdictions. Generally in construction, engineering and energy disputes vast schedules of amendments are drawn up to sit behind standard form contracts. At the drafting stage, experienced parties often feel sufficiently equipped to deal with not only the contractual negotiations but also the contract drafting, choosing to dispense with lawyers. Whilst the drafting may appear sufficient at the time of execution, the real problems around the intricacies of the language and the interrelationship between various obligations, liabilities and entitlements only really become apparent when the parties are at odds over what a particular provision actually means.

Whilst disputes over workmanship issues naturally arise in the energy sector, they are markedly less common. This is perhaps at odds with general construction disputes where workmanship disputes are rife. Energy projects are however specialist and complex and it is possible that only experienced (often global) contractors bid for these projects and are ultimately awarded the work, and rightly so.

It is worth noting that whilst these general trends emerge across the global energy sector, specific jurisdictions have their own interesting nuances. For example, in the UK disputes around incorrect, incomplete or late design are not particularly frequent but in the Middle East, these are common causes of claims and disputes. Paul Mansell, head of the HKA London Office and Global Lead of the Energy, Resources and Industrial technical business summarised his thoughts as follows:

“The sample based on the selected geographies and sectors/subsectors identified 159 projects with an average CAPEX of $450m, with an average cost claimed of $78m, or 17% of the original contract value, and an average EOT claimed of 59% of the original contract period. From a regional perspective the comparative figures were as follows:

United States

Caribbean &

Latin America

Middle East

United Kingdom

$254 mn

Av. CAPEX

$445 mn

Av. CAPEX

$738 mn

Av. CAPEX

$386 mn

Av. CAPEX

47.9%

Av. EOT claimed

50.9%

Av. EOT claimed

64.4%

Av. EOT claimed

$69.0%

Av. EOT claimed

27.6%

Av. cost claimed

45.1%

Av. cost claimed

84.5%

Av. cost claimed

170.5%

Av. cost claimed

The average cost claimed across the regions is significantly higher in the UK than in the Middle East and in turn the Caribbean and Latin Americanand US, The average EOT claimed follows a similar pattern with UK highest and US lowest.

Predominantly

Bespoke

FIDIC Other

$646 mn

Av. CAPEX

$632 mn

Av. CAPEX

$173 mn

Av. CAPEX

75.5%

Av. EOT claimed

56.1%

Av. EOT claimed

31.0%

Av. EOT claimed

63.4%

Av. cost claimed

263.2%

Av. cost claimed

31.0%

Av. cost claimed

Bespoke Contracts are the most common contracts in most regions whether for Power or Renewables, with FIDIC being the most common standard form of contract. Notably, the average cost claimed is approximately four times higher for FIDIC based contracts than for bespoke contracts, whilst conversely the EOT claimed is significantly less.

The top two causes of claims and disputes were common to both bespoke and FIDIC contracts -contract management issues and late design information. The level of skill and/or experience was also a common top 5 factor - in our opinion this competency gap lies behind many of the top causation factors.

The three most common procurement routes were EPC/Turnkey, Lump Sum and Design and Build with EPC exhibiting significantly greater percentage costs claimed. There is a notable difference in the percentage EOT claimed with EPC lowest and D&B the highest.

When comparing the more established power and utilities sector with the ‘newer kid on the block’ renewables sector the analysis shows that incorrect design and workmanship issues were significantly higher for renewables than for power and utilities in the UK, however overall there were many more common issues between the sectors including contract management/interpretation, late design/approvals and skills/experience levels.”

To get a feel for the US perspective Brad Thompson, Team Lead for the Energy Industry Group at Duane Morris says:

“Texas is often considered the energy capital of the United States, with the full range of energy generation assets from traditional oil & gas facilities, to nuclear plants, to wind, solar, geothermal and battery-powered assets. As such, Texas sees the same range of disputes and project-related difficulties encountered elsewhere in the world. There is, however, a recent Texas-centric energy issue that has arisen in connection with the recent unprecedented Winter Storm Uri that plunged the entire state of Texas into a prolonged freeze event. The sustained freezing temperatures led to a large loss of generating capacity as generating units from a variety of sources began to trip offline, leading to a near complete collapse of the entire grid system in Texas.

“There are billions of dollars in gains or losses at stake, and the only certainty that remains is that there will be prolonged disputes over who should bear responsibility for the outages and market clearing prices from the storm.”

Again for the US markets Jeff Hamera, Vice Chair Construction Group at Duane Morris comments:

“The themes of insufficient funding, ignoring contractual procedures, unplanned-for events, scope changes, and cost overruns are the immediate precursors to most claims. However, a shortage of skilled and seasoned personnel in the US often results in project engineers and project managers who are inexperienced in the specific type of project at issue being nevertheless thrust into a key role without adequate training, mentorship or management support, and rarely a budget to engage consultants or attorneys for assistance before problems arise. A project engineer with a shiny new diploma or a veteran project manager who has only worked for a regulated utility is often unprepared to meet the demands of running a successful project in the modern marketplace.”

As they say, life is complicated. Causes for disputes in sectors will vary, as they will geographically. Where contracts are bespoke an early investment in time at the outset will ensure that the intention of the parties as to risk and responsibility is clear. Similarly, where a standard form contact is utilised, and outside the US FIDIC is popular[2], the amendments made warrant careful consideration. We have seen instances where the amendments go too far and it’s questionable whether it’s really a FIDIC contract! FIDIC themselves have set out the ‘Golden Rules’ to ensure that parties do not go too far with the risk allocation.

The global pandemic has of course introduced another tier of problems. Parties will need to give thought to risk allocation if we have to accept that Covid will not be eradicated, and there could be other pandemics.

Notes:

  1. HKA’s integrated research program that collects and analyses data on claims and disputes in the built environment - looking at the causes of claims disputes from over 1100 construction and engineering projects across 88 countries.
  2. That said recently FIDIC North America has been formed after key associations have signed a collaboration agreement. Furthermore, FIDIC and the European Investment Bank have announced signing a five year co-operation agreement.