Construction Contracts: Who Bears the Risk of Cost Overruns?

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Julian Bailey and Ralph Goodchild | White & Case

Construction contracts may be priced in a number of ways. For most contracts, even those which are “fixed price”, there is usually scope for cost/price variability. Four cases from December 2020 highlight some of the difficulties that can arise when parties agree that payment should be based on cost.

Case 1: Never Pay Retail

Alebrahim v BM Design London Ltd [2020] EWHC 3393 (TCC) concerned a contract for refurbishment of a residential property.  

  • The employer sued the designer/contractor for alleged overpayments under the contract, arguing (among other things) that under the terms of the agreement she should not have to pay the designer/contractor more than the cost to the contractor (trade price) per item plus a fixed profit margin. The works under the contract were expressed to be priced on an “estimate of cost” basis.
  • The designer/contractor argued that the basis of remuneration should be the retail price of each item, and that this reflected normal industry practice.  

The court held that on the proper interpretation of the contract the employer should pay only the trade price of each item plus profit, in particular construing the contractor’s obligation to “procure” as indicative that remuneration should be based on the trade price. 

Case 2: Blowing the Budget

In Optimus Build Ltd v Southall [2020] EWHC 3389 (TCC), a contractor claimed damages for repudiatory breach of contract by the employer, on the basis that the employer had wrongfully terminated the contract during a dispute over the contract payment mechanism. 

  • The court held that the employer’s acceptance of the contractor’s “budget estimate” for the works gave rise to a lump sum pricing structure, and that the employer had been wrong to contend that the agreement was for a “cost plus” approach. The case was slightly unusual, as the court noted, in that employers rarely seek “cost plus” contracts due to the cost uncertainty inherent in them.
  • It was relevant that the budget estimate had been given in response to a request from the employer for a lump sum quotation, and that it was transmitted by an email referring to “price”. 
  • Even though the budget estimate was not offering a price “fixed in every respect”, this was mainly because it referred to some items being potentially supplied by the employer, and suggested that there could be savings. There was no reference to wording such as ‘estimated costs’, or to any mark-up for overhead and profit. The court found these features to be consistent with a lump sum offer.

Case 3: Paid for One’s Own Breach?

ABC Electrification Ltd v Network Rail Infrastructure Ltd [2020] EWCA Civ 1645 involved a contract for the performance of power upgrade works for the West Coast Main Line railway in England. There was no dispute that payment under the contract was to be based on cost.

  • The contract in question was based on the Target Cost Version of the ICE Conditions of Contract. In this amended standard form, the contractor was not entitled to recover “Disallowed Cost” which included “any cost due to negligence or default”.   
  • The contractor sought a declaration that the use of the word “default” meant that it should be paid costs caused by its own breaches of contract; provided that there was no “blame or culpability” associated with such breaches.

The English Court of Appeal dismissed the application on the ground that the natural meaning of “default” is simply a breach of a contractual obligation. It was irrelevant that “default” had been added into the contract by amendment of the standard form.

Case 4: Reimbursement during Contractor Delay?

Santos Limited v Fluor Australia Pty Ltd & Anor (No 1) [2020] QSC 372 concerned an EPC contract for upstream facilities as part of an LNG project in Queensland, Australia.

  • The EPC contract allowed the contractor to recover its costs of performing the works on a reimbursable basis, subject to costs needing to be “properly” and “reasonably” incurred. The contractor had been reimbursed “on account” as the works were performed.
  • The employer subsequently sought to counterclaim from the contractor sums totalling around AUD$475m, which were invoiced and paid during the period between (a) the contractual completion date; and (b) the date when the contractor actually completed the works, in part because the contractor was in breach of its obligation to complete on time.

The Supreme Court of Queensland held that merely because costs had been incurred in a delayed period, it could not be said that they were outside the category of costs which the contractor was entitled to recover. Importantly, the contract included a clause making clear that the contractor was not precluded from recovering costs in the period after the contractual completion date.

