Linked Claim and Equivalent Project Relief Clauses

Published on LinkedIn on 18 August 2020

The recent court decision in Transurban WGT Co Pty Ltd v CPB Contractors Pty Ltd [2020] VSC 476 (the Transurban Linked Claims Case) shines a light on the legal efficacy of linked claim and equivalent project relief provisions in reducing the risk of insolvency for special purpose project companies due to claims by its subcontractors for extra money or extra time. This article explains the purpose of these provisions and the problems and limitations associated with them, before offering some suggested solutions.

What are Linked Claim and Equivalent Project Relief Clauses?

To understand the purpose of linked claim and equivalent project relief provisions, one must first understand the broader contractual structure in which they fit. They are common on privately financed public private partnerships (PPP) projects, where:

  • a government agency contracts with a special purpose project company for the financing, design, construction, operation and maintenance of an infrastructure facility, such as a new toll road;
  • the project company subcontracts its obligations to design and construct the infrastructure to a D&C contractor on back-to-back terms with its upstream obligations under its project contract with government;
  • the project company subcontracts its obligations to operate and maintain the infrastructure to an O&M contractor on back-to-back terms with its upstream obligations under its project contract with government;
  • the project company borrows the money it needs to pay its D&C contractor for the design and construction of the infrastructure from lenders who agree to lend the money on the basis that they can have recourse to the project company only (and not its shareholders) for repayment of the loan.

 

By using ‘limited recourse’ debt, the project company’s shareholders (the equity investors) are able to limit their financial exposure to the project to the amount of equity that they invest in the project company. 

But because the lenders can’t have recourse to the other assets of the project company’s shareholders, the lenders need to be satisfied that the risk of the project company becoming insolvent has been reduced to an acceptable level.

Among the risks that the lenders will be concerned about are:

  • the risk that the D&C contractor’s entitlements to extra time or extra money under the D&C contract will exceed the project company’s corresponding entitlements under the upstream project contract; and
  • the risk of a dispute between the project company and the D&C contractor arising out of these entitlements being resolved in a manner inconsistent with the resolution of a corresponding dispute between the project company and the government agency.

These risks both fall into the category of risks sometimes referred to as ‘gap risk’ – i.e. the risk of a ‘gap’ emerging between the project company’s upstream rights and obligations on the one hand, and its downstream rights and obligations on the other hand, which could result in an unfunded liability (or ‘funding gap’) for the project company.

To address these risks, it is common for the project company to include linked claim and equivalent project relief provisions in its downstream contracts. These provisions typically provide that:

  • the project company, upon receiving a claim from the D&C contractor under the D&C contract, must diligently pursue any corresponding claim the project company has against the government agency under the upstream project contract including, if the government agency rejects the claim, by seeking to resolve the upstream dispute in accordance with the upstream dispute resolution procedure in the project contract (the ‘linked claim clause’);
  • the D&C contractor’s right to progress and resolve the downstream dispute in accordance with the dispute resolution procedure in the downstream D&C contract will be suspended while the corresponding upstream dispute between the project company and the government agency is being progressed in accordance with the dispute resolution procedure in the upstream project contract (the ‘suspension clause’);
  • the D&C contractor accepts that it will be bound by the outcome of the upstream dispute resolution process and its entitlements under the D&C contract in respect of the downstream dispute will not exceed the project company’s corresponding entitlement under the upstream project contract (the ‘equivalent project relief clause’);
  • the D&C contractor must indemnify the project company for the costs of pursuing the upstream claim, provided the project company does so as directed by the D&C contractor; and
  • if the project company fails to diligently pursue the corresponding claim, the suspension clause will cease to apply and the D&C contractor will become entitled to progress its claim through the downstream dispute resolution process.

The Transurban Linked Claims Case highlights some problems and limitations with these provisions.  

Transurban Linked Claims Case

The Transurban Linked Claims Case concerns the West Gate Tunnel Project. The State has entered into a project contract with a special purpose project company owned by Transurban for the financing, design, construction, operation and maintenance of the West Gate Road tunnel. The project company has, in turn, subcontracted its obligations to design and construct the road tunnels to CPB Contractors Pty Ltd and others (the D&C contractor). The downstream D&C contract includes linked claim and equivalent project relief provisions as described above.

The D&C contractor has made numerous claims against the project company, mostly arising out of the discovery of the extent of PFAS contamination where the two tunnels will be constructed and the difficulties the D&C contractor is experiencing in disposing of the PFAS contaminated soil to allow the tunnel works to commence.

