Q&A: Construction arbitration in the face of energy transition and climate change

June 2023  |  SPECIAL REPORT: INTERNATIONAL DISPUTE RESOLUTION

Financier Worldwide Magazine

June 2023 Issue

FW discusses construction arbitration in the face of energy transition and climate change with Mark Crossley at Hogan Lovells, David Wallach at King & Spalding and James Bremen at Quinn Emanuel Urquhart & Sullivan, LLP.

FW: To what extent are concerns around climate change accelerating the global energy transition? How is this trend impacting the construction sector specifically?

Bremen: While the coronavirus (COVID-19) pandemic, rising energy demand and the war in Ukraine have caused an increase in the reliance on fossil fuels, the pace of the global energy transition seems likely to increase over the longer term. The factors influencing this include concerns around climate change – particularly as its consequences become more evident – and the need to ensure energy resilience and affordability. The extent to which the construction sector will be impacted by the global energy transition will vary between jurisdictions, depending on their natural resources and the nature of their economies. Having said that, one would expect the construction sector in most jurisdictions to see an increase in both new projects, especially alternative and renewable energy projects and redevelopments, and for those projects to require a reduction in carbon emissions, the use of recycled materials, and increased efficiency in the heating and cooling of buildings and the use of water.

Crossley: In our experience, the sector is acutely aware of the science that has informed international and national agreements and treaties aimed at encouraging countries to reach targets for reducing or eliminating the key causes of climate change. One key way of doing this is to adopt greener forms of energy, and construction companies understand that the manufacture of materials they use and the processes they engage in have historically consumed large amounts of traditionally-generated forms of energy. They are equally concerned about the pressure and scrutiny their reputations are under from the public, governments and their competitors, and how critical it therefore is to be investing in less energy-intensive construction materials and processes. In addition, those companies that specifically focus on energy projects are keen to invest in projects and technologies which promote alternative forms of energy generation.

Wallach: It is no secret that the global energy transition is driven largely by concerns about climate change. The extent to which these concerns directly impact the construction sector is illustrated dramatically by the Inflation Reduction Act of 2022, which seeks to reduce the US’s carbon emissions by 40 percent by 2030. The Act provides hundreds of billions of dollars in tax incentives, grants and loans to encourage investment in a wide variety of clean energy technologies. This is leading to a raft of construction projects across an array of sectors, including multibillion-dollar projects to build new factories or convert existing ones to produce electric vehicles, batteries, solar panels and hydrogen. It is also spurring the construction of new mining operations to extract lithium, cobalt, copper and other minerals needed for the energy transition.

“For large construction projects related to energy transition, issues associated with delay, defects and performance testing are all ripe sources of dispute.”
— Mark Crossley

FW: Are you seeing an increase in energy or climate related disputes in the construction sector? Are there any common threads?

Crossley: Given there are more projects related to alternative and renewable energy sources, it is perhaps not surprising that we are seeing more of them enter difficulty and end up in dispute, particularly as many involve new technologies. The use of this technology generates not only disputes regarding delay and defects, but also disputes which involve the installation of materials, systems, goods and services, such as the writing, launch and maintenance of software, which are often also tackled by construction and engineering lawyers and experts, since they have experience of large, complicated systems requiring the skilled coordination of people, goods and services. Third parties are also starting to bring claims – in litigation, rather than in arbitration – as legislation is gradually introduced enabling them to bring climate-related claims against players in the construction sector.

Wallach: There has been a dramatic increase in the number and size of climate-related projects, including projects in the energy industry. For example, multibillion-dollar projects to build battery manufacturing facilities are currently planned or under way in Kentucky, California, Oklahoma and Kansas, among other locations. New mines to extract minerals needed for the energy transition are being planned or built throughout the American West. Vast solar and wind projects are being built across the US and the rest of the world. These projects frequently involve implementation of new technologies or deployment of existing technologies on a scale that has not previously been seen. This inevitably leads to complications, delays and disputes at all stages, including design, supply, construction and commissioning. We are already starting to see disputes arising from these types of projects, although most of them are in their early stages. More disputes will inevitably follow as the projects mature.