Commercial Implications

The four cases above illustrate the general principle that parties are free to agree whatever payment terms they choose in their contracts. Courts will interpret payment provisions based on their plain words, even where the result may appear unusual or even uncommercial. Moreover, the cases highlight the following matters of importance to parties entering into construction and engineering contracts:

  • “Cost means cost”: unless specifically defined, the word “cost” will usually refer to the cost to the contractor of performing works or procuring goods (Alebrahim). The cost of an item may be different (i.e. less than) its retail price. Similarly, payment on the basis of “cost” is different from payment of a “reasonable remuneration” (or quantum meruit), which usually refers to the market value of goods and services provided;  
  • Budget estimates can give rise to a lump sum price: in less formal situations where contracts are not contained in a signed, agreed document, a “budget estimate” may amount to a “fixed price” if the parties’ dealings indicate an agreement to this effect (Optimus). That may be a relatively rare situation, though, because most commonly an “estimate” denotes a provisional yet uncertain figure, where the final out-turn is usually based on actual cost;
  • The importance of “disallowed cost”: where target cost or “cost plus”/cost reimbursable contracts are used, it is highly desirable for the contract to specify which types of cost may not be claimed by the contractor (as was the case in ABC Electrification). The usual expectation of an employer is that the “cost” it will pay for is something which has translated into “value” for the project. By providing that costs incurred due to the contractor’s default or other breach of contract are irrecoverable, this ensures that the employer is not required to reimburse the contractor for its own inefficiencies or mistakes. Drafting to this effect may be found, for example, in NEC4 Option E clause 11.2(26) (definition of “Disallowed Cost”); and
  • Cost of the works vs prolongation costs: the fact that a contractor claims costs during a period of culpable delay does not mean that the costs are necessarily “unreasonable”, or should be treated as “Disallowed Cost” (if such a definition is used). A distinction is usually made between (a) those costs that would always need to be incurred by the contractor in performing the works (which are reimbursable); and (b) costs arising purely due to culpable contractor delay (which are not). The distinction is not necessary where the contractor’s delay is excusable, and the contract generally contemplates the contractor being reimbursed for all work properly performed.

Expert Determination Clauses: A Tailored Alternative for Construction Projects?

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James Ebert and Steven Fleming | Jones Day

In Short

The Situation: Construction disputes face unique challenges in addition to those faced in other types of commercial disputes. Parties often agree to adopt independent expert determination as a means of managing these challenges. 

The Concern: Many boiler-plate independent expert determination clauses are not sufficiently tailored to the nature of construction projects or the particular circumstances of the project.

Looking Ahead: Independent expert determination can be a useful tool for the management of disputes in construction projects. In order to obtain this benefit, expert determination clauses should be carefully drafted to ensure that the prescribed process reflects the intention of the parties and is tailored to the circumstances of the particular project.

Construction disputes face additional challenges compared to other commercial disputes for various reasons, including:

  • projects involve a multitude of participants and stakeholders, including principals, contractors and subcontractors with a range of different interfaces and interests; 
  • the disputes concern complex technical matters in addition to legal issues;
  • huge volumes of documentation from many sources are generated during projects, including technical documents, correspondence and emails; and
  • participants are required to balance the legal and commercial aspects of claims and timely resolution of disputes with good project execution and the maintenance of ongoing relationships. 

To overcome these challenges in major projects, parties often agree to adopt independent expert determination for disputes that may arise. This is a process in which an independent expert is appointed to decide disputes. The types of dispute that can be determined, the relief that can be awarded and whether the expert’s decision is binding will depend on the terms of the expert determination clause. 

The popularity of the mechanism has increased due to the flexibility it can offer compared to full-scale litigation in terms of simpler procedure, expedited timing and reduced costs, as well as the perception that it is less subject to judicial intervention. However, parties should also consider whether it will be appropriate to the type of disputes anticipated. For example, a likely lack of a right to appeal and the typical absence of features of litigation such as discovery and cross-examination may be less attractive for higher-stakes disputes. 

Status of Expert Determination / Role of the Courts in Expert Determinations 

Typically, there are two stages of an expert determination process where courts may become involved: 

  1. at the outset, when a party seeks to engage the expert determination process, the other party might seek to restrain the process from proceeding by seeking a stay of the process; or
  2. after a determination has been made, an aggrieved party might seek to have a court overturn the determination. 

