In order to meet the Paris Agreement goals of capping global warming at no greater than 1.5 degrees Celsius, it is essential that there is a transition to low embodied carbon materials. Cement, steel and aluminium each produce 7-9% of global carbon emissions and billions of dollars of infrastructure is built each year using these materials.
If the necessary transition is to occur, it will be critical that the construction and infrastructure sector successfully pivots to using materials and products which involve drastically reduced greenhouse gas emissions when manufactured, transported and used.
If demand is there, then material suppliers would be expected to innovate and invest to deliver these low embodied carbon materials. There is a ‘chicken and egg’ problem however. Without sufficient and reliable supply chains, it is challenging for principals seeking to procure infrastructure to insist that low embodied carbon materials be used in their next project.
Other challenges include updating building standards, proving the efficacy and durability of the low embodied carbon materials and allocation of design and engineering risk in these emerging areas. Clever people are working on these issues and let’s assume they are solved – because they have to be.
How should contracts respond?
This still leaves important contractual issues to be addressed. How should contracts provide for the requirement that the contractor must use low embodied carbon materials?
At first blush, the answer seems obvious – simply require the use of the low embodied carbon materials in the specification. But what are the consequences if the builder does not comply with that promise?
Reputation aside, a contractual promise is only meaningful it is ultimately enforceable by the courts. This type of promise involves the enforcement of non-monetary benefits and is in a category with many other environment, social and governance (ESG) obligations, a category with which contract law struggles.
Sometimes builders breach contracts
Imagine the scenario where a builder has contracted to build a new billion dollar privately financed road for a fixed price and by fixed date. If the builder fails to complete on time, it will pay $100,000 per day in delay liquated damages. Delivery of a number of precast concrete pillars to support elevated ramp structures sits fairly on the critical path. But pre fabrication of those pillars is delayed because the delivery of the low embodied carbon cement which the builder has promised to use is held up.
Supply of low embodied carbon cement at this scale is new, there have been unforeseen issues with the builder’s chosen suppler and alternative suppliers are few and unlikely to be able to respond any more quickly. But the builder can immediately switch to traditional high embodied carbon Portland cement and mitigate its risk of paying the substantial delay liquidated damages, not to mention its own delay costs.
The switching cost will be covered by a claim against the low embodied carbon cement supplier but contractual limits on liability will prevent recover of the liquidated damages and delay costs. So a commercially rational builder makes the call and uses the Portland cement.
Twelve months later the road is complete apart for the usual minor defects. The road meets all the completion criteria although at this point it comes to light that the high embodied carbon cement has been used. This ‘defect’ is not such that it will prevent the road from being used and otherwise fit for purpose so completion must be certified and the principal is left with a defects claim. The road has not been constructed in accordance with the specification. It is clear breach of contract but what is the principal’s remedy?
The principal’s remedy?
The remedies for traditional defects involve complications but the law does provide answers. A defect is a breach of contract. The measure of damages for breach of contract is the amount needed to put the wronged party in the position it would have been had the contract been properly preformed. In the case of a traditional defect, and subject to any clear contract terms to the contrary, this can be reduced to a monetary amount being the cost of rectification of the defect. In some cases, this may necessitate demolishing the infrastructure and starting again.
There is a reasonableness test which comes into play. If the impact of the defect is relatively low compared with the cost of rectification, then the alternative approach may be to award the wronged party damages equal to the diminution in value of the project.
But if the ‘defect’ is not using a low embodied carbon material, rectification is hardly the right response. If the objective is to lower the lifecycle greenhouse gas emissions of the project, rebuilding using the low carbon material would simply exacerbate the problem. Regardless of the low embodied carbon nature the material, it must involve more greenhouse gas emissions to do that extra work.
The alternative approach of diminution in value is also problematic. The principal has a project which is fit for purpose and can be fully utilised as intended. In order to provide a damages remedy, the law needs to identify a loss to the principal. Perhaps the principal may have wanted to publicise the reduced carbon footprint of its project and that opportunity is lost or it may have need to satisfy third party stakeholders, such as customers, investors, financiers or employees, of its ESG commitments. Potentially the project was to be on sold with certain low carbon attributes and there may be some reduction in the on-sale price.
Less directly, the intention of using the low carbon material may have been to promote and strengthen the supply chain for future projects. Such losses are likely to be difficult to quantify and, together with the inherent risks and costs of litigation, this will be a barrier to the principal successfully bringing a claim.
A contractual promise is ultimately only as good as the remedy for its breach. A large infrastructure or building project is typically treated as a one off transaction between the builder and the principal, rather than an ongoing relationship. To make low carbon materials promises meaningful it will be necessary to also agree the remedy for their breach at the time of contract.
For breach of non-monetary obligations, one approach which has support in case law takes the form of a liquidated damages regimes.