The project company has generally made corresponding claims against the State in accordance with the linked claim clause. There are, however, some aspects of the downstream claims that have not been replicated in the upstream claims – which I’ll return to below. The D&C contractor has referred the downstream disputes to a downstream arbitration under the D&C contract. The project company has, in turn, referred the upstream disputes to an upstream arbitration under the project contract.

The D&C contractor now wishes to progress the downstream arbitration even though the upstream arbitration process has not yet concluded. The D&C contractor is arguing that the clause containing the linked claims clause, the suspension clause and the equivalent project relief clause is not enforceable because it offends the prohibition against pay when paid provisions in the Victorian security of payment legislation. It is also arguing that some of the downstream claims are not linked claims, and so the suspension clause does not apply to them.

This resulted in the project company applying to the Supreme Court for an injunction to stop the D&C contractor from progressing the downstream arbitration process. The Court refused to grant the injunction and has instead found that all of the matters raised by the project company in its application, including the enforceability of the suspension clause, should be determined by the downstream arbitral tribunal.

Claims unique to the downstream parties

The Court’s decision highlights the project company’s exposure to gap risk as a result of claims by the D&C contractor that are unique to the downstream parties and, therefore, fall outside the linked claim and equivalent project relief regime.

In the Transurban Linked Claims Case, these included the D&C contractor’s claims that

  • the D&C contract was terminated by reason of a Force Majeure Termination Event under the contract. 
  • the D&C contract is void from its inception by reason of common mistake as to the extent of PFAS contamination;
  • the performance of the D&C contract has been frustrated by reason of the PFAS contamination; and
  • the D&C contract should be set aside because of misleading representations as to the extent of PFAS contamination prior to its execution.

The project company has not made a corresponding claim under the upstream project contract, no doubt because it does not wish to terminate its right to levy tolls on users of the new road.

Because there is no ‘linked claim’ under the upstream project contract that corresponds with these downstream claims, the suspension clause and equivalent project relief clauses can’t apply to these claims. 

This is not an issue that can be fixed by the approaches that have been developed to overcome the pay when paid prohibition. Rather, it serves as a reminder to equity investors, debt financiers and governments that it is simply not possible to totally eliminate ‘gap risk’ via a back-to-back subcontract.

Is the equivalent project relief clause enforceable?

There have long been concerns that equivalent project relief clauses are unenforceable because of the prohibition against pay when paid provisions in Australia’s security of payment legislation. These concerns became real in 2005 when a UK court held that an equivalent project relief clause offended a similar UK prohibition against pay when paid provisions in the case of Midland Expressway v Carillion Construction Limited [November 2005] 2963 (TCC).

The concerns were reinforced by the Australian High Court decision in Maxton Constructions v Vadasz [2018] HCA 5, which found that a provision in a construction subcontract that allowed a head contractor to withhold retention moneys under a subcontract until certain events had occurred under the head contract was a ‘pay when paid’ provision, and therefore legally unenforceable under the relevant security of payment legislation. You can read more about this decision in this article.

It is therefore odd that the contractual approaches that have since been developed to overcome the pay when paid prohibition and improve the legal enforceability of equivalent project relief clauses, such as those set out in the Guidance published by the Construction Committee of the City of London Law Society, rarely feature in Australian PPP sub-contracts.

The decision in the Transurban Linked Claims Case didn’t need to address this issue, as that decision was limited to questions concerning applications to the Court to stop the downstream dispute being progressed through the downstream arbitration process while the upstream dispute resolution process was continuing. It is an issue, however, that the arbitration tribunal will need to consider in due course.

Suggested solutions

The prohibition against pay when paid provisions in construction contracts shouldn’t apply to equivalent project relief provisions in construction contracts entered into by a special purpose vehicle on project finance transactions. Equivalent project relief provisions on project finance transactions was not the evil that the prohibition was designed to address. The security of payment legislation in each state and territory should therefore be amended to exempt such equivalent project relief provisions from the prohibition. Let’s call this the ‘legislative solution’.

Pending implementation of the legislative solution, project financiers should ensure that the project companies to whom they lend on a limited recourse basis include linked claim and equivalent project relief clauses that adopt appropriate strategies to overcome the pay when paid prohibition, such as the multi-tiered approach recommended by the Construction Committee of the City of London Law Society.

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Thanks to Julia Krapeshlish for her assistance with this article.

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