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On October 30, 2009, the DC Superior Court confirmed an August 17, 2009 arbitration award issued by a three-member arbitration panel in New Athens Generating Co. et al. v. Bechtel Power Corp. et al. The Panel awarded $26,950,000 in liquidated damages against the construction giant Bechtel Power Corporation, EPC contractor of a $533 million power plant, after finding that it was responsible for over 200 days of delay and that the liquidated damages provisions of the EPC contract were not a penalty and were enforceable as a matter of law. The arbitration panel further found against Bechtel on virtually all of its $94 million in claims against the project’s owner, merchant power company, New Athens Generating Company, LLC (“New Athens”).

The decision in New Athens is particularly significant regarding the enforceability of liquidated damages provisions. Liquidated damages provisions are too frequently overlooked, but can – and will – be enforced, often without consideration of actual damages.

American courts use two models to determine the reasonableness and enforceability of a liquidated damages clause. Under both, the clause is enforceable if the stipulated amount is found to constitute reasonable compensation to the owner for inexcusable delay, and unenforceable if the amount is found to constitute a penalty. The two approaches differ as to whether the actual damages suffered should have any bearing on the “compensation” versus “penalty” determination. While jurisdictions differ on the issue of how the reasonableness, and consequently the enforceability, of a liquidated damages clause should be determined, i.e., whether the liquidated damages clause should be viewed solely as of the time of contracting, or with the benefit of hindsight, the New Athens decision reflects on the former, as the Panel found that the owner’s actual damages, calculated in hindsight, were irrelevant to the determination of the reasonableness and enforceability of the liquidated damages provision.

The panel ruled that in order for the $149,000-a-day liquidated damages to amount to constitute a penalty, “the quantum of damages proposed must be shown to be unreasonable at the time that the contract between the parties was negotiated.” The fact that the amount may, with the benefit of hindsight, be higher than the damages actually suffered is of no consequence. The panel concluded that the evidence clearly established that the amount stipulated by the parties in the EPC contract “was reasonable at the time the contract was entered into.”

This conclusion was based on both parties’ knowledge and sophistication with respect to the economics of financing, construction and operating a power plant, Bechtel’s previous experience working with New Athens’ parent company on “numerous other EPC projects,” and the fact that both parties were represented by “competent and experienced negotiators” at the time the EPC contract was entered into.

The final award provides a clear and succinct statement of the law regarding the enforceability of liquidated damages provisions.

Facts:

The case involved a March 2001 Engineering Procurement and Construction Contract between New Athens and Bechtel for the design, procurement and construction of a $533 million 1080 megawatt power plant in upstate New York . Prior to entering into the EPC contract with Bechtel, New Athens had issued a purchase order to Siemens Westinghouse Power Corp. in April of 2000 for three 501G gas turbines. New Athens subsequently assigned the Siemens contract to Bechtel in June of 2001, after which Bechtel assumed responsibility for Siemens’ performance as a subcontractor.

The EPC contract required Bechtel to achieve substantial completion on certain dates during July and August of 2003. Bechtel, however, did not achieve substantial completion until March 18, 2004, eight months behind schedule, triggering the contractual liquidated damages of $149,000 a day. At the end of the project, Bechtel claimed $94 million for the outstanding contract balance of $26 million plus some $70 million in alleged changes and compensable delays of over 200 days. Central to Bechtel’s claims was its assertion that New Athens had directed changes and improvements to the Siemens gas turbines, thereby interfering with and delaying Bechtel’s work. Siemens was a third-party respondent in the arbitration based on New Athens’ claim for indemnification.

The Arbitration Proceedings:

The arbitration proceedings were organized into three phases, sequenced to address three major issues: (1) technology risk – did New Athens or Bechtel bear the “technology risk” associated with Siemens’ new 501G gas turbines; (2) Force Majeure – was Bechtel entitled to its claimed $9 million for an alleged Force Majeure event relating to adverse winter weather; and (3) Project Delays/Liquidated Damages and Other Related Issues including – (a) were product modifications issued and implemented by Siemens during construction “betterments” for which New Athens was liable, (b) who was responsible for the delays to the project, (c) were $149,000/day in liquidated damages provided in the EPC contract an illegal penalty, (d) was a 2004 settlement agreement between New Athens and Bechtel setting the date for substantial completion enforceable, and (e) was Siemens liable to New Athens for indemnification.

