As of late 2020, we continue to work through the dislocation of COVID-19 across all sectors of the economy, including the major projects sector. Despite regulating complex billion dollar infrastructure with design lives of up to 100 years, in most part the contracts for these projects were negotiated with little consideration of the possibility of a global pandemic.

As a consequence, the parties bound by these contracts are left to ponder, argue and dispute over where the disruption, delay and cost consequences of COVID-19 should fall, bound by the terms they have agreed, however inadequate or unintended.

Unsatisfactory as that all may be, at least the parties come to the issue plausibly protesting that they could not have anticipated COVID-19 and so they are not at fault in failing to provide for it.

But there is another systemic shock bearing down on us which will relegate COVID-19 to the minor leagues – namely climate change. And this time, no reasonable business person will be able to claim they were unaware. Yet we continue to struggle to adequately think through climate change’s implications for major infrastructure and major projects contracts remain rooted in the past.

COVID-19 has given us some intuition about the impact of systemic risk which grows exponentially. We need to tap into that intuition and reconsider standard contract terms as the impacts of climate change loom.

This article considers one standard element of the major infrastructure contracts – the fit for purpose warranty – and asks how it will stand up to the challenges of climate change. It considers the practical importance of standards in framing expectations of what fit for purpose means. Yet such standards are neither determinative of this question legally and, more troublingly in a number cases, backward rather than forward looking. The consequence is that they are unlikely to be fit for the task in the face of an unprecedented and unpredictably changing environment.

For parties contracting today, it will be unreasonable to assert that the risks of climate change should not have been at the forefront of their thinking when contesting claims in the future. The systemic nature of climate change impacts call into question the efficacy of traditional project specific approaches to risk transfer with implications not just for existing and upcoming projects but financial reporting across project portfolios. Other options need to be explored to better address climate change risk in long term contracts.

What is the fit for purpose warranty?

Most Australian design and construction contracts for major infrastructure will include an express fitness for purpose warranty. A typical formulation may be that the contractor warrants that as at the date of completion, the works are fit for purpose by reference to the purposes, functions and uses which are current and apply as at completion and comply with the requirements of the contract and all applicable laws and standards.With projects involving a long-term operation and maintenance phase, the contractor may also warrant that the works will remain fit for purpose for the term of the project.

The concept of ‘fit for purpose’ is typically defined as fit for the works’ intended purposes, functions and uses as specified in, or reasonably inferred from, the technical scope and the contract more generally.

The technical scope will include a range of standards with which the works must comply. It will typically specify design lives for components of the works. In the case of structural items, these design lives will be for multiple decades and perhaps as long as 100 years.

Even if not specified expressly, it will be reasonable to infer from the scope that the project is to be capable of being operated and maintained for at least the project term – anywhere from 20-40 years.

It is difficult enough at the best of times to determine the content of the fit for purpose warranty. But for projects which have recently started and are to come, the next several decades will not be the best of times. Fitness for purpose will inevitably be assessed in the context of major infrastructure which is to be utilised thorough a period of profound change.

In considering the content of fitness for purpose in this context, there are several ideas which need to be unpacked.

Reliance on standards

In practice, it seems that contractors, and their engineering and design consultants, lean heavily on standards as a proxy for fitness for purpose. The idea is, provided they design and construct to applicable standards, contractors will have satisfied their obligations and should not be open to a claim that the works are not fit for purpose. Certain standards may have ‘deemed to satisfy’ or ‘DTS’ criteria.

If a contractor meets that criteria, there is no further question as to whether the relevant aspect of the standard has been satisfied. Contractors do have the flexibility to meet the criteria in different ways if appropriate in the circumstances of the particular project but the onus is on the contractor to justify the different approach.

In major infrastructure projects, the standards which contractors have to comply with are typically many and detailed. There may also be multiple standards on the same issue – Australian standards, international standards and specific standards developed by particular government bodies.

While there may be contractual rules to determine which standard to follow in the case of inconsistency, often the rules end up requiring the contractor to comply with the highest standard if there is a choice or a conflict.

Contractors may be forgiven for thinking that if they have managed to design and construct to the most demanding of the standards applicable to the works they cannot be criticised. This though is not the case.

The UK Supreme Court decision of MT Højgaard A/S v E.ON Climate & Renewables UK Robin Rigg East Ltd (Højgaard) supports the proposition that it is not necessarily sufficient to simply comply with a standard. If there is some more general purpose for which the works are to be designed and constructed, that further purpose needs to be satisfied, even if it is more onerous or different to the standard. And further, the onus is on the contractor to discover that mere compliance with the standard will not meet that purpose.

