Design-Build Teammates—Who Pays Liquidated Damages First?
October 2004
Although design-build is now a "mainstream"
construction project delivery system, there remain many challenges in properly
allocating the risks arising from this system, particularly among design-build
team members. A recent case demonstrates how this issue was handled by two major
industry players with the context of liquidated damages.
by Michael
Loulakis
Wickwire Gavin,
P.C.
Siemens Westinghouse Power Corp. v Dick Corp., et
al., 293 F Supp 2d 336 (SD NY 2003), involved a suit between members
of a consortium over which a member had responsibility to make the initial payment
of liquidated damages to a power plant owner for project delays. The court,
after looking carefully at the consortium agreement between the parties, concluded
that the construction contractor member of the consortium had the ultimate responsibility
to pay the owner, and then to seek reimbursement from the turbine vendor member.
Siemens Westinghouse Power Corporation (SWPC) and Dick Corporation formed
a consortium to construct a power plant in Londonderry, New Hampshire, for AES
Corporation (AES). The contract called for the payment of liquidated damages
of $85,000 per day if the project did not achieve "Provisional Acceptance" by
a certain date. When Provisional Acceptance was delayed, AES began assessing
liquidated damages. Dick made the initial liquidated damages payments, totaling
around $3.6 million. At some point, AES began drawing its liquidated damages
from letters of credit posed by SWPC. SWPC ultimately paid AES over $18 million
in liquidated damages as a result of project delays.
A dispute arose between SWPC and Dick over who had the initial responsibility
to pay AES the liquidated damages. SWPC argued that Dick was obligated to pay
AES first, with the ultimate apportionment of such damages between SWPC and
Dick to be determined later. Dick contended that it was only required to pay
liquidated damages to the extent of Dick's fault. The parties were not able
to resolve this conflict, resulting in SWPC filing a lawsuit against Dick, its
sureties, and others.
The Consortium Agreement
Section 7.6.2 of the consortium agreement was one key provision relative
to this dispute. It stated:
- Liquidated damages or other obligations to the Owner arising from delayed
completion of the Project, or any part thereof, shall be the responsibility
of and shall be paid by Dick as specified in Section 6.3.2 hereof.
Another key provision to this dispute was Section 6.3.2 of the consortium
agreement, which read as follows:
- Without limiting the generality of Section 6.3.1 above, in the event
Siemens Westinghouse is late in performing its obligations under Exhibit
G, Siemens Westinghouse will, as its exclusive liability and Dick's sole
remedy, be responsible for paying to Dick: the lesser of: (i) the liquidated
damages payable in accordance with Article 9, Delay in Delivery, and Article
10, Provisional Acceptance Delay/Bonuses/Final Acceptance, of Exhibit G,
provided however, in no event shall Siemens Westinghouse's responsibility
for payment of such liquidated damages exceed the sum of $85,000 per day,
and (ii) the demonstrated impact costs Dick incurs in working around or
accelerating its work to overcome the delay caused by Siemens Westinghouse,
subject to the exclusions and limits on recovery of such costs in Section
9. In no event will Siemens Westinghouse be liable to Dick for delay claims
hereunder if liquidated damages would not have been payable pursuant to
Exhibit G. Dick will be responsible for payment of any scheduled liquidated
damages to be paid to Owner. Dick will also be responsible to pay Siemens
Westinghouse the bonus referred to in Article 10, Provisional Acceptance
Delay/Bonuses/Final Acceptance, of Exhibit G.
SWPC argued that these provisions called for SWPC to pay liquidated damages
to Dick, not the Owner. It also cited provisions of the EPC contract that required
the payment to AES of liquidated damages on a monthly basis, and that it would
be impossible to calculate SWPC's share of the damages, according to the formula
in Section 6.3.2, on a monthly basis. Moreover, Section 6.3.2 capped SWPC's
share of the liquidated damages at the "demonstrated impact costs Dick incurs
in working around or accelerating its work to overcome the delay caused by Siemens
Westinghouse," which was a complex analysis that could not be performed on a
monthly basis. SWPC also looked to Exhibit G, which stated that SWPC would only
be liable for liquidated damages for delay in delivering certain component parts
if, after the late component part is delivered and installed, it is determined
the SWPC was the "sole cause" of the project's delay. All of these points meant
that Dick had to pay liquidated damages in the first instance.
Dick argued that Sections 7.6.2 and 6.3.2, read together, meant that Dick
would only be obligated to pay AES after the damages were properly assessed
and SWPC paid its share to Dick. Dick relied on the clause, "Dick will be responsible
for payment of any schedule liquidated damages ..." and contended that the future
tense implied that Dick will be responsible for payment after SWPC paid its
share to Dick. Dick also pointed to 10 separate provisions of the consortium
agreement which supported the proposition that each member of the Consortium
was responsible for its own acts and omissions.
The court noted that even though the contract did not explicitly state that
Dick was to pay the damages "in the first instance," or otherwise state that
Dick was to pay those damages "before apportionment," the overall structure
and language of the provisions required a finding in favor of SWPC. Since the
payment obligations ran from Dick to AES, and separately from SWPC to Dick,
the structure suggested that SWPC was to reimburse Dick for its payments to
AES. It was also persuaded by the fact that Dick was unable to counter SWPC's
observation that the complex apportionment calculations required by Section
6.3.2 could not be performed alongside the monthly payment schedule required
under the contracts with the Owner.
The Role of the Sureties
The court also concluded that Dick's sureties were jointly and severally
liable to reimburse SWPC for its $18 million payment to AES. The sureties had
argued that they could not be liable on Dick's behalf because the surety bonds
required, as a condition precedent to payment, that SWPC fulfill all its contractual
obligations.
- The Surety shall not be liable to Obligees, or either of them, unless
the Obligees, or either of them, have faithfully performed all of the obligations
of Siemens Westinghouse Power Corporation as outlined in the Agreement.
…
The sureties argued that SWPC failed to perform its obligation to pay its
share of the liquidated damages and, as a result, they were not required to
pay. SWPC argued that another provision of the surety bond controlled, with
this provision stating:
- Notwithstanding the provisions herein above, in the event of a dispute
between the Principal and Obligee, the Surety shall not be liable to the
Obligee until the applicable dispute resolution procedures as outlined in
the Agreement have been exercised by the Principal and Obligee, provided,
however, that the Surety shall be liable for those obligations of the Principal
which are nevertheless required to be performed by Principal under the Agreement
pending the outcome of such dispute resolution procedures.
The court agreed with SWPC, finding that Dick had the obligation to pay liquidated
damages to AES pending the dispute resolution procedures regarding apportionment.
The Significance of the Case
The Siemens Westinghouse case is significant
from a variety of perspectives, particularly in that it shows how sophisticated
parties develop their consortium agreement. The text quoted above shows that
the parties obviously considered the issue of which of the two companies was
to bear the initial responsibility for paying the owner liquidated damages.
While the language could have been written a bit clearer, particularly if Dick
believed at the time of contracting that its position was right, the most telling
point was that it was virtually impossible to apportion responsibility for delay
during contract performance.
What is the lesson smaller industry players can learn from Siemens Westinghouse about forming their design-build
teams? You need to figure out which team member will be financially responsible
to the owner and potentially "out-the-cash" pending full resolution of all issues.
Do not be misled into thinking that this is just a financing issue and involves
a temporary outlay of funds. It can be a huge factor in how the overall case
will be resolved. The party who pays first has a strong incentive to get the
case resolved quickly and may face pressure to settle on less than favorable
terms.
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