Australia: Epc Contracts For Wind Energy Projects - South African Re Ipp Programme - Lessons Learned From Phases 1 And 2 (October 2012) Part 4

SPLIT EPC CONTRACTS

One common variation on the basic EPC structure illustrated above is a split EPC Contract. Under a split EPC Contract, the EPC Contract is, as the name implies, split into two or more separate contracts.

The basic split structure involves splitting the EPC Contract into an Onshore Construction Contract and an Offshore Supply Contract.

There are two main reasons for using a split contract. The first is that it can result in a lower contract price since it allows the contractor to make savings in relation to onshore taxes - in particular, on indirect and corporate taxes in the onshore jurisdiction. The second is that it may reduce the cost of complying with local licensing regulations by having more of the works, particularly the design works, undertaken offshore. In addition, in some countries which impose restrictions on who can carry out certain activities like engineering and design services, splitting the EPC Contract can also be advantageous because it can make it easier to repatriate profits.

However, a split EPC contractual structure can arise in another context in renewable energy projects. For example, in the case of wind farms, the manufacturers of the wind turbines have successfully avoided taking the turnkey responsibility by entering into a supply contract and a balance of plant contract (i.e., the foundation works, civils and erection etc.) instead of an EPC Contract.

There are risks to the project company in this structure. This mainly arises because of the derogation from the principle of single point of responsibility.

Unlike a standard EPC Contract, the project company cannot look only to a single contractor to satisfy all the contractual obligations (in particular, design, construction and performance). Under a split structure, there are at least two entities with those obligations. Therefore, a third agreement, a coordination and interface agreement or wrap-around guarantee, is often used to deliver a single point of responsibility despite the split.

Under a wrap-around guarantee, an entity, usually either the offshore supplier or the parent company of the contracting entities, guarantees the obligations of both contractors. This delivers a single point of responsibility to the project company and the lenders. Where the manufacturer of the turbines, panels etc and the balance of plant contractor are separate entities, in many circumstances neither company will be prepared take the single point of responsibility for the performance of the obligations of both contractors under the wrap-around guarantee. Accordingly, the lenders will want to be satisfied that the interface issues are dealt with in the absence of a single point of responsibility.

To provide assurance to lenders that the risk of interface and coordination issues arising between the two contracts will be minimised, the contractors and the project company should enter into a coordination and interface agreement. In addition to setting out the general coordination and interface arrangements relating to the performance of the works, to minimise interface risk the lenders will generally seek to ensure that the contractors are jointly and severally liable in respect of the performance of the 'coordination obligations' relating to the project, which may include activities such as the coordination of programmes, site access, document provision, work handover and defect rectification.

KEY RENEWABLE ENERGY SPECIFIC CLAUSES IN EPC CONTRACTS

General interface issues

As noted in the earlier section above, an EPC Contract is one of a suite of agreements necessary to develop a renewable energy Facility. Therefore, it is vital that the EPC Contract properly interfaces with those other agreements. In particular, care should be taken to ensure the following issues interface properly:

• commencement and completion dates;
• liquidated damages amounts and trigger points;
• caps on liability;
• indemnities;
• entitlements to extensions of time;
• insurance;
• force majeure; and
• intellectual property.

Interfacing of Commissioning and Testing Regimes

It is also important to ensure the commissioning and testing regimes in the EPC Contract mirror the requirements for commercial operation under the PPA. Mismatches only result in delays, lost revenue and liability for damages under the PPA or concession agreement, all of which have the potential to cause disputes.

