Articles

26 December 2024

Introduction

The construction industry is a contributor to global greenhouse gas emissions at each stage of the project lifecycle. This is particularly so when ‘scope 3’^[2] or indirect emissions across the value chain of a completed project are considered. As international pressure to cut emissions escalates, fuelled by shareholder and grassroots activism, several national and local government bodies are likely to adopt stricter environmental laws and standards. In turn, this will impact approvals processes, as well as funding and insurance requirements for new projects. Existing projects may also be impacted. Accordingly, project stakeholders at all stages of lifecycle and value chain should remain abreast of local environmental developments.

The construction community has heeded the general call to arms and offered contributions to promoting more environmental approaches across their sphere of influence. One such initiative is the Chancery Lane Project^[3] – a worldwide pro bono initiative, which publishes template legal clauses aimed at solving legal issues arising from climate change. Over 100 model clauses for use across a range of commercial contracts for different sectors have been published, peer reviewed and are now being assessed for application in different jurisdictions. A number of these are relevant to the construction industry. It will be interesting to see how they are adopted, either directly by project participants on the advice of their lawyers, or through industry bodies publishing template construction contracts.

This article offers a summary of the measures proposed by both FIDIC and NEC, as publishers of market-leading construction contracts, to incentivise compliance with environmental requirements and allocate associated risks between contracting parties.

International Federation of Consulting Engineers (FIDIC)

FIDIC launched its Climate Change Charter in November 2021 as a call to action for the construction community to commit to taking steps to reduce emissions – both operationally and embedded within existing infrastructure  – and to support climate change adaption through promoting the design of resilient assets. The Charter does so through suggesting actions for individual engineers, companies, project teams and FIDIC member associations.

FIDIC itself also commits to providing best practice clauses and developing industry guidelines to achieve the goals of the Climate Change Charter.

FIDIC’s standard form contracts already contain a number of clauses targeted at addressing environmental concerns. For instance, sub-clause 4.18 of the 1999 Red and Silver Books provides that a contractor “shall take all reasonable steps” to protect the environment both on and off site. The affirmative language was upgraded in the 2017 editions so that “necessary steps” are instead required. While this change elevated the contractor’s obligation, absent an agreed environmental standard to measure compliance against, this provision has no bite. It is not clear what are “necessary steps”. FIDIC’s suggested drafting, if left unamended, could be unenforceable in certain jurisdictions for lack of certainty. This clause also provides no recourse for an employer where it does not directly suffer economic loss if the contractor breaches the environmental protection obligation.

Other suggested clauses are more practical. For instance, the 2017 suite of contracts introduced a requirement for contractor compliance with any environmental impact statement. Sub-clause 6.9 of the 1999 Second Editions also empowers the Engineer to remove any person who persists in conduct which is prejudicial to the protection of the environment. Again, to heighten their effectiveness, these provisions must be benchmarked against local or national requirements for environmental protection and environmental impact statements so that performance can be objectively measured.

Finally, sub-clause 8.5(c) of the 2017 Red and Yellow Books provides expressly that an extension of time will be granted where the works are delayed due to “exceptionally adverse climatic conditions”, and certain extreme weather events (including hurricanes and typhoons) are recognised by FIDIC to constitute events triggering force majeure provisions (see sub-clause 18.1 of the 2017 Red Book). It will be interesting to see how the risk allocation for mechanisms such as force majeure are adjusted for extreme weather events (and other issues going to the heart of asset resilience) as such events occur more frequently and can better be predicted with improvements in climate science.

Given FIDIC’s environmental commitments as an organisation, we should expect to see a greater prioritisation on drafting to meet environmental risks in future FIDIC forms.

New Engineering Contracts (NEC)

In July 2022 NEC published its Option X29 clause, which is designed to address climate change risks.^[4] It does so by enabling employers to state their Climate Change Requirements, which form part of the contract Scope, and to provide specified targets for the provision of the contracted works in a Performance Table. The targets of the Performance Table are the basis upon which pricing adjustment may occur, dependent upon the extent to which the targets are met or exceeded. A contractor must also submit its Climate Change Plan, setting out the steps it will take for the strategic implementation of the employer’s Climate Change Requirements.  

By requiring contracting parties to consider the climate change regime and specific targets at the outset of the project, a benchmark is provided against which compliance can be monitored. A contractor is able to factor into its project administration the costs, time and impact of compliance. The achievement of the targets set out in a Performance Table will entitle a contractor to pre-defined amounts for payment. Conversely, if a contractor fails to achieve a Performance Table target, the contractor will be liable to the employer for the relevant amount.

