In Iberdrola Energy Projects v. Oaktree Capital Management L.P., 2024 WL 3363321 (N.Y. App. Div. July 11, 2024), a New York appellate court held that a nonrecourse provision in a construction contract entered into by sophisticated parties barred tort claims against the alleged breaching party.

Defendants Oaktree Capital Management L.P. (“Defendants”) created a special-purpose entity, “Footprint Power Salem Harbor Development LP” (“Footprint”), to serve as the company charged with constructing a new gas generation plant to replace an old coal power plant (“the Project”). Defendants owned, controlled, and managed Footprint, and were Footprint’s majority and controlling equity holders.

In 2014, Footprint retained Plaintiff Iberdrola Energy Projects (“Plaintiff”) to be the Project’s procurement and construction contractor. Under the terms of the contract, Plaintiff was required to post a standby letter of credit for 20% of the contract price (approximately $140 million) as security for Plaintiff’s performance. Footprint was permitted to draw on the letter of credit only “upon any Contractor’s breach or failure to perform, when and as required, any of its material obligations under th[e] Contract with five Business Days prior written notice to Contractor.” The contract contained a nonrecourse provision that provided for no tortious or breach of contract recourse against Footprint’s, and Footprint’s general partners, related to the Project. There was also an arbitration provision in the Contract and a choice of law provisions stating the contract was governed by New York law.

A series of delays in the Project occurred. Disputes arose during the construction, and on the substantial completion date of May 31, 2017, work was still not completed. For the next several months, the parties negotiated over change orders while Plaintiff continued to work on the Project.

On April 15, 2018, almost a year after the intended completion date, and when the project was 98% complete, Footprint gave Plaintiff notice of termination for cause, citing, among other things, Plaintiff’s failure to achieve substantial completion by the required date. Simultaneously, Footprint gave Plaintiff notice of Footprint’s intent to draw on the letter of credit, and eventually drew the $140 million from the letter of credit. A replacement contractor was hired by Footprint and the remaining work was completed.

Plaintiff filed an arbitration complaint against Footprint for breach of contract, tortious conduct, and violations of the Massachusetts Unfair Trade Practices Act, ultimately seeking $700 million in damages. The Arbitration Panel determined that Footprint lacked cause to terminate the contract and that Footprint terminated the contract as a pretense to draw on the letter of credit. After offsetting Plaintiff’s damages with those of Footprint, the arbitration panel issued a final award in Plaintiff’s favor of $236,404,377.00. The award was confirmed by a trial court, but Footprint filed for bankruptcy, reducing the possibility that Plaintiff would recover on the award.

While the arbitration proceeding was pending, Plaintiff sued Defendants Oaktree Capital Management for tortious interference with contract, fraud, unjust enrichment, and violations of the Massachusetts Unfair Trade Practices Act. Plaintiff alleged that, as the work progressed, Defendants were concerned about a loss on their investment, so they lied to Plaintiff so it would continue working on the project until it was approximately 98% complete. Plaintiff alleged that Defendants then encouraged Footprint to terminate the contract to access the $140 million available under the letter of credit, which Defendants then used to pay a third party to complete the remaining 2% of the work.

Defendants moved to dismiss, invoking the language in the nonrecourse provision. The trial court granted the motion and Plaintiff appealed. Ultimately, the Appellate Court affirmed in substantial part the ruling that the nonrecourse provision barred the tort claims against Footprint’s principals, i.e. Defendants Oaktree, but also ruled that Plaintiff was entitled to replead the fraud cause of action.

The Appellate Court held that the nonrecourse provision was not limited to breach of contract claims. The plain language of the provision exculpated Defendants from liability for any claims related to or in connection with the contract. All of Plaintiff’s claims were predicated on conduct taken under the contract. Therefore, all of the causes of action related to the contract were barred by the nonrecourse provision.

The Appellate Court emphasized that the nonrecourse provision was broadly worded. If Plaintiff had wanted to limit the nonrecourse provision to breach of contract claims, the nonrecourse could have been drafted to expressly say so, emphasizing that Plaintiff was a sophisticated commercial entity that knowingly contracted with a special-purpose entity, knew the special-purpose entity might not be able to satisfy an arbitration award, and could have bargained for greater protection.

Construction companies and contracting parties should take special heed of this case and ruling. First, they should be aware of nonrecourse language in their contracts and ensure their recovery mechanisms are adequately protected in the event of a dispute. Second, contracting construction companies should consider the risks when contracting with special purpose entities and analyze the potential legal risks associated with such.