Testing/trialling requirements under both contracts must provide the necessary project company satisfaction under the EPC Contract and system operator/offtaker satisfaction under the PPA or Connection Agreement. Relevant testing issues which must be considered include:

• Are differing tests/trialling required under the EPC Contract and the PPA and/or the Connection Agreement? If so, are the differences manageable for the project company or likely to cause significant disruption?
• Is there consistency between obtaining handover from the Contractor under the EPC Contract and commercial operation? It is imperative to prescribe back to back testing under the relevant PPA and the EPC Contract which will result in a smoother progress of the testing and commissioning and better facilitate all necessary supervision and certification. It must not be forgotten that various certifications will be required at the lender level. The last thing the lenders will want is the process to be held up by their own requirements for certification. To avoid delays and disruption it is important that the lenders' technical adviser is acquainted with the details of the project and, in particular, any potential difficulties with the testing regime. Therefore, any potential problems can be identified early and resolved without impacting on the commercial operation of the Facility.
• Is the basis of the testing to be undertaken mirrored under both the EPC Contract and the PPA? For example, in the context of wind, what basis are various noise tests to be undertaken?
• What measurement methodology is being used? Are there references to international standards or guidelines to a particular edition or version?
• Are all tests necessary for the contractor to complete under the EPC Contract able to be performed as a matter of practice?

Significantly, if the relevant specifications are linked to guidelines such as the relevant IEC standard, consideration must be given to changes which may occur in these guidelines. The EPC Contract reflects a snapshot of the standards existing at a time when that contract was signed. It may be a number of years post that date in which the actual construction of the project is undertaken thus allowing for possible mismatches should the relevant standards guidelines have changed. It is important that there is certainty as to which standard applies for both the PPA and the EPC Contract. Is it the standard at the time of entering the EPC Contract or is it the standard which applies at the time of testing?

Consideration must therefore be given to the appropriate mechanism to deal with potential mismatches between the ongoing obligation of complying with laws, and the contractor's obligation to build to a specification agreed at a previous time. Consideration must be given to requiring the satisfaction of guidelines "as amended from time to time". The breadth of any change of law provision will be at the forefront of any review.

The above issues raise the importance of the testing schedules to the EPC Contract and the PPA. The size and importance of the various projects to be undertaken must mean that the days where schedules are attached at the last minute without being subject to review are gone.

Discrepancies between the relevant testing and commissioning requirements will only serve to delay and distract all parties from the successful completion of testing and reliability trials.

These are all areas where lawyers can add value to the successful completion of projects by being alert to and dealing with such issues at the contract formation stage.

We have included a sample testing schedule in Appendix 2, which relates to wind projects under the RE IPP Programme. Although the testing regime for a particular project will be dependent on a range of factors, such as the specific technology used, and will be heavily scrutinised by the lenders' technical advisers, the sample testing schedule illustrates the key matters and considerations outlined above.

Interface issues - split contract structure

In some circumstances, a split contract structure may be used to achieve a lower overall contract price than would be achieved under an EPC Contract. For example, a structure with a BOP Contract and an Equipment Supply Contract may be used. However, if a split structure is used, it is critical that a single point of responsibility is provided. If not, the project company will be left with interface risk which will impact on bankability.

Matters that are critical to providing a single point of responsibility are:

• providing that no claim is available by the contractor against the project company arising out of an act or omission of any other contractor; and
• preventing split contractors from having the ability to make a claim on the project company due to the default of one of the other contracting entities (e.g. equipment supply contractor claiming against the project company for a default caused by the balance of plant contractor).

If a split contract structure is used, we recommend that the following clauses be inserted to provide this mechanism:

Interface issues - contractor and operator are the same or related entities

Similarly, as is the case in many projects under the RE IPP Programme, where the contractor and the operator under the O&M Contract are the same or related entities ultimately controlled by the same parent company, rather than a true 'arms-length' relationship, the EPC Contract should include a mechanism that prevents the contractor and operator from (i) relying on the delay or underperformance of the other to obtain relief from the project company under their respective contracts and (ii) seeking to rely on the actions of the other as a defence to a claim by the project company for delay or nonperformance. If not, this may impact on bankability.

These provisions can be included in the EPC Contract itself (in which case back to back clauses should be included in the O&M Contract) or otherwise in a separate coordination and interface agreement that sets out the coordination and interface obligations of the parties in relation to the project.

