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The Impact of Ambiguity in Construction and Engineering Contracts for Energy Projects

A July 31, 2012 ruling by a federal district court illustrates the importance of using clear provisions in contracts for energy construction.  The case centered on a developer’s argument that its contract with an engineering firm contained a performance guaranty concerning the operation of a biomass plant.

If the guaranty provision were clear and unambiguous, developer arguably would have been entitled to summary judgment against the engineering firm.  However, because the court found ambiguity in the provision, a jury will now determine what the parties intended.

Background

Developer entered into a contract with engineer to develop a biomass-to-energy plant.  In addition, developer executed a power-purchase agreement (PPA) with a utility, which imposed certain project milestone dates with liquidated damages.

The engineering contract contained a provision that, according to developer, constituted a performance guaranty obligation on the engineer.  It states:

Overall plant performance guarantee will be achieved via guarantees by suppliers of individual equipment and the undertakings of the Contractor and certain project investors as well as by the undertaking of [Engineer] in this Agreement. Equipment performance guarantees will be written into the specifications for each piece of major equipment with financial penalties for performance shortfalls. Factory performance test combined with on site performance testing will verify that equipment is achieving desired performance. A highly qualified design team is being proposed for this project with the necessary experience to design and support your project during construction. The design will be performed in our [out-of-state] office.  [Engineer] will work together with your Construction Manager, Contractor and Owner’s Representative to ensure that your project is designed and built to the high standards you require in order to achieve your continual goals.

According to developer, engineer recommended the use of a gasification/boiler system.  The system’s supplier guaranteed that developer would need no more than a set amount of feedstock to operate the plant.  At some point, an error was discovered in the fuel tonnage calculation, meaning that more than the expected amount of feedstock was required.

The error significantly impacted developer and the viability of the project.  Specifically, it affected feedstock volume, pro forma financials, economic viability, financing possibilities, and entitlements under the air permit it previously obtained.  Importantly, the error would cause delay to the start date beyond the milestone dates set forth in developer’s PPA with the utility.

Eventually, a payment dispute erupted, and litigation ensued.  Engineer asserted claims for breach of contract, quantum meruit and unjust enrichment, and assumpsit and account stated.  Developer countered with claims based on professional malpractice and negligence, negligence per se, breach of contract, breach of express and implied warranties, and unjust enrichment.

The Importance of the Contract

Developer argued that the above-cited language constituted a guaranty by engineer that the overall plant performance would conform to the stated fuel requirements.  Engineer argued that the contract did not impose a guaranty but merely established the scope of engineering services.

As support, engineer argued that the parties’ contract was a modified design-bid-build contract under which developer would contract separately with a designer and builder.  In contrast, it continued, the agreement was neither a design-build contract nor an engineer-procure-construct contract (commonly known as an EPC contract) that would include a promise to deliver a “turnkey plant.”

The Impact of Ambiguity

Developer moved for summary judgment based on its stance that the contract imposed a performance guaranty on engineer.  In analyzing the applicable contract law, the court noted that if the contract did, in fact, contain a clear and unambiguous guaranty, there would be no need for interpretation by the court or a jury.  If the guaranty were not fulfilled, the contract would have been breached.

However, the court ruled that the contract’s purported guaranty provision was ambiguous.  The provision used the term “guaranty,” but it was not clear whether it was imposing a guaranty obligation on engineer, or was simply describing guaranties needed from the supplier.  While the contract required engineer’s “‘assurance’ regarding overall plant performance,” it did not explain the scope of the “assurance” or “the specific contours of ‘overall plant performance.'”   Finally, contrary to developer’s argument, the court declined to impose a “turnkey” requirement on engineer in the absence of specific contractual language to that effect.

Conclusion

In summary, the court concluded:

Thus, it is clear that [engineer] provided a guarantee to [developer] regarding some aspect of the development and implementation of the [biomass] plant, but it is unclear precisely what [engineer] agreed to guarantee. Accordingly, although the Court FINDS that [engineer] guaranteed something, the Court FINDS an ambiguity regarding the subject and scope of the “guarantee.”

The case illustrates the importance of drafting contracts with clear expressions of the parties’ obligations and entitlements.  For instance, instead of using form contracts or documents prepared by one of the parties, contracting parties should seek the assistance of counsel to develop contracts that reflect the parties’ negotiated allocation of obligations, risks, and rewards.

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