fidic silver book in power projects

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Construction Issues: EPC Contracting and

FIDIC Silver Book Francis Ho An Update on Real Estate Laws in Senior Associate, King & Spalding LLP the UAE and Saudi Arabia Email: [email protected] Radisson Blu Media City Hotel, Tel: +971 2 652 3426 Dubai, UAE Mob: +971 50 557 0446 31 January – 1 February 2010

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EPC Contracts §  Engineering, procurement and construction contracts are most

common form of contract used in major international infrastructure projects

§  An EPC Contractor’s obligations typically include: §  “Turnkey responsibility” to deliver:

§  a complete facility §  for a guaranteed price §  by a guaranteed date §  which must perform to a specified level

§  Because EPC Contracts involve Contractor taking a high level of risk they are, to some extent, resisted by contractors (partially due to high insurance costs). That said, they are still the dominant model because sponsors and lenders prefer certainty they offer

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FIDIC Silver Book §  FIDIC – International Federation of Consulting

Engineers §  Standard Forms of Contract widely used in international

engineering and construction projects §  Range of contracts – White, Red, Yellow, Orange and

Silver Books §  Silver book – Turnkey contract which departs from usual

balance of risk allocation in FIDIC contracts

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Basic Contractual Structure of a Power Project

Lenders

Government Equity Support

Agreement

EPC Contract

EPC Contractor

Project Co

O&M Contractor (often a Sponsor)

Concession Agreement

Fuel Supply Agreement

Fuel Supplier

Direct Agreement

Financing and Security Agreements

PPA

Offtaker

Longterm O&M Contract

Sponsors

Note: Contractors often become one of sponsors in large projects now although ordinarily sell down their interest after financial close as they wish to free up their capital for other projects

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Bankability §  EPC contracts must have risk allocation that satisfies Lenders §  Lenders focus on ability (or more particularly the lack of) Contractor to

claim: §  Additional costs; and/or §  Extensions of time

§  Lenders also look to Contractor’s security (e.g. parent company guarantees/bank guarantees securing Contractor’s performance)

§  The less comfortable Lenders are with the above, the more equity the Sponsors will be required to contribute

§  Lenders will also need to be satisfied with technical risk §  Price is a general “bankability” issue also (but a broader project issue) §  Engineering, procurement and construction contracts are most common

form of contract used

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General Bankability Issues in Construction Contracts

§  Fixed completion date (Silver Book Art. 8.2) §  Fixed completion price (Silver Book Arts. 4.11 and 14.1) §  No or limited technology risk (Silver Book Arts. 5.8, 7.5, 9.1 and 11

etc) §  Output guarantees (Silver Book – no performance LDs, rather

obligations to remedy defects and/or reduction in contract price) §  Liquidated damages for both delay and performance §  Security from Contractor and/or its parent (Silver Book Art. 4.2) §  Large caps on liability – ideally none but often one is negotiated

(Silver Book Art. 17.6) §  Restrictions on ability of Contractor to claim extensions of time and

additional costs (Silver Book Arts. 13.1 and 13.4) §  An EPC Contract (and Silver Book with amendments) generally

delivers above

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Key Clauses in EPC Contracts and Common Approaches (1)

§  Single point of responsibility – Contractor is responsible for all design, engineering, procurement, construction, commissioning and testing activities. If EPC Contractor is a joint venture, liability/responsibility is joint and several (Silver Book Arts. 4.1 & 5 – “fit for purpose”)

§  Fixed Contract Price – limited opportunities for Contractor to claim extra costs/time. Generally limited to directed variations to works (Silver Book Arts. 13.1, 14.1 and 20)

§  Fixed completion date – guaranteed date for completion. Failure to meet this date will attract LDs. In order for these to be enforceable they must be a genuine pre-estimate of the loss that the project company will suffer if the power station is not completed on time (Silver Book Arts. 8.2, 13 and 20)

§  Note: Additionally extension of time clause must provide for an EOT to be granted where Contractor is delayed due to act/omissions of owner/project company (Silver Book Art. 8.4(c))

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§  Performance Guarantees: Project Co’s revenue will come from revenue from project. This is important to service project debt. It is vital then that facility performs in respect of output, efficiency and reliability. This is purpose of the Performance Liquidated Damages payable by the Contractor if performance requirements are not met. (Silver Book does not provide for performance liquidated damages – see e.g. Art. 9.4. Can be amended as required.)

§  Performance Liquidated Damages must also be genuine pre-estimate of loss. They are usually calculated on net present value (less expenses) calculation of revenue foregone over the project

§  E.g. in case of a power station what this might mean is if plant output is 5 MW less than required performance liquidated damages will be designed to compensate project company for that loss of revenue for life of project by being unable to sell that 5 MW

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§  Caps on liability: most EPC Contractors will baulk at unlimited liability. Market is generally a cap at 100% of the Contract Price. Sub-caps of 20% of Contract Price on delay and performance liquidated damages also common (Silver Book – LOL is dealt with in Special Conditions – see Art. 17.6)

§  Consequential damages are also generally excluded. Profit also often expressly excluded (Silver Book Art. 17.6)

§  There may be some exceptions to those caps (e.g. wilful misconduct, breach of patent rights)