In some cases, the contractor and the operator may seek to argue that interface issues are minimal because, although controlled by the same parent company, different entities have been formed (including for the purpose of fulfilling local ownership and participation requirements) to perform the works and services under the two contracts.

The key issue for project companies and lenders is whether the parties are controlled by the same parent company. This is because, while it may ultimately be unlikely, lenders may be concerned about the risk that entities within the same corporate group may seek to manipulate their obligations under the contract.

For example, consider the situation where the contractor and the operator for a project are related entities. The contractor has been delayed in achieving commercial operation under the EPC Contract and delay liquidated damages are accruing. The parent company of the contractor and the operator may determine that the net loss to the parent company in respect of the project will be minimised if the delay is instead shifted to be the responsibility of the operator under the O&M Contract, for example, by the operator failing to provide staff to be trained by the contractor in respect of the operation of the Facility. The monetary amount of the liability of the operator for failing to provide staff for training purposes will in most cases be substantially lower than the rate of delay liquidated damages being levied on the contractor, due to the lower value of and lower caps on liability etc. provided under the O&M Contract.

To avoid this potential manipulation and shifting of risks under the EPC and O&M Contracts, we recommend including the horizontal defences and no relief clauses set out above.

Interface issues between the Offtaker and the EPC contractor

At a fundamental level, it is imperative that the appropriate party corresponds with the relevant offtaker/ system operator during construction on issues such as the provision of transmission or distribution facilities and the relevant testing requirements and timing.

The project company must ensure the EPC Contract states clearly that it is the appropriate party to correspond with the offtaker and the system operator. Any uncertainty in the EPC Contract may unfortunately see the EPC contractor dealing with the offtaker and/or the system operator thus possibly risking the relationship of the project company with its customer. Significantly, it is the project company which must develop and nurture an ongoing and long term relationship with the offtaker. On the other hand, it is the contractor's prime objective to complete the project on time or earlier at a cost which provides it with significant profit. The clash of these conflicting objectives in many cases does not allow for such a smooth process. Again, the resolution of these issues at the EPC Contract formation stage is imperative.

Interface issues on site access

Access to land for the siting of a Facility involves negotiations with the landowner or the appropriate land authority. More often than not, the co-existence of components of the Facility such as wind turbines with rural holdings will result in the project company entering into access agreements with the landowners. The more common arrangements will be land leases providing possession and site access for the duration of the construction and operation of the Facility. While the leasing of land to renewable energy companies provides long term income that complements farming income, the substance of the land lease agreements with landowners is the subject of much discussion and negotiation, principally to ensure that the environmental and development impact of the Facility is considered and managed properly. Securing land rights for good development sites may be difficult if there is community opposition to these developments. Principal responsibility for obtaining access to the site and negotiating the terms of the lease agreements will lie with the project company. However, in order for the project company to comply with the terms of the land lease or other access agreements, the project company will have to ensure that the contractor under the EPC Contract complies with all the terms and conditions of the land lease agreements. The contractor must also accept some degree of responsibility for the ongoing liaison and coordination with landowners during the construction and operation of the Facility. Given that considerations and concerns will often differ between landowners, the specific requirements of the landowners should be taken into account at an early stage in the negotiation of the terms of the EPC Contract. Such concerns will vary from prohibitions on the depth of excavation to allow farming activity, to access agreements for grazing and stock transportation.

The project company should only be required to provide possession and access as permitted under the negotiated land lease or site agreements, and the obligations of the project company under the land lease or site agreements should be flowed down into the EPC Contract. The contractor should be appraised of the specific conditions and requirements of the landowners to ensure that the contractor is aware of the limits on access to the site on which the Facility is to be constructed and operated. The contractor must formally acknowledge the project company's obligation to comply with the terms of the land lease or site agreements and must accept responsibility for compliance with the terms of the land lease or site agreements which are affected by the contractor's design and construction obligations under the EPC Contract.