Bremen: We have noted a particular increase in disputes in the renewables sector, coinciding with the increase in renewables projects. These disputes often relate to the youth of the renewables sector, which lacks the relationships and familiar ways of working established long ago in other industries, the impact of weather, ground and accessibility conditions given the location of many of these projects, and the use of cutting edge or innovative designs, materials and ways of working, such as with claims relating to defects or delays arising from their practical implementation. We are also seeing an increase in investor-state disputes resulting from the cancellation of projects on environmental and climate related grounds.

FW: For large construction projects, how would you characterise risks around delays to completion, failure to achieve commissioning standards or lower than anticipated output? Do such problems regularly result in complex, high-value claims?

Bremen: A delay, failure to achieve the anticipated output or failure to achieve commissioning standards may have a substantial impact on the overall cost and value of a project. As a result, these issues, together with defects and changes, often lead to disputes. Moreover, the cost of these projects means that claims can be very high value. The high value of these claims, together with their technical complexity, can make it difficult for parties to amicably resolve issues as they arise. In some jurisdictions it can also be difficult for project participants to admit fault or make decisions on complex issues with high-cost consequences. Again, this can result in disputes where one of the participants would rather receive a court, expert or arbitral tribunal determination than take ownership of a decision.

Wallach: Delays to completion probably account for the largest single cause of major construction disputes. Delays can cause substantial costs both to the contractor and the owner. The contractor incurs the costs of having a workforce and equipment mobilised on site longer than planned, as well as the loss of opportunity cost of not shifting its resources to other profitable endeavours. The owner incurs losses from not having its facility delivered and operating on schedule, which can quickly mount into astronomical figures. As a result, the owner’s losses from delays are typically addressed through liquidated damages clauses to make the risk to the contractor manageable. In addition, the potential for disputes is exacerbated by the fact that it can be extremely difficult to pinpoint the precise cause of critical delays. This often allows both sides to plausibly conclude and argue that the other is responsible for any delays and increases the likelihood of a dispute.

Crossley: For large construction projects related to energy transition, just as with any other type of construction project, issues associated with delay, defects and performance testing are all ripe sources of dispute. Some energy transition projects face a greater risk of encountering these problems as they deploy novel technology or have to be constructed in unstable environments, for example offshore wind turbines, where good weather windows are required for the cost and time efficient installation of wind turbines. These factors are exacerbated by current supply chain disruptions, global shortages of materials and labour – especially a lack of engineers and project managers – and price inflation. Instability leading to delay can also be heightened where political or statutory factors lead to the late approval of aspects of nationally significant infrastructure for energy transition.

“The owner’s losses from delays are typically addressed through liquidated damages clauses to make the risk to the contractor manageable.”
— David Wallach

FW: To what extent are growing environmental, social and governance (ESG) expectations and broader climate change goals leading to an increase in ESG-related disputes for construction companies?

Wallach: Environmental, social and governance (ESG) expectations have been growing across all industries and construction is no exception. On the contrary, the construction industry is particularly sensitive to ESG expectations, both directly from shareholders in the case of publicly traded firms and indirectly from clients. It has been estimated that the construction industry accounts for about 10 percent of annual CO2 emissions. It uses vast amounts of fuel, concrete, steel and other carbon-intensive resources. ESG-related disputes may arise from a number of fronts. For example, voluntary or mandatory sustainability reports or ESG reports can lead to claims that reported information is inaccurate or misleading. Contractual requirements to use more environmentally friendly sources of energy and materials can lead to increased costs and choked supply chains. It is hard to gauge the extent to which the industry has already been hit with these types of disputes because so many construction disputes are subject to confidential arbitration, but the risk of ESG-related disputes is constantly growing.

Crossley: Given the construction industry uses 32 percent of global natural resources, and the built environment accounts for 30 percent of global greenhouse gas emissions, construction companies are facing more ESG obligations and climate-change legislation. Consequently, they are starting to launch or face claims along the supply chain where it is believed those duties have been breached, both in national courts and in arbitral tribunals. As mechanisms for third parties to bring ESG-related claims are being introduced in some jurisdictions, construction entities, wherever they are incorporated or carrying out business, are also slowly beginning to encounter claims from third parties who believe ESG obligations are not being complied with.

