Category: EPC Contracts

Contract administration – ugh, really?

Contracts are not for everyone.  They can be complicated, convoluted, repetitive, ambiguous, conflicting, confusing and very, very long.  The meaning can be wrapped up in legal speak, and the intention lost behind a wall of whatsoever’s, thereto’s and pursuant’s. 

But in a fully-wrapped EPC contracting arrangement, the contract is the biggest tool at the Employer’s disposal; the biggest weapon in the arsenal.  So if the Employer has a nice weapon at their disposal they should surely know how to use it, right?  Right.

Herewith a visualisation of a fully wrapped EPC contract.  Good for hitting irritating contractors over the head.  Especially if you make the rope nice and tight.
Herewith a visualisation of a fully wrapped EPC contract. Good for hitting irritating contractors over the head. Especially if you make the rope nice and tight.

Again, as ever, this post focuses on the technical aspects of EPC contracts.  The legal eagles will be better placed to discuss how and when the contract can be enforced, but here are some ideas for making sure the Employer has a handle on some of their rights and obligations.

Know the content

They run for hundreds of pages, but someone on the Employer’s side should have a good understanding of how the contract conditions translate into project execution.  What should the Contractor be doing right now? Should they be carrying out design works? Should they be submitting these for review?  Should they be developing a programme?  Should they be ordering equipment that will take a long time to deliver?  Should they be making sure that someone is reviewing and signing off on design documents?  Should they be preparing manuals/test plans/quality plans?  Should they be submitting progress reports?  What should these reports contain?

The Employer’s requirements, the programme of works (or project schedule), the milestone schedule, the scope of works, the list of deliverables, the other bits… they should all be providing a clear picture of what the Contractor should be doing and how they should be doing it.

If you don’t know what they should be doing, how can you issue warnings when they’re veering off the intended path?

Know your rights and obligations

So the Contractor thinks you should be approving their design drawings, do they? They think you’re at fault if the design is later found to be non-compliant?  If you know your rights you’ll be able to point them to the part of the contract that tells them that they keep that responsibility until the sun sets on the project.

Alternatively, if you don’t know what’s in the contract, you may miss the fact that you’re supposed to have reviewed a document within two weeks, and after that you have no more say.  Then you may be stuck with an O&M manual that misses the point entirely, and a very confused operator.  Oops.  You may also be required to provide the Contractor with a permit before they can finish some scope of works.

Know the limitations of what you can ask for

The Contractor needs to make sure that the facility is designed and constructed in a way that complies with the contract.  This means that they have the responsibility for interpreting the conditions and responding appropriately.  It doesn’t help if the Employer comes along and says ‘do it like this.’  What if ‘this‘ isn’t ‘that‘ and ‘that‘ was in the contract?  The when the thing blows up and it is found to be from ‘that‘, the Contractor can point to the request and put their hands in the air, decrying any responsibility.

Of if the Employer has someone on site, that person can raise a fuss when they see things being done in a way that hasn’t been agreed, but to ask the Contractor to do something directly, which may impact the progress or cost of the project can be a dangerous move.  Unless that request stops something physically dangerous from happening.

Notify the Contractor of an observation, inform them that this is not in compliance with their requirements, ask them what they intend to do about it, ask them for an assessment on how this may have impacted the project.  But it is for them to come up with a solution.  You can ask them strongly.  With some force.  With a LETTER (gasp).  But putting your foot too deeply into the runnings of a supposedly fully wrapped project can open up a can of liability worms.

Make sure they know what’s what

Belting out your version of what’s in the contract can make you feel contractually superior, but this is has a lot more of an impact if the Contractor has also read the thing.  Reminding them of some deliverable in advance can help prevent you from having to chase them for it later.  It also means that they know that you’re on top of things, and that you won’t be letting them sneak through their obligations.  Having a session at the beginning of the project where people who are involved in seeing the thing through get to sit down and discuss what is expected (and contractually required) of both is useful.  Because you don’t really want the lawyers involved if you can avoid it.

Hahahahaha, you didn't submit the programme in time, now you're going to be late...  Hahahahaha. Oh, wait. I'll be late too.
“Hahahahaha, you didn’t submit the programme in time, now you’re going to be late… Hahahahaha.”
“You’ll be late then too, numpty.”

 

 

Completion Certificates for major works

There are many milestones in a renewable energy facility project, and the contract should have a breakdown of these milestones in the milestone schedule.  These help everyone involved in the project to keep track of how works are progressing, and where there are possible risks to the project completion date.