In both stages, Australian courts are generally reluctant to interfere and typically interpret clauses liberally so that parties are held to the agreed expert determination process. This has resulted in few instances where an expert determination has been stayed or overturned. The circumstances where this has in fact occurred are generally limited to where:

  • enforcing the expert determination procedure could result in a multiplicity of proceedings;
  • persons not party to the contract have an interest in the outcome of the determination;
  • the expert’s determination goes beyond the task that the expert was engaged to perform (e.g., they have misconceived their role or function or asked themselves the wrong question); or
  • there has been an error of law in the expert’s determination.

Judicial reluctance to interfere with expert determination was recently confirmed in The Illawarra Community Housing Trust Limited v MP Park Lane Pty Ltd [2020] NSWSC 751. The plaintiff argued that an absence of express procedural rules, mechanisms and safeguards in the expert determination process rendered the clause unenforceable. The court disagreed and held that the lack of prescribed steps meant the parties had agreed to leave it to the expert to determine the process. 

Tips for Drafting

When drafting the expert determination clause, parties should carefully consider the language they are using and ensure that the clause:

  • accurately defines the scope of the disputes to be resolved by expert determination so that there can be little argument as to which disputes are subject to expert determination, and considers how to deal with any possibility of multiple and differing types of disputes;
  • clearly identifies the circumstances in which an expert determination will be binding, or will be open to further agreed review mechanisms or still permit a party to litigate the issue in court;
  • considers what expertise the expert should possess and how they will be selected;
  • provides adequate time periods and allows the expert to test the veracity of key factual matters for the nature of construction disputes. Many boilerplate commercial dispute resolution clauses include short timeframes that are unrealistic, and lack sufficient avenues for testing key facts, given the significant volume of documents and complex technical and legal matters that arise on projects; and
  • does not imitate traditional court procedure too closely. Clauses that imitate court procedure too closely, e.g., by requiring witness evidence under oath or cross-examination, risk losing the benefits provided by the flexibility of expert determination.

These aspects should be tailored to the parties’ commercial objectives, and made as clear as possible to minimise the risk of ancillary disputes over the scope or procedure for expert determination.

Two Key Takeaways

  1. Adopting contractual expert determination mechanisms may assist the parties to manage disputes in a way that better supports the project and minimises costs.
  2. Parties should avoid adopting generic boilerplate clauses and instead tailor expert determination processes to the needs of the project.

First-Step Analysis: Bringing Insurance Litigation Proceedings in USA

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Mary Beth Forshaw | Simpson Thacher

Preliminary and jurisdictional considerations in insurance litigation

Fora

In what fora are insurance disputes litigated?

Most insurance disputes are litigated in state or federal trial courts. An insurance action may be subject to original federal court jurisdiction by virtue of the federal diversity statute, 28 USC section 1332(a). In this context, an insurance company, like any other corporation, is deemed to be a citizen of both the state in which it is incorporated and the state in which it has its principal place of business.

If an insurance action is originally filed in state court, it may be removed to federal court on the basis of diversity. Absent diversity of parties or some other basis for federal court jurisdiction, insurance disputes are litigated in state trial courts. The venue is typically determined by the place of injury or residence of the parties, or may be dictated by a forum selection clause in the governing insurance contract.

Some insurance contracts contain arbitration clauses, which are usually strictly enforced. If an insurance contract requires arbitration, virtually every dispute related to or arising out of the contract typically will be resolved by an arbitration panel rather than a court of law. Even procedural issues, such as the availability of class arbitration and the possibility of consolidating multiple arbitrations, are typically resolved by the arbitration panel.

Practitioners handling insurance disputes governed by arbitration clauses should diligently comply with the procedural requirements of the arbitration process. Arbitration provisions in insurance contracts may set forth specific methods for invoking the right to arbitrate and selecting arbitrators. Careful attention to detail is advised, as challenges to the arbitration process are commonplace. An insurance dispute that originates in arbitration may ultimately end up in the judicial system as a result of challenges to the fact or process of arbitration.