Bremen: While environment litigation is not new, the political, legislative and social focus on these issues – in particular, environmental and climate concerns – together with the potential for criminal prosecution or reputational damage if things go wrong, has meant that they are increasingly reflected in the drafting of construction contracts. As obligations relating to these issues are incorporated in contracts, and given the pressures involved, they become increasingly ripe for disputes. Looking specifically at climate change, many of the obligations relating to the materials used and the way in which a structure is built, operated and maintained are technical in nature and are therefore addressed in the scope of works, rather than the terms and conditions of a contract. For example, the NEC4 contract includes an optional new clause – Option X29 – which, if selected, requires a contractor to comply with ‘climate change requirements’ to be set out in the scope of works and in respect of which performance targets may apply.

FW: How would you characterise the benefits of arbitration as a dispute resolution method for energy or climate related disputes in the construction sector? Is it particularly effective in scenarios where parties from across the globe are involved?

Crossley: Although arbitration is well regarded because awards can be enforced in other states that have signed the 1958 New York Convention, with regard to energy and climate-related disputes more broadly – rather than narrowly defining them as, for example, typical disputes associated with a project for the construction of any energy-generating plant – there are unlikely to be many cases going to arbitration at this stage. This is because arbitration is concerned with disputes between private individuals and has always struggled to deal with multiparty disputes effectively. Therefore it is likely to be difficult for concerned third parties, for example environmental or indigenous people groups, to succeed in bringing such claims, at least in the short term.

Bremen: The cost and technical expertise required for energy and renewables projects means that they typically involve participants from numerous jurisdictions, and arbitration has a number of advantages in those circumstances. For example, a contractor negotiating with a state or state-related entity may be reluctant to have disputes resolved by the domestic courts of the same state and insist on arbitration seated in a neutral jurisdiction. The wide adoption of the 1958 New York Convention also provides parties with comfort that an arbitral award should ultimately be enforceable internationally. Other benefits of arbitration for these projects include its confidential nature, particularly where politically or commercially sensitive issues are involved, the ability to appoint arbitrators who have experience of highly complex and technical disputes, and its procedural flexibility which allows sophisticated parties a degree of control over procedural matters.

Wallach: The construction and energy industries generate more international arbitration cases than any other sectors. There are very good reasons that these industries turn to arbitration to resolve their disputes. Among other considerations, arbitration is confidential, typically involves discovery procedures that are less onerous than litigation and allows the parties to have the matter decided by a panel of specialists. Construction and energy disputes frequently arise between parties that have ongoing business relationships and arbitration may be more conducive to preserving such relationships than other forms of dispute resolution. In addition, large construction and energy disputes frequently involve parties from different countries. The widely ascribed 1958 New York Convention ensures that arbitral awards are readily enforceable across jurisdictions in a way that domestic court judgments may not be. All of these benefits will apply with at least as much force in climate-related disputes.

“The nature of the new construction projects on the horizon and the numerous pressures on those projects make it inevitable that there will be problems and, therefore, disputes.”
— James Bremen

FW: How important is it for parties to be able to select arbitrators with relevant knowledge and experience of the issues in dispute? Is this a key feature of complex climate-related disputes in the construction sector?

Wallach: The selection of arbitrators is the single most important factor in ensuring an efficient and just arbitration that results in an enforceable award. The best arbitrators in any matter will depend on the particular circumstances of the dispute. Some construction disputes involve general commercial matters for which specialised knowledge and experience is not necessary. More often though, large-scale construction disputes implicate complex issues that require experience in the field. For example, disputes will frequently arise over the causes and consequences of delays, which will require analysis of voluminous construction schedules using specialised software, such as Oracle’s Primavera or Microsoft Project. Arbitrators who lack deep experience with construction disputes may struggle to understand and manage these types of issues.

Bremen: Appointing arbitrators with an understanding of the issues inherent in complex climate-related disputes and highly technical construction projects will not only save the parties time and money having to explain those issues, but will also increase the likelihood of the correct outcome being achieved. In our experience, high-value and technically complex construction disputes are typically determined by arbitrators who are very experienced construction lawyers or former judges. However, there is generally no requirement for lawyers to be appointed and, if the issues at the heart of the dispute are technical rather than legal, it may be more appropriate to appoint an expect in the relevant field. We do note, however, that niche technical areas can have a limited pool of experts, so parties considering the nomination of an arbitrator should be careful to check that there are no conflicts of interest.