There are a few major milestones that signify the end of a large piece of work, the shift from one activity to another or the handover of works from the Contractor to the Employer.  These major milestones may be accompanied by a certificate, included in the contract schedules, that formally recognise the completion of a certain aspect of works.

Let’s look at three major milestones that may merit the inclusion of completion certificates.

Mechanical completion

This milestone signifies the end of all construction and installation activities.  The facility is sitting there, like a dormant giant, ready to be switched on and commissioned.  All visual checks have been completed by the Contractor, as well as checks and tests that confirm that bolts have been tightened, cables have been connected properly, roads have been compacted, structures have been erected and equipment has been installed.  And these checks have been done in accordance with the accepted project inspection and test plan.  The resulting paperwork has been compiled and signed off by the Contractor’s duly authorised representative and it has been filed in a way that makes it available to the Employer to review (easily, so it needs to be filed logically).

This is a big milestone, because it means that the facility is considered to be safe to electrify.  The Contractor has done their due diligence through their quality inspections, and there is no perceived risk to human life in turning the thing on.  There may be minor works outstanding, but these should be just that, MINOR, and they should be recorded in detail on a snag list.  Snags should not affect how the facility operates, nor should they encompass a major portion of the works.

Practical completion

Also called commercial operation, this is the point at which the facility has been commissioned, initial performance tests have been completed, and the facility is ready to start exporting power to the grid.  This is a major milestone, as the facility can start generating revenue from the sale of electricity.  As mentioned in a previous post on commercial operation, this also typically triggers the Defect Liability Period, and is the start of the performance monitoring period.  Any adjustments to the contract price resulting from the actual installed capacity not meeting the contracted installed capacity are agreed here.

As I’ve covered this milestone already, I won’t talk in too much detail about it, other than to say that there will probably be a lot of stakeholders who have an interest in how the milestone has been achieved.  Independent engineers appointed on behalf of the utility, the lender or other interested or regulatory bodies may require access to test results and performance data.  They may also have a say in whether the milestone has been achieved.  This will depend on the contracting strategy, the local context and regulations and the number of stakeholder with a say in how the project is run.

There will probably be a lot of pressure from the Contractor, at this point, to confirm that this milestone has been achieved, as they will be looking to minimise the risk of liability for delay liquidated damages.  It can be quite a stressful part of the project, with pressure from all sides to ensure that data and information is reviewed thoroughly, without causing undue delays.  It is for this reason that the conditions to be met for practical completion should be clearly defined in the contract.

Schedule_programme

The contract should allow for the Employer to confirm that this milestone has been achieved even if all of the conditions have not been met, without giving up their rights under the contract.  It can be in the project’s interest to start seeing positive cash flow, before everything is 100% complete.  The big caveat here is that this should not be at the expense of the health and safety of those operating the facility, or result in any environmental damage.

Final completion

This is the milestone where the Employer and the Contractor shake hands and walk away from each other (with relatively small strings still attached).  This signifies the end of the Defect Liability Period and the performance monitoring period, and any compensation to the Employer resulting from facility underperformance is agreed.  The Employer is effectively saying that they accept the facility as it is, and that the Contractor has made good on any issues (mechanical or performance) that have come up since practical completion.

There are some conditions that will survive this milestone.  Most notably of which is the warranty on equipment (module performance warranty is typically 20 years at least).  Manufacturer warranties may be transferred from the Contractor to the Employer, and the Employer may follow up with the manufacturer if defects become apparent, or the the liability to resolve equipment malfunction may remain with the Contractor.

Latent defect warranties would also survive final completion.  These protect the Employer from construction issues that may only manifest way down the line, and are often linked to legal requirements (depending on the country).

Performance guarantees and liquidated damages

This follows on from yesterday’s post on Delay Liquidated Damages, as there are a few principles that overlap.  Most notably of which is that the Employer’s biggest stick in an EPC contract is the use of financial penalties if the Contractor doesn’t meet what they have agreed to in the contract.

Possibly my favourite cartoon ever.  Via XKCD.

Where DLDs are used to protect the Employer against delays, contracts make use of performance guarantees to ensure that the facility does what it was intended to do.  This post looks at two types of guarantees and penalties that exist.

Guarantee on installed capacity

Prior to achieving practical completion, or meeting the commercial operation date (COD), there will be a list of activities that need to be completed.  These will include (amongst others) commissioning activities, pre-COD performance tests, and the submission of required documentation.  The contract is likely to require the Contractor to demonstrate that the constructed facility meets the stated technical specifications, including the overall installed capacity.