§  Security – EPC Contract will require that performance security be supplied by the Contractor in respect of its obligations under EPC Contract (Silver Book Art. 4.2)

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§  Market security includes: §  Bank guarantee for between 5-15% of Contract Price §  Retention (withholding of 5-15%) of each payment under EPC

contract (Silver Book Arts. 4.2 and 14.3(c) and Annex F) §  Advance Payment Guarantee – if an advance payment is made

(Silver Book Art. 4.2 and Annex E) §  Parent Company Guarantee – to secure Contractor’s

performance if it does not perform (Silver Book Art. 4.2 and Annex A)

Variations §  Project Co must have right to order variations/agree to suggested

variations – clause must contemplate omission of work as well as pricing (Silver Book Arts. 3.5 and 13)

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Defects Liability §  Contractors required to repair defects 12-24 months following

completion of performance testing – can be one period or tiered (Silver Book Art. 11)

Intellectual Property §  Contractor must warrant it has the rights regarding any proposed

LP. Also note there is often an indemnity for breach (Silver Book Art. 17.5)

Force Majeure §  Parties excused from performance for certain Force Majeure events

(Silver Book Art. 19) Suspension §  Project Co has this right (Silver Book Arts. 8.8 to 8.12)

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Termination §  Contractor has very limited rights e.g. non-payment/

extended suspension, material breach by employer (Silver Book Art. 16.2)

§  Project company has much broader rights. This will be tied with third party agreements. Can terminate: §  For convenience (Silver Book Art. 15.5) §  For breach/insolvency, otherwise (Silver Book Art.

15.2)

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Power-specific Clauses in EPC Contracts

§  General interface issues: §  Commencement and completion dates §  LDs amounts and trigger points (NB: Silver Book does not

provide for performance liquidated damages and will need adaptation)

§  Caps on liability §  Indemnities §  Entitlements to extensions of time §  Force Majeure (Silver Book fairly wide, “beyond a Party’s

Control” and could “not reasonably have been provided against before entering into the Contract”)

§  Third party interfaces §  Intellectual Property

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Key Power Issues §  Grid Access §  EPC Contract must provide that Project Company provides Grid Access –

this has 2 levels: §  (a) obligation to ensure that the infrastructure is in place; and §  (b) obligation to ensure that Contractor is permitted to export power

§  Interfacing of commissioning and testing regimes (fuel for testing?) §  Consistency between testing/offtake/PPA regime? – important that they

relate §  Interfacing of issues between the Offtaker and EPC Contractor §  Project company must control relationship with Offtaker (on-going

relationship) §  Silver Book will require substantial modification – issues such as

connection, metering, point of delivery and third party interfaces to be dealt with

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Key Performance Issues in Power Projects (1)

§  Liquidated Damages is main relevant provision governing performance §  Output LDs (how many mega watts produced) §  Heat rate (how much fuel burnt to produce required power

output) §  Delay liquidated damages Testing performance – most common approaches §  Functional Tests – pumps/conveyers/pressure vessels. Test

functionality of parts at station but not whole station. Important as condition LDs will attach

§  Emissions Tests – compliance against environmental requirements. Absolute obligation – generally not linked to LDs

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§  Silver Book will require substantial modification to provide for performance liquidated damages and testing in power projects: §  Employer’s remedy for defective plant accepted into service is

a reduction in the Contract Price; and §  Testing and commissioning provisions are generally defined

and require further definition – can use technical schedules §  Guarantee Tests – these are the ability of power station to meet

the performance criteria set out in Contract §  Generally these are set at “maximum” level of required

performance. Lender’s input will be important in determining this level. Lender’s interest though will be that debt service obligations are met – Sponsor’s interest will be to get optimal performances

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§  “Hand-over” ought to occur after all performance tests are satisfied. This retains Sponsor’s potential rights to both performance and delay damages

§  Contractor’s will often request a right to modify station in event performance guarantees are not met (EPC Contract must allocate costs for this eventuality)

§  Silver Book provisions will need modification to be made applicable to project specific requirements (See Art. 9 of Silver Book)

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Technical Issues §  Testing procedures ought to be set out in EPC Contract including:

§  Testing Methodology (i.e. American Society of Mechanical Engineers)

§  Testing Equipment – (who must provide it, where will it be, how sensitive)

§  Tolerances – what is margin of error? §  Ambient Conditions – what atmospheric conditions are

assumed to be base case (testing results will need to be adjusted to take into account any variance from these conditions)

§  If a multi-unit station individual unit tests and then whole of plant testing

§  Provision of fuel and consumables

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To EPC or not to EPC?

Advantages 1.  Bankable 2.  Certainty (as far as that is possible) 3.  “Turnkey” responsibility on the

EPC Contractor

Disadvantages 1.  Higher Contract price than

alternative structure due to risk allocation (and built-in Contractor contingencies)

2.  Limited scope for Project Sponsor to intervene if problems arise during construction

3.  Not many players

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To Silver Book or not to Silver Book? §  Silver Book very general and requires modification for

complex process driven projects §  No provision for lender or concession grantor step-in in

project-financed (including PPP and BOT) deals §  Dispute resolution provisions require consideration –

currently dispute adjudication board appointed (can be expensive)

§  Performance liquidated damages against Contract Price reduction – lenders’ requirements and debt servicing

§  Substantial modification required for project-financed deals