Grid Access

EPC Contracts will generally only provide for the handover of the Facility to the project company and the effectiveness of the PPA once all commissioning and reliability trialling has been successfully completed. This raises the important issue of the contractor's Grid Access and the need for the EPC Contract to clearly define the obligations of the project company in providing Grid Access.

Lenders need to be able to avoid the situation where the project company's obligation to ensure Grid Access is uncertain. This will result in protracted disputes with the contractor concerning the contractor's ability to place load onto the grid system and to obtain extensions of time in situations where delay has been caused as a result of the failure or otherwise of the project company to provide grid access.

Grid Access issues arise at two differing levels, namely:

1. the obligation to ensure that the infrastructure is in place; and
2. the obligation to ensure that the contractor is permitted to export power.

With respect to the obligation to ensure that the infrastructure is in place, the project company is the most appropriate party to bear this risk vis-à-vis the contractor, since the project company usually either builds the infrastructure. Issues that must be considered include:

1. what are the facilities that are to be constructed and how will these facilities interface with the contractor's works? Is the construction of these facilities covered by the PPA, connection agreement, concession agreement or any other construction agreement? If so, are the rights and obligations of the project company dealt with in a consistent manner?
2. what is the timing for completion of the infrastructure – will it fit in with the timing under the EPC Contract?

With respect to the contractor's ability to export power, the EPC Contract must adequately deal with this risk and satisfactorily answer the following questions to ensure the smooth testing, commissioning and entering of commercial operation:

1. what is the extent of the Grid Access obligation? Is it merely an obligation to ensure that the infrastructure necessary for the export of power is in place or does it involve a guarantee that the Grid will take all power which the contractor wishes to produce?
2. what is the timing for the commencement of this obligation? Does the obligation cease at the relevant target date of completion? If not, does its nature change after the date has passed?
3. what is the obligation of the project company to provide grid access in cases where the Contractor's commissioning/plant is unreliable – is it merely a reasonableness obligation?
4. is the relevant Grid robust enough to allow for full testing by the contractor - for example, the performance of full load rejection testing?
5. what is the impact of relevant national grid codes or legislation and their interaction with both the EPC Contract and the PPA?

Many EPC Contracts are silent on these matters or raise far more questions than they actually answer. Given that the project company's failure will stem from restrictions imposed on it under either or both the PPA or the concession agreement, the best answer is to back to back the project company's obligations under the EPC Contract (usually to provide an extension of time and / or costs) with the PPA. This approach will not eliminate the risk associated with Grid Access issues but will make it more manageable.

A variety of projects we have worked have incurred significant amounts of time and costs in determining the Grid Access obligations under the EPC Contract. This suggests that it is a matter which must be resolved at the contract formation stage. Therefore, we recommend inserting the clauses in Part III of Appendix 1 ¹⁶ .

Serial defects

A 'serial defect' occurs where there is a repeated failure of the same component or repeated failure from the same root cause in a predetermined percentage of commissioned equipment. The concept of serial defects is particularly relevant to EPC Contracts where a large number of units the same piece of equipment are to be supplied (such as wind turbine generators).

For example, in relation to wind Facilities, a serial defect can be defined as substantially the same defect having the same root cause has been identified as a percentage of a consignment (i.e. a consignment of wind turbine generators of substantially the same size otherwise delivered, or ready to be shipped, to the Site) of the wind turbine generators delivered, or ready to be shipped, to the site for incorporation into the Facility.

We suggest including a clause that provides that if a serial defect is identified in a consignment of wind turbine generators (notwithstanding that no such defect may have been identified in any particular wind turbine generator), any other wind turbine generators or consignment from the same factory production lot as the consignment of wind turbine generators in which the serial defect is identified will be deemed to have the serial defect. If a serial defect is identified, the project company should also have the right to direct the contractor to replace a particular wind turbine generators and/or consignment of wind turbine generators.

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