Technology Risk

Bechtel and New Athens each claimed that the other bore the technology risk associated with Siemens’ newly designed gas turbines, and thus was responsible for the interferences and delays caused by design problems and product modifications. Agreeing with New Athens on virtually every point, the Panel ruled that Bechtel had assumed the technology risk associated with the three 501G turbines and the resulting impacts, and that Bechtel was therefore responsible for project delays associated with the Siemens equipment.

Force Majeure

The Panel found that winter weather in 2002 constituted a Force Majeure event, under the EPC contract. However, with regard to Bechtel’s $9 million weather Force Majeure claim, it rejected the vast majority of Bechtel’s claimed damages and awarded Bechtel a mere $1 million out of the $9 million claimed.

Project Delays

In the final phase, the Panel ruled that the product modifications issued and implemented by Siemens during construction were necessary to achieve substantial completion, and not, as Bechtel claimed, unnecessary enhancements or “betterments” for which New Athens was liable. Since Bechtel assumed the technology risk associated with the Siemens equipment, the Panel denied Bechtel’s product modifications claims in their entirety.

In reaching its decision, the Panel held that Bechtel understood that the project was intended to use three early 501G turbines which Siemens had marketed without confirmation that the equipment would operate with minimal need for further product modifications, and thus, Bechtel assumed the risk that remedial product modifications might be necessary to address problems with the immature Siemens technology.

The Panel also rejected Bechtel’s claim that the $149,000 a day liquidated damages provided for in the EPC contract were an illegal penalty. The Panel held that under New York law, New Athens’ actual damages, calculated in hindsight, were irrelevant to the determination of the provision’s enforceability. Rather, in order to constitute a penalty, “the quantum of damages proposed must be shown to be unreasonable at the time that the contract between the parties was negotiated [and] [t]he fact that the quantum may, with the benefit of hindsight, be higher than the other party actually suffered is of no consequence.” The Panel concluded that the evidence established that the amount stipulated by the parties in the contract “was reasonable at the time the contract was entered into.”

This conclusion was based on, inter alia, the parties’ knowledge and sophistication with respect to the economics of operating a power plant, Bechtel’s previous experience working with New Athens’ parent company on “numerous other EPC projects” and the fact that both parties were represented by “competent and experienced negotiators” at the time the EPC Contract was entered into. The Panel also noted that Bechtel’s power plant economics expert had failed to consider the reasonableness of the liquidated damages amount as of the time of contracting, and, simply focused on the reasonableness of the economics of New Athens operating the plant at the time in 2003 and 2004. Instead, the Panel accepted New Athens’ expert’s testimony because he had “investigated the reasonableness of the quantum of liquidated damaged at the time of contract formation.”

The Panel also ruled that the 2004 settlement agreement between New Athens and Bechtel, setting the date of substantial completion, was enforceable and that Bechtel had failed to present any credible evidence that it was misled into entering into the agreement. Because the Panel rejected Bechtel’s claims, Siemens was not liable to New Athens for contribution or indemnity.

Award:

In its final award, the Panel ruled that Bechtel had a contract balance of $22.4 million, was owed $4.5 million for uncontested change orders, and was entitled to $1.3 million for Force Majeure events. The Panel awarded Athens $26.95 million in liquated damages due to Bechtel’s late completion of the project. Thus, the net amount which Bechtel was awarded was a mere $1.35 million as compared to its claimed $94 million.

About the Author:

Judah Lifschitz was lead counsel for New Athens Generating Co. LLC. He is Co-President of Shapiro, Lifschitz & Schram, P.C., (www.slslaw.com) a Martindale-Hubbell AV-rated attorney and SuperLawyer. He can be reached at lifschitz@slslaw.com or 202.689.1900, ext. 3025.