Højgaard involved the design and construction of two offshore wind farms at Robin Rigg in the Solway Firth, off the coast of the UK. The contractor designed the grouted connections on foundation structures for the wind turbines in accordance with an international industry standard. The design was certified by an independent certifying authority.

Unfortunately, and unbeknownst to all involved, the standard had a numerical error resulting in an under-calculation of the relevant loads the foundations could cope with. The error was only identified after installation when another offshore wind farm at Egmond aan Zee started to fail, an investigation was carried out and the industry participants were alerted of the error.

The result was the Robin Rigg foundation structures designed in accordance with this erroneous calculation began to fail.

In a unanimous judgement, the UK Supreme Court held that it was clear from the fit for purpose warranty in the contract that the wind turbines where to have a design life of 20 plus years and that, notwithstanding that the contractor had met its obligations to design the foundations structures in accordance with the applicable standard, the foundation structures were not designed to last 20 years. The result was that the risk of identifying the error in the standard rested with the contractor.

Compliance with a standard did not dilute the absolute terms of the separate fitness for purpose warranty. And it was not relevant that the contractor had exercised due care and professional skill and complied with good industry practices.

The approach is in line with the Supreme Court of Canada decision of The Steel Company of Canada Ltd v Willand Management Ltd[ which the UK Supreme Court referred to with approval. Højgaard has not been considered by Australian courts but there is nothing to suggest it would not be followed in Australia.

Systematic error

Future litigants may seek to dismiss Højgaard as a rare case where there was an error in the standard. The vast majority of standards will not contain such errors and in many cases have stood the test of time. So, on this narrow view, it remains a reasonable strategy for contractors to look to meet standards and assume there is minimal risk that compliance with the standards will not, in turn, ensure they design and construct works which are fit for purpose.

But it is suggested that even on this narrow view, this approach is highly problematic in the face of climate change. There is genuine concern that the impacts of climate change will make standards systemically unreliable. In many respects, standards are based on historical information, in particular, climate data. They assume a relatively unchanging external environment and are updated only slowly. In Australia, for example:

‘Climate files based on weather data as old as the 1980s are still being used in buildings designed in 2020 and expected to have a lifetime up to 2080’.

Research indicates UK standards are similarly using historic climate data, leading to inaccurate estimates of building energy requirements and possibly resulting in buildings not being suitable for the next millennium.

Standards intentionally take account of risk and will prescribe approaches typically designed to address some highly unlikely scenarios. But the base line for coming up with those probabilities is developed from historic experience. Standards have never had to deal with the prospect of a rapidly changing and increasingly unpredictable external environment and rapidly changing ways in which people will need to engage with infrastructure in response.

To take a specific example, the COAG Energy Council Major Projects Implementation Team recently commissioned an assessment of current standards for assessing the thermal requirements of building materials and sizing and specification of heating, ventilation and air conditioning systems or HVAC for buildings currently being designed for Australian cities.

The conclusion was that the standards take no proper account of likely increase in thermal load due to increased mean and maximum day and night time temperatures, humidity, average wind speeds and urban heat island effects. The result is a material underestimation of air conditioning requirements and the efficacy of night purge systems and over estimation of heating requirements.

While HVAC is just one example, across the multitude of design issues in a major infrastructure project, it is reasonable to assume that historically based and static standards will increasingly become divorced from the lived experience of the ways in which infrastructure must respond.

If the principle in Højgaard is applied, then it will not be defence for the contractor to claim they designed to standards if the infrastructure does not otherwise prove to be suited for use as the environment changes.

Knowledge at the time the work is performed

If standards are not a good guide to the requirements of fit for purpose, what about the principle that the content of the fit for purpose warranty should be determined based on the knowledge of the parties at the time of contract or when the work is performed? In the example drafting referred to above, the fit for purpose warranty specifies that the fitness for purpose of works is to be determined by reference to purposes, functions, uses and requirements current at the time the works are completed.

This approach is supported by the Victorian Supreme Court decision of Barton v Stiff which suggests that the purpose will be influenced by the knowledge of the parties at the time that work is performed.

In this case, the contractor used bricks in building a house which were of good quality for normal site conditions. However, they were inadequate to prevent the penetration of salty groundwater. Unusually, highly salty groundwater ended up being present on the site.

It was held that the builder could not have anticipated the salty groundwater and so was determined not to have breached the fit for purpose warranty by not having used “exposure" bricks which would have dealt with the salty groundwater.

