Energy-related construction and design contracts are complicated instruments that are replete with pitfalls for both sides. A recent Georgia case discussed the complexity of energy-construction projects, especially where one party assumes responsibility for both design and installation.
Background on EPC Contracts
In the energy-construction industry, contracts that require one party to design and install the project are quite common. They are typically referred to as engineering, procurement, and construction contracts, or EPC contracts. While they are common, they represent huge sources of potential liability. If any part of the project does not result as originally planned, the design-contractor is almost certain to face a serious lawsuit.
Background of the Case
In a recent case before the Georgia Court of Appeals, a design-contractor entered into two contracts with a plant owner. The first contract required design, and the second required installation, of a custom energy system to generate heat energy to power the owners’ plant. Excess heat would power a boiler and turbine to produce electricity for use or sale.
The project experienced several problems. It was unable to meet applicable emissions requirements, and it did not produce enough steam to generate the level of electricity required by the contracts. The owner ultimately filed suit against the design-contractor.
Did the Design-Contractor Breach the Contract?
At trial, the jury sided with the owner and rendered an award of over $8.4 million. The jury based the award, in part, on evidence of the following installation defects:
- Where the design called for alloy materials, the contractor installed carbon steel nuts, which disintegrated at the high temperatures found on the project; and
- The design-contractor misaligned the expansion joints in the primary air heater of the system, which caused the system to leak thermal energy and created enough force to shear bolts off the system.
Based on these deficiencies, the jury found that the design-contractor breached the installation contract, and the Court of Appeals affirmed the award.
Did the Breach Justify $8.4 Million in Damages?
The jury awarded the owner several types of damages, including direct repair damages, ongoing maintenance costs, delay damages, and the cost of a new boiler that was not originally called for by the contract.
The jury relied on testimony of the cost to fix the defects and replace damaged equipment. While the appellate court could not exactly recalculate the jury’s damages figure, it held that evidence admitted at trial supported the range of damages awarded by the jury. In reaching this conclusion, the court held that the jury may have found that the owner was entitled to delay damages because the project was not able to begin operation until almost one year after the scheduled completion date.
Finally, a substantial portion of the damages awarded by the jury included the cost to procure and install a stand-alone boiler. In the lawsuit, however, the contractor argued that awarding the cost of a new boiler was inappropriate because (i) the contract did not require the boiler, (ii) installation of the boiler would place the owner in a better position than set forth in the contract, and (iii) the cost was disproportionate to the loss in value caused by the defects.
In response to the contractor’s arguments, the court sided with the owner because damages for defective construction claims include “the reasonable cost of completing performance or of remedying the defects if that cost is not clearly disproportionate to the probable loss in value.” The court concluded that the jury was authorized to find that the only way to remedy the defects was to install the additional boiler. Moreover, the contractor had the opportunity to argue to the jury that the new boiler would place the owner in a better position than called for by the contract. Accordingly, the jury presumably considered these arguments but, nevertheless, ruled in favor of owner.
The implications of this case should not come as a surprise to those in the energy-related construction industry. First, from the design-contractor’s perspective, EPC contracts and similar contracts pose huge potential risks. In the traditional structure of construction projects, by contrast, the construction and design responsibilities are typically assumed by two or more entities. This typical delivery structure (sometimes referred to as design-bid-build) spreads the risk around. In an EPC contract, the design, construction, and installation responsibilities are centralized and assumed by one entity.
As this case illustrates, the concentrated risk profile of an EPC contract or similar contract can result in damages of high magnitude. Unless the contract contains adequate protections, the design-contractor assumes liability for the performance of the project, which is sometimes subject to performance guaranties. Accordingly, the design-contractor has unlimited exposure to liability to bring the project into compliance with the performance standards in accordance with the terms of the contract. This exposure can be mitigated by including provisions in the EPC contract for limited liability and waiver of consequential damages.
From the owner’s perspective, EPC contracts can provide great delivery systems for building the project. As in this case, the owner has a single point of responsibility and if a dispute arises, it brings lawsuit against only one party. The owner is not caught in the crossfire between the designer and contractor because they are the same entity. One drawback, however, is that the owner must play an active role in the design and construction phases of the project. An option to accomplish this is to hire a construction manager. By contrast, in the normal construction delivery scenario, the architect purports to fill the role of a neutral party, to a certain extent.
As demonstrated by the recent case, design-construction contracts raise significant risk-allocation issues. It highlights the importance of contract drafting and addressing these issues before executing the contract.