Causes of action

When do insurance-related causes of action accrue?

Insurance litigation frequently involves a request for declaratory judgment or breach of contract claims, based on allegations that an insurer breached its defence or indemnity obligations under the governing insurance policy. Insurance-based litigation may also include contribution, negligence or statutory claims. For any insurance-related claim to be viable, it must be brought within the applicable statute of limitations period, which is governed by state law. In determining whether a claim has been brought within the limitations period, courts address when the claim accrued. For breach of contract claims, the timing of claim accrual may depend on whether the claim is based on an insurer’s refusal to defend or failure to indemnify. When a claim arises from an insurer’s failure to defend, courts typically endorse one of the following positions:

  • the limitations period begins to run when the insurer initially refuses to defend;
  • the limitations period begins to run when the insurer refuses to defend, but is equitably tolled until the underlying action reaches final judgment; or
  • the limitations period begins to run once the insurer issues a written denial of coverage.

When a claim arises from an insurer’s refusal to indemnify a policyholder, courts have held that the claim accrues either when the underlying covered loss occurred or when the insurer issues a written denial of coverage.

A legal finding that a policyholder’s claim is time-barred is equivalent to a dismissal on the merits.

Preliminary considerations

What preliminary procedural and strategic considerations should be evaluated in insurance litigation?

At the outset of insurance litigation, practitioners must conduct a careful evaluation of possible causes of action in light of the available factual record in order to assess procedural and substantive strategies. When an insurance dispute turns on a clear-cut question of law and could appropriately be resolved on a motion to dismiss or a motion for summary judgment, dispositive motion practice should be considered. For example, if an underlying claim for which coverage is sought alleges an occurrence that arose after the insurance policy at issue expired or alleges facts that fall squarely within the terms of a pollution exclusion, the insurer may file a dispositive motion to seek swift resolution of its coverage obligations. In contrast, where an insurance dispute presents contested issues of fact, practitioners should be vigilant about formulating case management orders and discovery schedules. Insurance-related discovery is often contentious, expensive and time-consuming, and may give rise to disputes regarding privilege or work product protection. In this respect, document retention policies must be implemented and in some cases, confidentiality stipulations may be appropriate. Finally, a preliminary assessment of any insurance matter should involve consideration of whether it is appropriate to request trial by jury or whether to implead third parties, including entities such as co-insurers, third-party tortfeasors or insurance brokers.

Damages

What remedies or damages may apply?

Many insurance coverage lawsuits seek relief in the form of a judicial declaration that articulates the scope of coverage under the insurance policies in dispute. In essence, one or more parties request that the court enter a ruling that coverage is available or unavailable before addressing the appropriate remedy or damages. If the court issues a ruling declaring coverage to be exhausted or otherwise unavailable, the appropriate remedy or damages may be dismissal of the action with or without costs imposed on the insured.

Where courts find coverage to be available, they often go on to address the issue of remedy or damages in a separate phase of the case. The most common measure of damages in insurance litigation is contractual damages, which may be awarded in connection with a breach of contract claim. The amount of contractual damages is typically based on the coverage due under the relevant policies (or, for a claim of rescission, the amount of premiums to be refunded). In complex insurance litigation, such as that involving multiple layers of coverage with injuries or damage spanning an extended period of time, the damages calculation may be more involved, often requiring expert testimony.

Aside from basic contractual damages, additional amounts may be recovered in certain insurance disputes. For example, some jurisdictions may allow consequential damages based on economic losses that flow directly from the breach of contract or that are reasonably contemplated by the parties. Additionally, some jurisdictions permit attorneys’ fees awards under certain circumstances.

Whether attorneys’ fees awards are available may be governed by state statute, relevant case law or, in some cases, the insurance agreements themselves. Arbitration clauses, in particular, may provide for the payment of the prevailing party’s attorneys’ fees and costs. While attorneys’ fees may be difficult to recover, the threat of an attorneys’ fees award may affect the dynamics of settlement negotiations.

Infrequently, the possibility of tort-based or punitive damages can arise in insurance litigation. These damages may come into play in the context of claims alleging that an insurer acted in bad faith or violated state unfair or deceptive practices statutes.