For instance, for a PV facility, this may mean that the nameplate capacities of all the modules installed need to add up to, say, at least 100MW.  If the Contractor finishes the installation, and for one reason or another, the modules do not add up to 100MW, the Employer would naturally be disinclined to pay the full contract price for an inferior product.

It is at this stage that the contract would allow for a reduction in the overall contract price, if the Contractor has under-delivered on the facility’s capacity.  Note, the contract should not include any allowance for the Contractor to receive additional funds if the facility is over capacity.

The calculation for amounts owed may be as simple as a pro-rata adjustment of the contract price based on capacity delivered, but this may differ from project to project, and technology to technology.

Guarantee on facility performance

The performance tests that take place prior to achieving COD are typically carried out over a week or two.  They are there to show that the facility can perform as expected, but they are not long enough to show if there are operational issues that may only show themselves over a longer period.  For instance, the pre-COD tests may take place during the low-wind season.  This means that the tests show how the facility operates when wind turbines don’t have to rotate at high speeds.

Enter the performance monitoring period.  This often overlaps with the Defect Liability Period (during which the Contractor is on the hook for any equipment or construction defects that show their face), but is not necessarily directly linked to this (more on the DLP later).

The performance monitoring period is normally about a one or two year period, during which the facility’s operation is monitored.  Its performance is compared to what was expected, given the available solar/wind/other resources, and the Contractor is liable to compensate the Employer for any underperformance.

The method of determining the amount payable is carried out upfront, through the calculations specified in the contract for Performance Liquidated Damages.

PLDs should:

  • Be reflective of the losses incurred by the Employer for any facility underperformance
  • Be sufficient to compensate the Employer for the facility’s operational life (say 20 years)
  • Be a good balance between compensating the Employer without increasing the contract price to an excessive level
  • Not double-penalise the Contractor for any reduction in installed capacity, if there has already been an adjustment to the contract price, pre-COD
  • Clearly reflect any cap on PLDs that may apply (note there may be an aggregated cap on both PLDs and DLDs)

Lastly, as with DLDs, the Employer should be incredibly cautious of engaging in any activities during the Contractor’s execution of the works that may be construed as a direct request or order, which may be argued to have impacted on the facility’s performance.  While the Employer may choose to have close involvement during the project, the decisions made in designing and constructing the facility are up to the Contractor, and any direct instructions (not relating to H&S or environmental compliance issues) should be avoided wherever possible.

Delay liquidated damages – EPC contract watchits

In an EPC contract that Contractor has a lot of autonomy.  They get to define the details of the design, they manage the procurement, say how and when construction activities take place and they’re in charge of commissioning.  They need to deliver a completed product, in accordance with the specs outlined in the contract, to an acceptable quality and on time.

The Employer shouldn’t really have too strong a role in this scenario.  They have a couple of rights in the contract at their disposal to push or motivate the Contractor to ensure that they’re building the right thing and will have it finished on time.  These are largely big financial sticks.

Delay

If the Contractor runs overtime, the Employer has what are often called Delay Liquidated Damages (DLDs).  These damages are calculated ahead of time, based on the expected losses to be experienced by the Employer for every period of delay (most often calculated on a daily basis) and the method of determining the damages payable is included in the contract.

There are few things to consider when determining the rate of DLDs.

  • They need to be reflective of the actual losses to be experienced by the Employer, so should be based on expected revenue from electricity sales, costs to the Employer associated with construction delays, etc.  These should be linked to the project’s financial model.
  • They should be adequate to incentivise the Contractor to complete works on time
  • The higher the DLDs, the higher the level of risk to be carried by the Contractor, and this may impact the overall contract price.  This will naturally be discussed and agreed during contract negotiations.
  • There is likely to be a cap on the total DLDs payable, and this should be agreed upfront, and should be inline with industry standards and local regulations.

Something that the Employer should be particularly careful about once the Contractor has started works is making sure that they are extremely cautious about issuing any instructions to the Contractor that could be interpreted as having an impact on the project completion date.  This naturally excludes any instruction issued by the Employer as a result of having witnessed any non-compliance with Health and Safety and Environmental regulations, but putting their nose in how the Contractor goes about their work could be argued to have led to project delays.

Lastly, it may be in the Employer’s interest to forego DLDs, or to defer claiming DLDs.  This could be if the Contractor is short on cash, and needs all available cash to finish the project (especially if certain tasks need to be fast tracked).  The contract should allow for this without the Employer giving up any of their rights.