However, in the case of other environmental issues where it is may be considered common sense, the builder would be responsible for addressing the issue. For example, in building on clay soils in London, the builder would be expected to consider that the foundations may move if the moisture content of the clay soils change[ or a contractor installing a television mast would need to ensure it could withstand ordinary weather conditions in order for it to be fit for purpose.

The difficult question then becomes what climate related changes a builder today should be required to take into account. Contractors cannot be expected to design an infrastructure to withstand every conceivable risk. Either the laws of physics or prohibitive cost mean that building cannot be expected to survive a rare but extreme earthquake, meteor strike or military attack to take perverse examples.

A design warranty can be considered to require that a structure is designed with a sufficiently high probability of functioning for the design life. It is not a guarantee that it will do so in all circumstances.

The designer’s task is to apply the ‘state of the art’ at the time of the design task. ‘State of the art’ refers to the art and science that would be applied by competent and experienced practitioners involved in the practice of engineering.

Although it will evolve over time, the ‘state of the art’ is not necessarily the science or engineering known to academics researching at the cutting edge of known technology. And notwithstanding available computing facilities and artificial intelligence, at least for now, it continues to require the input judgement of trained, skilled, experienced and up to date practitioners.

The design of infrastructure involves a number of design parameters that are typically not known with precision and will vary from structure to structure and location to location.

Some of the most important of these are parameters are the properties of the environmental conditions that a structure may be subject to during its life, and the loads it must withstand to remain in service at the level required or under extreme events to remain safe. Forces of nature such as wind loading, thermal loading, maximum flood and tidal surge levels and precipitation (rain, hail and snow) impacts are generally determined on the basis of professional consensus drawing on experience at the relevant location and statistical analysis of available records.

For major infrastructure, the contractors, and the engineers and designers who work on them, are highly sophisticated and considered to be at the top of their professions. In considering what the current ‘state of the art’ is, it is suggested that no reasonable business person today could take the view that significant impacts of climate change are reflected in historical data, regardless of the mitigation measures the world may take. Those changes are expected to have exponential impacts. It will therefore be difficult to look to historical norms as a base line or to argue that only gradual departures from those historic norms could reasonably be expected.

At the same time, contractors (and indeed all of us) struggle to imagine all consequences that may flow. Scientists and other experts legitimately postulate a wide range of scenarios and point to the uncertainties in those forecasts. This challenge just becomes more pronounced when extrapolated over the multi-decadal design lives of typical infrastructure.

Practically, and some may say controversially, while the law may require the fitness for purpose of works to be assessed at the time work is undertaken, compliance with this standard will necessarily be assessed at a future time by judges or arbitrators assessing the question at that future moment.

If climate impacts have proven to be significant, climate change will have become a core and consensus issue for main stream business and there will be real difficulty advocating that, as of today, the contractor was not required to fully attend to these risks and anticipate adverse impacts.

While ultimately a matter for expert evidence, it will be a challenging and technical argument that a design rooted in historic environmental data was acceptable if the common consensus and lived experience at that time of future dispute is quite different.

Effective or illusory risk transfer?

Major infrastructure contracts always deal with a range of risks, grapple with the uncertain future and allocate risks between the parties. A starting principle is that for efficiency, the risk should be allocated to the party best able to manage it and it should be priced.

Pricing risk is good in theory but seems to be difficult to do in practice. The full cost of a risk is rarely able to be absorbed in the construct sum if the cost is material. Market competition appears to price risk at a discount, weighted by the assumed probability that the risk may or may not occur.

Contractors need strategies to manage and mitigate a risk if they are to be expected to effectively bear that risk. In the case of fitness for purpose, engineering and design professionals are alive to the issue and are increasingly unwilling to accept the contractor’s fit for purpose warranting on a pass down basis. They increasingly insist that their duty only extends to professional due care and skill – that is, a promise not to be negligent.

The market for professional indemnity insurance is also tightening, limiting insurance as an option to lay off the contractor’s risk.

Certain risks are sufficiently costly that if they were to occur they could materially financially damage a contractor, end careers and potentially lead to insolvency and cessation of business.

For principals, they should take little comfort in this risk allocation even if the terms of their contracts are clear. If the occurrence of risk leads to, or threatens, insolvency or simply material financial damage short of insolvency, there will inevitably be significant dispute, transaction costs, delay and uncertainty in enforcing a claim. And in the case of insolvency, the unrecovered cost of the claim reverts to the principal.

Climate change impacts have the added issue that they are systemic. Impacts when they occur are likely to impact across whole sectors at the same time. It is one thing to contemplate the impact of a material risk eventuating on, but restricted to, a particular project. But a contractor may also be exposed to the simultaneous occurrence of risk across their entire contract portfolio.