NEC’s approach for including a liquidated damages regime in Option X29 for non-compliance with the Climate Change Requirements is a welcome development. NEC’s Option X20 clause provides a similar regime of payments upon achievement of key performance indicators listed in an incentive schedule, with no penalty for failure to achieve the agreed KPIs. However, this type of ‘carrot-only’ incentivisation does not address the practical realities that non-compliance with environmental targets might entail: the inclusion in Option X29 of a liquidated damages mechanism alleviates the need for an employer to demonstrate direct economic harm as a result of non-compliance with Performance Table targets.

Similarly, a ‘simpler’ environmental regime, where no Performance Table is included but a contractor provides a warranty that it will comply with the Climate Change Requirements, does not take into account the types of damage likely to result from non-compliance with such Requirements. From a general common law perspective, damages for breach of warranty broadly seek to put the claimant in the position it would have been in had the warranty been true (subject to the legal test for remoteness of damage and application of the duty to mitigate). Providing a warranty for environmental compliance introduces uncertain risk for a contractor. There seems little reason why either contracting party would prefer such an approach to adoption of the Option X29 payment regime for achievement of environmental targets.

When compared to FIDIC, NEC standard form contracts have a greater emphasis on early warning systems when contractual issues start to go awry. This approach is tracked through in the Option X29 clauses. If a contractor fails to comply with an employer’s Climate Change Requirements and that failure relates to the works themselves (i.e., the asset being constructed), the non-compliance will be a defect, requiring remediation. There is also provision for the Climate Change Plan to be revised during the works, and for changes to the Climate Change Requirements (and any associated price adjustment to a target in the Performance Table) to be compensable as a change to the contract Scope.

The success of Option X29 will lie in a commitment by the employer to identify and articulate its Climate Change Requirements. Performance Table targets must be both attainable and measurable to be capable of implementation. In common law jurisdictions, generally, the 

related payment regime may need to be a genuine pre-estimate of (direct) loss to be enforceable (or at least, not operate as a penalty), should a compliance and associated payment claim arise.^[5] It will be interesting to see how courts worldwide tackle the question of whether a clause constitutes a penalty in the context of environmental compliance disputes given the complex and long term impacts non-compliance can have.  

Legal advice on negotiated positions should be obtained as additional liabilities may be inadvertently introduced through the setting of environmental targets (for instance, where innovative technology is required for their achievement, etc.). Care must also be taken (where the governing law of the contract is that of a common law jurisdiction) that the Climate Change Requirements do not introduce a standard of care that elevates a contractor’s duty from acting with reasonable skill and care, to providing works that are ‘fit for purpose’ upon compliance with the employer’s Requirements – this may extend performance obligations beyond the cover afforded by professional indemnity insurance policies in some jurisdictions.

Irrespective of the potential for such pitfalls, NEC’s Option X29 provides a balanced approach to the allocation of climate risk and a flexible framework within which contracting parties can make adjustments for project and stakeholder-specific risk appetite.

Eye to the future – benchmarks and incentives

It is clear that for any environmental compliance regime – whether under FIDIC, NEC or otherwise – to be effective, it must be measurable by reference to a clearly articulated standard incorporated into a contract. Time will tell whether a generally accepted standard becomes accepted as an industry norm in certain jurisdictions or whether legislation will be required to achieve that. It is only when a benchmark for general environmental compliance is in place in the relevant jurisdiction, that the risk allocation regimes proposed in the FIDIC and NEC standard forms can be tested in a practical way.  

It is therefore in the interests of all project stakeholders to engage with local environmental conversations. This is a valuable opportunity for members across the construction community to contribute to the industry’s journey towards ‘net zero’ emissions.

Contributed by:

Samantha Tan - Senior Associate, Freshfields Bruckhaus Deringer; Sarah-Jane Fick - Senior Associate, Freshfields Bruckhaus Deringer^[1]

^[1] Samantha and Sarah-Jane are senior associates in the International Arbitration Group of Freshfields Bruckhaus Deringer.

^[2] The Greenhouse Gas Protocol (the most widely used greenhouse gas accounting standard), published by the World Resources Institute, considers three scopes of emissions: scope 1 are direct emissions from company owned and controlled assets; scope 2 are the indirect emissions released from the consumption by a company of purchased energy (i.e., indirect emissions as a result of running air conditioning in offices, etc.); and scope 3 are indirect emissions occurring throughout the value chain (both upstream and downstream) linked to a company’s operations. 

^{[3] See https://chancerylaneproject.org/ [last accessed on 5 December 2022].}

^[4] Eleven different versions of Option X29 are available for inclusion into the eleven variations of NEC4 contract.

^[5] Even where a genuine pre-estimate of loss is included for a target in a Performance Table, in civil jurisdictions such estimates remain subject to the potential for adjustment by local courts.