Hidden Risk

Frequently, consulting engineers are asked to review or negotiate part, or even all, of a complex written agreement on behalf of their clients. They may, for example, review a contract for the purchase of services or equipment, and they will often do this without the active involvement of lawyers.

Although many engineers are thoroughly experienced in drafting, they may be unaware of some legal subtleties. Any modifications to the wording of a printed or electronic standard form agreement, even by words filling in the blanks and, especially, by inserting or deleting entire clauses, may alter the judicial interpretation of that contract.

At the end of the day, what matters is not what the writers of the agreement think it means, but what a judge thinks it means. Any ambiguity in the meaning of any provision creates risk for your client. And, any weakness in your drafting that results in a loss for your client can result in a claim against your firm for professional negligence. It can be as risky for engineers to design contracts as it is for lawyers to design bridges.

Some kinds of agreements have been extensively litigated, so that their meanings are well established — although there may still be some unpleasant surprises. Other contracts, such as those involving new or unusual projects, will have little or no developed case law. Wind and nuclear generation fall into the undeveloped and, therefore, highly risky category.

Greatest danger is in what’s missing

Most people, when reading written agreements, look for something obviously wrong, and then negotiate to remove or modify that provision. But the greatest danger lies not in what cries out for deletion. The greatest danger lies in what is not in the agreement.

The written agreement normally specifies the obvious: the purchaser shall pay $X, and the vendor shall deliver Y goods or services on or before date Z. Then, there will be boilerplate changes covering subjects like default, termination, arbitration, force majeure, etc. But, a central purpose of any agreement for a product or service with a non-trivial cost is the allocation of risk between the parties. Who bears the risk of what foreseeable or potential future event? What, if anything, does the agreement say about these?

By way of illustration, commercial (and consumer) agreements for the purchase and sale of electricity usually specify a fixed price and quantity of kilowatt hours, regardless of the market price of electricity, for a maximum number of kilowatt hours in a given month or year. Your client, the purchaser, is delighted that the market price will no longer be a risk and that it can now plan on that price for the term of the agreement. In effect, your client has bought an insurance policy on the price of electricity, in return for making the vendor its exclusive supplier of electricity. Is this contract enforceable? Yes and no! The vendor’s standard form agreement specifies a fixed monthly quantity (or a high-low range) that the purchaser must purchase, but no quantity that the vendor is legally obligated to supply.

What happens if the market price spikes upwards, as your client had feared? The vendor can reduce its supply to reduce its loss. Can your client then go elsewhere to meet its electricity demand at a lower price? The answer is “No,” because: (a) as purchaser, your client has agreed to make the vendor its sole and exclusive supplier of electricity, and purchasing elsewhere would be a breach of the agreement entitling the vendor to damages; and (b) the vendor has not breached the agreement in any way, as there was no written obligation to supply all or any particular portion of the purchaser’s electricity requirements.

In short, the agreement assigned the risk of reduced supply, in any event, to the purchaser. And, the agreement would most probably state that the written agreement was the entire agreement between the parties. What does this mean for your client? — having to pay its exclusive supplier, the vendor, a higher price for electricity than the written agreement specified. In that case, your client will have paid a premium price for obtaining a fixed price guarantee that is of little or no value to it if the market price significantly increases.

Going to court

Your client could go to court to ask the court to ignore the “entire agreement” clause and “imply” into the contract a provision that the vendor must supply the purchaser’s entire demand, regardless of the market price, but it may be an uphill battle, and a costly one. The vendor’s response would be that the parties intended what the agreement said, and nothing more.

The lesson to the unwary is to look for such subtle, non-obvious omissions of risk allocation in the agreement, to identify these risks and allocate them. If, in this case, the vendor is unwilling to guarantee that it will supply the agreed quantities, you will know that your client bears the risk of non-supply. If the market price rises above the vendor’s comfort level, it will stop supplying your client until it can obtain a higher price.

Wind generation projects

A major risk with wind generation is the generators’ performance. Lubricants developed for European climates may freeze under North American winter conditions, causing the premature failure of gear, shaft and rotor parts. Wind velocities may suddenly accelerate in Canada, at rates considerably faster than in Europe. Sudden wind acceleration can damage rotor blades, unless they are constructed to withstand these forces. Rather than merely contracting to purchase a specific number of generators, therefore, the engineer may wish to require the manufacturer or vendor to provide a representation that this generator will operate to a certain standard for a specific temperature and wind velocity range for a certain number of years, and to provide a warranty to that effect. The remedy would be replacement without charge for premature failure or under-performance.

Nuclear projects

A major concern for any work done on a nuclear generator is an “incident” with release of significant radiation. Everyone with any connection to the generator will be joined in lawsuits in any country to which the contamination may be wind or water borne. There is no insurance for this, and Canada’s Nuclear Liability Act applies only in Canada. Only the most carefully planned indemnities and corporate structures can provide meaningful protection.

In conclusion, electricity contracts involve subtleties not always apparent to the reader. What is not in the contract is often more important than what is in it. Caution is essential, especially with wind and nuclear generation.

Andrew J. Roman is chair of Miller Thomson LLP’s Electricity Law Group, and a partner in the firm’s Toronto office.