In this case study, we will see how an early completion bonus can be a win-win opportunity for all the stakeholders of a project. Rather than spending time on pure price negotiations or worst-case legal subjects, the parties should collaborate to find win-win solutions and optimize the overall project value.
Context
The context of this case study is a multicultural negotiation for a privately developed concession to build and operate a hydro-power plant during 30 years. The power plant included multiple turbine-generator units.
The main project stakeholders were the following:
- The local Utility, the off-taker of the entire electricity production
- The Project Owner, the private developer
- The EPC Contractor
- The EM Contractor, supplier of the turbine-generator units as a subcontractor to the EPC Contractor
At the start of the negotiations, the Owner wanted to have a single taking-over of the entire power plant. This was probably because the single taking-over date would be the starting point of the 30 years’ concession period and of the loan repayment.
Initial exchange of arguments:
The EM Contractor explained that, due to the nature of the project, there would be value in allowing a sectional take-over (i.e. a taking-over per unit). In fact, the hydro-power project was of the run-of-the-river type, with a regular flow of water that would remain unused for energy production until the last unit would be commissioned and the overall power plant taken-over.
Acknowledging the advantage, the Owner wanted the EM Contractor to operate the units during several months without taking-over.
The usual business practice is that the units should not be used for commercial operation before the taking-over. Use before taking-over (except for commissioning and trial run) triggers deemed acceptance in standard contracts. Also, the insurances are different for the construction phase (CAR insurance) and operation phase (equipment breakdown insurance).
A win-win solution was found with an early completion bonus
The parties agreed to a mechanism of a single, final taking-over of the units which would be the reference date for the concession period. However, any unit that could be commissioned before this final taking-over would be transferred to (including a transfer of risk and insurance obligation) and operated by the Owner. An early completion bonus for each unit, digressive for the number of units put into service, was contractually foreseen from the start to motivate the Contractors all along the construction phase to find fast-track solutions.
The advantages for each of the stakeholders were as follows:
- The Utility benefited from early generation, avoiding further outages that were regularly occurring in the country and replacing very costly emergency diesel generated electricity by the lower tariff hydro generated electricity.
- The Project Owner benefited from their part of the bonus payments from the Utility (linked to the early operation). The early start-up of the electricity production improved the operators’ learning process leading to lower outages, higher availability and probably less warranty issues after the overall take-over of the power plant.
- The EPC Contractor and the EM subcontractor benefited from potential early completion bonus.
Contract training / Negotiation training
Actual impact of an early completion bonus
In spite of facing lots of challenges during the execution of the project (with considerable margin slippages), the Contractors managed to put into service certain turbine-generator units before the guaranteed taking-over date. The early generation was very welcome for the country and the Utility. The early completion bonus represented a relief for the extra construction costs that the Contractors incurred (also linked to acceleration measures). This outcome created a positive transition for the Owner from the construction to the operation phase.
Writing and agreeing on the complex early completion bonus mechanism consumed quite some time of the negotiation teams. But bringing the discussions to a win-win subject created a positive atmosphere during the contract negotiations based on trust, respect, transparency and pro-activity. This atmosphere was also beneficial to resolve other subjects that were not themselves win-win situations.
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2 Comments
Tansel Yılmaz · 25 August 2019 at 9 h 59 min
In many cases, the owner does not want to wait to take over the plant (in the sense of having control) only after the plant is tested, commissioned, performance-tested and ready for start-up. Often the owner will in fact be an experienced operator of the plant. It will therefore want its own people operating the plant as soon as it is able. In the energy sector, it will want to start selling electricity as soon as it is being generated following commissioning, but often prior to performance testing.
At this point the plant will simply be at the stage of testing and commissioning. The project will not yet have reached final completion and passed its performance tests.
How does the FIDIC Silver Book address the issue? The short answer is that it does not. The Silver Book simply moves through the stages whereby the plant is first engineered or designed (clause 5, Design), to how it is to be constructed (clause 7, Plant, Materials and Workmanship, and clause 8, Commencement, Delays and Suspension), then on to what would normally be mechanical completion (clause 9, Tests on Completion). It then deals with the process of handover to the owner (clause 10, Employer’s Taking Over). Following this, the FIDIC Silver Book provides an option for further testing (clause 12, Tests after Completion).
The FIDIC Silver Book does not deal explicitly with the issue commonly encountered on many large projects: the need for provisions to reflect the pre-completion control required by the owner. The testing and commissioning of plant is always a risky enterprise: vessels and pipework are pressurised and ‘hot’ testing may be implemented. This is an important issue, because control brings with it responsibility and risk. This has contractual implications (eg possible triggering of warranty or defects liability provisions), as well as impacting on insurance coverage (signalling, potentially, the end of the contractor’s All Risk cover and the commencement of the Operational or Business Interruption cover). This is another area where it is suggested that owners do not get what they want (absent amended provisions to deal with the issue).
Clause 17 (Risk and Responsibility) and clause 18(Insurance) will also need careful review and likely revision in this regard. It is worth mentioning that clause 30 of MF/1(Use before taking-over)1 recognises the possibility of early owner use of the works for commercial operation. This applies where, due to default of the contractor, issue of a taking-over certificate has been delayed by over one month but is subject to the works being ‘reasonably capable of being used.’
In practice, the FIDIC Silver Book terms will often be subject to amendment to allow the owner’s team to have control and commercial operation (but not responsibility), by providing expressly for such an apparent dichotomy. There will also be a need to provide some protection for the contractor. Balancing of interests can be achieved by allowing for the contractor to disclaim liability where the owner’s team fail to act in accordance with the contractor’s reasonable instructions.
1 Institution of Mechanical Engineers/Institution of Engineering and Technology, Model form of General Conditions of Contract (MF/1), 2000 Edition (Revision 4); obtainable via http://www.theiet.org/publishing/.
EPC Contract, win-win negotiation, LNTP on private investment project - AfiTaC.com · 7 December 2018 at 16 h 52 min
[…] a previous case study, we analysed the positive impact on the atmosphere brought by negotiating a win-win subject like “completing the construction phase early”. Many times, private investment projects take more time than expected to reach financial closure. […]