Liquidated damages regimes need to be carefully crafted to ensure they are ultimately enforceable. As a rule of thumb, the amount of liquidated damages needs to be a genuine pre-estimate of the principal’s loss arising from the breach determined when the contract is made. If the amount of the liquidated damages is considered extravagant or unconscionable, the risk of unenforceability increases.
Given the difficulties of valuing the loss suffered by the principal, a defensible approach to quantifying liquidated damages may be to consider one of the objectives of procuring the low embodied carbon materials, namely to reduce greenhouse gas emissions. For this objective, the builder could be required to pay an amount equal to the cost of carbon offsets to cover the additional greenhouse gas emissions from the materials actually used.
While payment of additional amounts may ultimately fall within the High Court’s broader formulation of protection of legitimate business interests, best practice is to aim for a contractual regime well between the enforceability ‘guard rails’.
Carbon offsets come in a variety of forms and prices. There are guaranteed, immediately available carbon offsets in the form of existing carbon credit certificates or carbon offsets which may accrue over time and so carry an inherent risk that the offsets may not ultimately eventuate.
Different forms of carbon offsets come with different levels of confidence in their impact on greenhouse gas levels. Reforestation offsets directly support withdrawal of CO2 from the atmosphere. Other projects which purport to have the benefit of displacing a higher greenhouse gas emitting alternative may, however, be subject to scepticism. Independent third party verification is important.
Once a type of carbon offset is identified for use in determining the liquidated damages amount, the next question is to determine whether to fix the liquidated damages amount by reference to market price for those carbon offsets at the time of the contract or at the time the liquidated damages are payable.
The first approach has the advantage of certainty both for the builder and the principal. The risk for the principal is that when the liquidated damages come to be paid, the market price for the equivalent carbon offsets may have increased. If the principal wants to buy carbon offsets to fully compensate for the carbon emissions resulting from the builder’s breach, the liquidated damages may not have sufficient funds to do so completely.
The alternative is to set the price at the time the liquidated damages are incurred. This addresses the issue of providing the principal with sufficient funds to pay for the necessary carbon offsets, but is a potential source of dispute if the source of the required price information is not clear. Ideally it would be a published index for a relatively liquid market. But even then there would need to be provision for fall back approaches if the index were not available at the relevant time.
The principal may have additional objectives such as supporting the creation of a market to supply low carbon materials, moving industry norms and proving concepts. The failure to achieve these objectives will not be compensated by the suggested approach to calculating liquidated damages. But this may be a necessary comprise to ensure an effective and enforceable regime.
Other remedies can also be considered but all have their limitations.
Injunctions and specific performance
Once the project has been built and the builder has used the wrong materials it is generally too late to insist on compliance with the contract through remedies such as injunction or specific performance. The principal would need forewarning that the builder was about to breach.
This could potentially be achieved by a principal’s representative closely monitoring construction activities and requiring confirmation of procurement of the correct materials before they are used. Such supervision may be feasible if it is ancillary to the usual supervision which focuses on key design and construction activities. Otherwise, it is a potentially costly additional bureaucracy.
Further the overall commercial context will be that the project is about the delivery on time and budget of the relevant infrastructure or building. While important, the embodied carbon intensity of input materials will often be an ancillary issue to this main objective. It would be a rare and particularly principled principal that would take the step and incur the cost of seeking an injunction and delaying the completion of the project to ensure the correct materials are used.
Other ‘nuclear’ remedies
In theory it is possible to list the failure to use low carbon materials as a major default giving the principal a right for to terminate the contract, or to make the use of low carbon materials a condition to the achievement of practical completion.
But in most projects these remedies will not be practicable. Commercially, the principal may not wish to avail itself of them as they would result in unjustifiable risk, disruption and cost leakage to the principal from a half or mostly completed project which cannot be used.
Other important considerations
Regardless of other measures taken to ensure an obligation to provide low embodied carbon materials is enforceable, it is essential for the principal to carefully consider the ubiquitous and general clauses limiting or excluding the builder’s liability for indirect or consequential loss.
The losses suffered by the principal are unlikely to be direct. The principal may necessarily have to claim loss of opportunity, business or reputation as the consequences of such a breach. It will therefore be important that the selected remedy for failure to use low embodied carbon materials, whether it is liquidated damages or otherwise, is expressly ‘carved out’ from any clause excluding the builder’s liability for indirect or consequential loss.
There is increasing pressure for the construction sector to transition to low embodied carbon materials and to do so effectively. In addition to delivery on their own climate change strategies, principals will need to satisfy the ‘low emissions’ demands from a range of stakeholders, including financiers and shareholders.
Unlike some other non-financial obligations such as occupational health and safety, modern slavery reporting and privacy, which have their own legislative enforcement regimes, attention must be given to putting in place contractual enforcement regimes to make the promises meaningful. This is especially true at a time when supply chains transition and the risk of non-compliance is at its highest.
Not ensuring that contractors deliver on their promise to use low embodied carbon materials runs the risks of reputational damage for ‘green washing’ and, in the extreme, potential class actions and other legal claims.