Power and energy construction projects are inherently risky. The industry faces unique and extraordinary challenges stemming from relatively slow growth in U.S. electricity consumption, changing end-user preferences as “green” power solutions grow in popularity, rapidly evolving technology, and complex regulatory schemes.
As with any other construction project, risk management and risk allocation amongst project participants is key to success. The project contract establishes the parties’ agreements and expectations regarding risk allocation.
The engineering, procurement, and construction (EPC) contract is the standard for power and energy construction projects. In its classic form, the EPC contract establishes aone-stop shop for the design and construction of the project. The EPC contractor is responsible for the engineering (design of entire power plant), procurement (purchase, installation, and performance of all equipment) and construction (construction of the plant) of the entire project.
Key provisions in an EPC contract used to manage and allocate project risks include:
- The EPC contractor’s standard of performance
- Pricing model
- Project time and schedule
- Mechanical, substantial, and final completion
- Delay and performance liquidated damages
- Limitation of liability
- Suspension, termination, and default
Project participants that strategically analyze the risks associated with these provisions, and negotiate and draft these provisions carefully, increase the likelihood of project success.
Ensuring ProjectCompletionAll these specific contract terms are critical to a successful project, but at the end of the day, an owner’s primary concern with any power and energy project is when they can start to generate power. The terms most critical to managing that concern are the project completion milestones—mechanical, substantial, and final completion.It is critical that these contract terms be drafted carefully to ensure that the owner can begin to operate as soon as possible and manage the parties’ expectations as to who carries the risks and responsibilities relating to the plant at different stages of construction.
It is imperative to keep in mind that the terms “mechanical completion” and “substantial completion” mean whatthe contract says they mean—and must be drafted extremely carefully.
The first step is mechanical completion which, in its most basic sense, means that the EPC contractor has installed all the equipment and it is operational. Some basic boilerplate requirements will go a long way. For example, to achieve mechanical completion the EPC contractor must perform the design, engineering, procurement permitting, construction, and installation of the equipment in accordance with the contract and manufacturer’s requirements and must complete the work necessary to cause the unit to operate safely. However, the devil is in the details, and it is important that all necessary mechanical and electrical needs of the specific project be contemplated and addressed in the contract as requirements for mechanical completion. No two projects are the same and thus no two mechanical completion contract provisions are the same.
The next step is substantial completion and integral to establishing this completion milestone is performance testing. The EPC contractor should be responsible for performingtesting to confirm that the equipment satisfies minimum performance guarantees as well as to establish emissions and regulatory compliance in order to achieve substantial completion.
Again, no two projects are the same and it is essential that all necessary performance testing needs of the specific project be determined and documented when these provisions are drafted. In addition, the substantial completion provision is the owner’s opportunity to set forth all the things that it will need from the EPC contractor before it is prepared to take over responsibility for operating the plant. This includes operations and maintenance (O&M) manuals, special tools, orientation and training, permits, licenses, and approvals. Finally, a requirement for substantial completion should always be that the owner and EPC contractor agree on a punch list for completion of the project.
Owner Liability Increases Following Completion
Substantial completion is the most important milestone because typically this is the stage that care, custody, and control of the project shifts from the EPC contractor to the owner. When this occurs the risk of loss for the equipment and project shifts from the EPC contractor to the owner and, typically, this is the stage at which the owner can begin commercial operations. Again, the contract language is key, and the parties should specifically address in their milestone completion provisions what is required of the EPC contractor before care, custody, and control shift to the owner and before the owner begins commercial operations.It is important that the owner draft the mechanical and substantial completion provisions so that the EPC contractor is required to deliver to the owner everything that the owner needs to take over the project prior to achieving these milestones. At this stage, the EPC contractor’s performance is largely complete, most of the compensation has been earned, and the owner assumes the risk of the project. Therefore, it is advisable to include anything of importance to the owner asa requirement for achieving these deadlines.
Often this means that achieving substantial completion will require the EPC contractor to complete more than just the tasks that are physically necessary for power generation. Therefore, the owner, who has an obvious interest in beginning power generation as soon as possible, has two very important competing interests. Both can be satisfied by including a provision in the EPC contract to allow for early commercial operations. Typically, such a provision would allow the owner to begin operating individual units or the entire facility once power can be safely generated. By incorporating such a clause into an EPC contract, an owner can protect itself and ensure that technical requirements of mechanical completion and/or substantial completion do not unnecessarily prevent generating power as soon as practicable.
Careful drafting of completion milestone provisions in an EPC contract is a necessary component of a successful project. It is critical to remember that every project is different, and your completion milestone details must be carefully drafted to match your project. However, these example provisions will help get you started down the right path.
Completion shall occur when: (a) the project is mechanically and electrically complete; (b) except for minor items of work that would not affect the safety and/or performance or operation of the project, all materials and equipment required to be installed pursuant to this agreement have been installed in accordance with the scope of work and manufacturer’s requirements; (c) all commissioning tests have been successfully completed; (d) all equipment and systems have been installed in a manner that does not (i) void any subcontractor or vendor warranties relating to such equipment or systems or (ii) violate any governmental approvals or applicable laws; (e) all equipment and facilities that are necessary for the full, safe, and continuously reliable operation of the project have been properly constructed, installed, insulated, and protected where required for such operation, and correctly adjusted, and the project as a whole can be used safely in accordance with the requirements of this agreement; (f) all systems necessary for power generation are ready to commence performance tests and operations; and (g) the initial punch list has been agreed upon by owner and contractor.
Substantial Completion shall be deemed to have occurred when all of the following have occurred: (a) EPC Contractor has achieved Mechanical Completion; (b) successful completion of all performance tests [required performance tests should be specifically delineated in a separate provision or exhibit]; (c) owner has received all reports and information to be provided to it by EPC Contractor [required reports and information may be specifically delineated in a separate provision or exhibit]; (d) owner has received all permits, licenses, and approvals required to be obtained by EPC contractor under this agreement; (e) all O&M manuals and special tools required to operate and maintain the facility have been acquired by EPC contractor and delivered to Owner; (f) EPC Contractor has provided an orientation and training program to Owner; (g) owner and contractor have agreed upon the final punch list; (h) owner has issued a Notice of Substantial Completion.
Care, Custody, and Control
Unless expressly assumed by owner at an earlier date, care, custody, control, and risk of loss of the project shall become the responsibility of owner upon the issuance of the Notice of Substantial Completion (so long as all requirements of Substantial Completion have in fact been satisfied) or the earlier termination of this agreement, provided that EPC contractor shall continue to perform work on punch list items, warranty claims, or any other workto achieve the performance guarantees.
Commercial Operations Prior to Substantial Completion
Notwithstanding any other provision of this contract, the owner shall have the right to cause commercial operations of one or more units to commence prior to substantial completion to the extent that the unit is capable of safely generating electric energy as follows:
The owner may commence commercial operations of one or more units or with respect to the facility prior to the date of substantial completion, unless the contractor reasonably objects to such operation for safety reasons. To the extent that substantial completion or final completion requires further performance tests after commercial operations have commenced, the owner shall cooperate, or shall cause the operator to cooperate, in the performance of such performance tests; provided, however, that performance tests to accomplish final completion or performance guarantees shall be subject to the owner’s commercial operations requirements. The contractor shall be entitled to an equitable adjustment, pursuant to a change order, (i) to the performance test results to account for degradation of the unit(s) from commercial operations of the unit(s) through substantial completion and (ii) for cost, schedule, or other relief, in each case, as may be appropriate under the circumstances.