Data Centres: Risk Management at the Contractual Stage

As the backbone of our digital existence, in an increasingly digital world, data centres are the engines of modern life. However, meeting the ever-growing demand for data centres brings with it a host of challenges for all stakeholders in the life-cycle of a data centre, from financing and developing the project, to its physical construction, to operating a live data centre.

The data centre industry continues to expand at an exponential rate, with the UK alone projecting a five-fold increase in spending on new UK data centres by 2029, from c.£2.38 billion to c.£10 billion.¹ This is a trend that is reflected in almost all jurisdictions globally.

However, whilst the focus of, and on, the data centre industry is in respect of the opportunities afforded by the ever-increasingly demand for data centre services, meeting that higher demand brings with it a host of challenges for all stakeholders in the life-cycle of a data centre, from financing and developing the project, to its physical construction, to operating a live data centre.

As the data centre industry races to meet the demand globally, it is more important than ever for those in the industry to consider and address all risks at the outset of any project. To ensure successful delivery and long-term operational efficiency of a project, stakeholders need to identify the risks associated with its development, identify the parties best placed to manage any such risk and then seek to mitigate those risks that cause delays and their effect, including supply chain issues, cost overruns, delays in planning or technical failures during construction and operational. Failure to do so is almost certainly going to result in increased construction costs, delay revenue generation and threaten project completion.

Over the course of a series of articles, we explore the some of the key risk management and dispute resolution mechanisms that data centre stake-holders can employ to at three key-stages of the life cycle: (i) the contractual stage; (ii) during the construction phase; and (iii) the operational stage.

In this first article in our Data Centre Risk Management series, we explore the potential risks facing stakeholders at the contractual stage of a data centre project, and provide our thoughts on ways to mitigate them.

Shortcomings of D&B Contracts for complexity of projects

Data centre construction projects differ significantly from traditional construction contracts due to their unique requirements. The interface between shell and core construction, fit-out contracts, contracts for the supply of long lead items and owner/operator contracts creates a complex contractual matrix. This intricacy is further compounded by the need for high-tech facilities, the integration of specialised systems (such as cooling systems) and ever-evolving client requirements.

To address these challenges, contracts must evolve beyond the standard forms of Design & Build ("D&B"). While D&B contracts are familiar and widely used, they often require significant amendment to accommodate the specific needs of data centre projects and in particular, the specific MEP requirements and testing regimes that are required for a data centre. As a result, this may not constitute the most cost-efficient approach. Ever-evolving changes in regulatory and customer requirements need to be accommodated, resulting in significant, and costly, amendments to data centre contracts.

As the data centre sector continues to grow, a shift towards alternative procurement models will be required. For example, employing a main contractor to provide management services enables the owner to retain greater control over the project and engage more specialist contractors. This allows for greater flexibility and earlier procurement of long-lead items, although demands a high level of coordination and familiarity among the parties involved. It does however deliver speed in terms of overall project timetables and speed to market is one of the ley drivers in procurement of any data centre.

Another strategy to address the shortcomings of D&B is to implement pre-construction services agreements to improve project setup. Having a contractor involved from inception promotes early design integration, better supply chain alignment and helps to deliver greater cost certainty at an earlier stage.

Power Supply and Grid Access Risks

Power supply is a critical issue for data centres, with grid connection delays posing significant risks to construction timelines. As a result, the costs associated with sourcing power often accounts for up to 80% of the total project budget.

These delays are something that the contract needs to address from the outset. Contracts must clearly allocate responsibility for securing grid connections, typically placing this on the developer, although acknowledging that temporary power solutions, such as generators, may be needed to perform some of the many systems testing that is required prior to handover of any data centre. This in turn requires provisions for procurement, maintenance and cost allocation and therefore an increasingly common amendment in data centre contracts relates to utility-related risk.

Supply Chain Challenges

One of the biggest tensions in the data centre sector at the moment is securing and maintaining the appropriate level of supply chain to deliver. This involves consideration of every phase, from the labour through to the materials and equipment and how these are procured. These projects rely heavily on specialist long-lead items with volatile availability, and disruption of the supply chain can delay project timelines and increases costs.

To reduce some risk for the contractor, owner furnished and contractor installed ("OOFCI") equipment might be used. This removes a contractor's risk of delivery delay that might stem from a supply chain issue. However, this does not take away any installation risk. Inclusion of fluctuation clauses assists in mitigating risks, as do clauses allowing for payment for offsite materials, advance payment, reduced retentions and incorporating a pain gain mechanism.

Sustainability and ESG Obligations

With data centres contributing to 2% of global greenhouse gas emissions, the industry faces mounting pressure to adopt sustainable practices. The NEC X29 and JCT 2024 embed environmental considerations, while there are various ESG clauses incorporated into the contracts. However, many of these are not mandatory, raising questions surrounding enforceability and benchmarking. 

The parties can address these requirement by strengthening the contractual obligations to include key ESG provisions  and making these mandatory, incorporating clear performance metrics and reporting requirements, and ensuring robust enforcement mechanism—thereby enhancing accountability and aligning data centre operations with evolving regulatory and stakeholder expectations. This is likely to require a mind-shift and may well result in increased costs and learning for contractors and developers alike.

Speed-to-Market Pressures and Schedule Risk

Few sectors face the same time pressures as the data centre industry. Delays in project delivery can result in lost contracts and capacity shortages for end-users, creating an intense speed-to-market pressure.

Such pressure necessitates certain contractual considerations, early completion incentives and delay damages. Contracts must therefore incorporate a blend of sophisticated delay damages and mechanisms whilst retaining flexibility. This is equally important for each of the developer, in as much as it will have back to back obligations with its customer and therefore needs to replace these arrangements as far as possible with the contractor to secure timely completion and for the contractor to be able to protect themselves from delay stemming from matters outside their control, such as utility connection delays or customer-instigated changes. It is all a matter of balance as the figures resulting from delayed completion of a data centre are unlike any other asset class.

Modular Construction: A Solution for Speed and Efficiency?

Modular construction is increasingly being adopted in the data centre industry due to its ability to reduce construction time by up to 50%. As a form of pre-fabrication, modular construction also brings the benefits of scalability and speed, with phased expansion possible. Similarly, it is deemed more sustainable, complementing the real drive within both the construction and data centre sectors to comply with sustainability requirements.

Modular construction proffers quality control by removing the risk of on-site errors. However, the converse to this is that any mistake in any single module will be replicated in the remining modules, attracting significant costs further down the line. Supplementary challenges, such as transportation logistics, must be carefully managed. A hybrid approach combining traditional and modular construction methods is emerging as a preferred strategy.

How We Can Help?

The data centre industry is evolving rapidly, presenting unique legal challenges in construction, risk management, and compliance. Simmons & Simmons has extensive experience advising on data centre projects, from pre-contract risk assessments to dispute resolution. Our dedicated team is here to help you navigate the complexities of this dynamic sector.

¹ UK data centre spend to soar to £10 billion a year - Barbour ABI