Crossley: Should the arbitration of such disputes gather pace, this is one area where arbitration may have an advantage over litigation, as parties have for many years valued having a say in the selection of tribunal members with relevant experience rather than leaving the allocation of a judge in the hands of courts. As with construction disputes, climate-related disputes involve highly technical terms, facts and issues. These are better decided by experienced practitioners. If arbitration tribunal members are being asked more often to rule on climate-related breaches in construction contracts and seen to do so effectively, parties may have greater confidence in bringing other climate-related disputes to such arbitrators, provided of course that the relevant jurisdictional thresholds for bringing such disputes are met. Of course, the judges in specialist courts such as the Technology and Construction Court in England and Wales are also gaining exposure to climate-related disputes and thereby experience.

FW: As companies strive to implement net zero and global energy transition programmes over the coming years, what predictions would you make for climate-related arbitration involving construction companies? How should they prepare for anticipated future developments?

Bremen: The global energy transition will require complex and novel solutions to be adopted, often in difficult geographic locations. The nature of the new construction projects on the horizon and the numerous pressures on those projects make it inevitable that there will be problems and, therefore, disputes. Many of those disputes will be resolved by international arbitration. Companies that will be involved in those projects, whether as project owners, designers, consultants or contractors, should get up to speed on the technical developments and solutions available. As ever, a proactive and commercially realistic approach, together with good record keeping, will be key to achieving a successful outcome should disputes arise.

Crossley: In construction arbitrations, I expect that climate-related issues will more often sit alongside the risks that have traditionally been associated with such disputes, such as delay, defects and money claims. However, given arbitration’s limitations in terms of its inability to deal effectively with multiparty disputes in most cases, the requirement for consent to submit to an arbitration agreement, and the current lack of institutional rules allowing climate-related arbitrations in their broadest sense to be brought by third parties against construction industry players, I doubt there will be a flurry of such cases soon. However, construction companies should still carry out due diligence in order to understand the likelihood of climate-related arbitrations being brought against them in all jurisdictions, and to be in a better position to develop arguments to address any such actions.

Wallach: The number of climate-related arbitrations will inevitably grow. Climate-related cases involve a broad array of disputes. They include disputes arising from the impact of climate change on construction operations and from the impact of construction operations on the environment. Climate-related cases also include disputes that may not themselves directly flow from or impact climate change, but which arise from projects that are related to the energy transition or other measures aimed at mitigating or adapting to climate change. Steps that companies can take include staying informed and periodically reviewing their operations to ensure that they are well-positioned for climate-related risks and disputes, carefully reviewing force majeure clauses to ensure that they appropriately allocate climate-related risk, and carefully structuring overseas operations to maximise protection under bilateral and multilateral investment treaties.

 

Mark Crossley ensures clients benefit from the legal, technical and sector knowledge of Hogan Lovell’s construction and engineering transactional and dispute resolution lawyers. He develops engaging training and resources that reduce risks and improve efficiency for businesses. During the pandemic, his checklist on COVID-19 and force majeure was the firm website’s most viewed article, and for 18 months he chaired a fortnightly webinar informing the industry of the latest developments worldwide. He can be contacted on +44 (0)20 7296 2173 or by email: mark.crossley@​hoganlovells.com.

David Wallach has more than 17 years of experience representing clients in international arbitration and litigation. His practice is focused on high value, complex construction and commercial disputes. He has worked in a broad array of industries, including oil and gas, agriculture, retail and pharmaceuticals. He has also handled matters arising from projects in Asia, Australia, Africa, the Middle East and Latin America. He can be contacted on +1 (415) 318 1215 or by email: dwallach@kslaw.com.

James Bremen is chair of Quinn Emanuel’s construction and engineering practice and has over 20 years of experience in the world’s largest and most complex construction projects and most difficult disputes. He has worked in over 25 countries on both project documentation and claim resolution, including as counsel in some of the world’s largest construction arbitrations, in the oil and gas, power, renewables and major infrastructure sectors. He can be contacted on +44 (0)20 7653 2000 or by email: jamesbremen@quinnemanuel.com.

© Financier Worldwide

THE PANELLISTS

 

Mark Crossley

Hogan Lovells

 

David Wallach

King & Spalding

 

James Bremen

Quinn Emanuel Urquhart & Sullivan, LLP

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