Even if relatively moderate in the context of just one project, their cumulative impact may limit the contractor’s ability to respond to any one particular claim. It may be determined that a contractor’s balance sheet can accept an increased cost of a certain amount if it arises on a particular project, assuming losses the contactor is absorbing across the rest of its portfolio are randomly distributed in accordance with historic sector norms. It is less clear whether the contractor’s balance sheet will be able to absorb that level of loss occurring across multiple projects within a relatively short period.

Also, most contractors can be expected to be similarly impacted. It is unlikely that one contractor who is underperforming will be able to be readily substituted for another who can perform.

Roll up into reporting

It is now reasonably well understood that boards must now take account of the risks of climate change in preparing financial statements and their annual reports. For contractors, this raises immediate considerations of impacts on supply chains and input costs, and potentially the need to adopt different lower carbon intensive materials and construction methodologies.

Indeed, if climate impacts are expected to require significant new infrastructure and refitting of existing infrastructure, this may presage increased demand and growth opportunities.

However, if climate change involves a material, difficult to predict, systemic and exponentially increasing disconnect between the purpose of infrastructure understood historically and what that purpose is in a changing future, then such reporting will also need to grapple with the potential liabilities contractors may face across their contract portfolios.Even if contractors can discount the future risk sufficiently to continue to contract based on current forms and precedent risk allocations, without detailed consideration of the risks climate change poses, it is not clear that their investors and financiers will be comfortable with reporting which does not grapple with issue, at least on a contract portfolio basis.

What are the options?

While this is a hard problem, steps can and should be taken to work through it.

First and foremost, the risk should be recognised and consider in a deliberate way (though that may be easier said than done).

The great benefit standards have had is that the difficult modelling to support a standard was inherent in the standard. If that modelling is no longer sufficient because it does not extrapolate to account for a changing external environment over the term of the project, then there is a need for new and appropriate modelling to be undertaken.

Practically, this is computationally intensive, requires access to the requisite expertise and is expensive. There may be limited science and engineering resources available to even the top-tier contractors to undertake this task. The more efficient approach would be to have this work done centrally and standards upgraded. It may require government to co-ordinate and fund this option to make it available for projects currently in planning.

Secondly, it needs to be recognised that this issue is based on the typical fit for purpose warranty drafting currently and historically used. But, as with most contractual matters, the risk allocation can be amended by express language.

It is not imagined that principals who are engaging a contractor to design and construct major infrastructure will be particularly interested in taking back fit for purpose risk in a general sense. After all, it is the contractor and its professional advisors who are the experts and it is this expertise which the principal is buying. But, as a matter of efficient risk allocation, there would seem to be clear scope to better define the purpose of infrastructure and the limits on risk the contractor is prepared to accept in specific areas.

At least by making assumptions of the immediate micro climate applicable to a particular project explicit, consensus choices can be made about technical solutions and cost trade-offs. If the principal ultimately decides not to fund a particular risk mitigant, then there would be a reasonable basis for the contractor to argue for a corresponding qualification to the fitness for purpose warranty and agree language which avoids future disputes.

Lastly, there are limits on liability which can be agreed both in terms of monetary amount and time. Major infrastructure contracts often have relatively high liability caps both in proportion to the contract price and in absolute terms relative to the balance sheet of the contractors. This is driven by the size of the contracts and the need of the principal and its financiers to be assured there is sufficient head room in the liability cap to cover the costs of a replacement contractor if the contract is terminated before completion.

Fit for purpose claims are most likely to manifest post completion. It would seem that there is scope to negotiate sub-caps for fitness for purpose liability due to climate change impacts which allow contractors to better manage their exposures to this systemic risk across their contract portfolios yet keep sufficient skin in the game to assure principals that contractors and their design teams will be properly motivated to take account of the more foreseeable of climate change impacts.

Contractors can also place time limits on their exposure to fitness for purpose risks which only manifest many years after completion. While statutory liability periods do apply, there are reasons to consider that liability under indemnities or pursuant to tort extend after the works are completed.

Given the risks posed by climate change increase with time, express language could be agreed providing a clear cut off for the contractor’s liability under the fit for purpose warranty.

Looking ahead

Climate change requires a careful reconsideration of the assumptions and practices underlying core terms in major infrastructure contracts. Current projects will have lifetimes which cover decades when climate change impacts are anticipated to apply.

Thinking through the risk allocation inherent in a typical ‘fit for purpose’ warranty highlights the need to reconsider old approaches based on historic data and practice. It will be difficult to defend a backward-looking approach as ‘state of the art’ when the future is expected to be very different.