Where monetary damages are awarded in an insurance action, a corollary issue is the imposition of pre-judgment (or post-judgment) interest. The imposition and rate of interest may be determined by the parties via explicit contractual language. Absent governing language, the question of whether a prevailing party is entitled to pre-judgment or post-judgment interest and, if so, the applicable interest rate, is typically governed by state law. When pre-judgment interest is allowed, determination of the accrual date is paramount because opposing positions can differ by many years, and resolution can have a significant impact on the total damages award. Courts have utilised different events for determining the interest accrual date, including when payment was demanded, when payments are deemed due under the applicable policy and when the complaint was filed.

Under what circumstances can extracontractual or punitive damages be awarded?

Certain states permit policyholders to seek extracontractual or punitive damages when an insurer allegedly has acted in bath faith or violated unfair or deceptive practices statutes. Bad faith allegations frequently relate to an insurer’s refusal to defend or settle an underlying matter, but can also stem from other conduct, such as claims-handling practices. Some jurisdictions do not recognise tort claims arising out of an insurer’s breach of contract. In those jurisdictions, a policyholder’s recovery typically is limited to contractual damages, with no opportunity for punitive damages. Some courts in those jurisdictions, however, may allow recovery of extracontractual damages (eg, lost income or related economic losses) against an insurer if the losses were foreseeable and arose directly out of the breach of contract.

In jurisdictions that recognise bad faith tort claims against an insurer, policyholders face several obstacles when seeking punitive damages. In most but not all cases, a punitive damages claim is not actionable without an adjudication that the insurer has breached the insurance contract. Even where an insurer is held to have breached a contract, and a policyholder has established bad faith or statutory violations, punitive damages are extremely difficult to recover. Most jurisdictions strictly require the party seeking punitive damages to meet a high burden and to prove ‘wilful or malicious’ conduct, ‘malice, oppression or fraud’ or ‘gross or wanton behaviour’ by the insurer. Furthermore, some jurisdictions impose an elevated burden of proof, requiring that bad faith be shown by ‘clear and convincing evidence’.

Law stated date

Correct on

Give the date on which the information above is accurate.

18 December 2019

Arbitration Denied: Third Appellate District Holds Arbitration Clause Procedurally and Substantively Unconscionable

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Stephen M. Tye and Lawrence S. Zucker II | Haight Brown & Bonesteel

In Cabatit v Sunnova Energy Corporation, the Third Appellate District held that an arbitration clause in a solar power lease agreement was unenforceable because it was procedurally and substantively unconscionable.

In Cabatit, Mr. and Ms. Cabitat entered into a solar power lease agreement (the “Agreement”) with Sunnova Energy Corporation (“Sunnova”). Ms. Cabitat, who signed the agreement, speaks English but does not understand complicated or technical terms. The salesperson scrolled through the agreement language and Ms. Cabatit initialed where the salesperson indicated, even though she did not understand most of what he was saying. The salesperson did not explain anything about the arbitration clause nor did he provide Ms. Cabatit with a copy of the Agreement.

Subsequently the Cabatits sued Sunnova, alleging Sunnova damaged their roof during installation, and that the replacement roof was inferior to the roof they had damaged.  In addition, the Cabatits alleged violations of the California Home Improvement Law, Home Solicitation Law, Unfair Competition Law, and Consumer Legal Remedies Act. Sunnova moved to compel arbitration based on an arbitration clause in the Agreement. The trial court found the arbitration clause unconscionable and denied Sunnova’s motion.

On appeal, Sunnova contended (1) the arbitration clause requires the Cabatits to submit to an arbitrator the question whether the clause is enforceable, (2) the trial court erred in finding the arbitration clause unconscionable, and (3) despite the trial court’s conclusion to the contrary, the rule announced in McGill v. Citibank, N.A. (2017) 2 Cal.5th 945 (McGill) — that an arbitration agreement waiving statutory remedies under the Consumers Legal Remedies Act, the unfair competition law, and the false advertising law is unenforceable — does not apply to the circumstances of this case.

In affirming the trial court, the Court of Appeal first discarded Sunnova’s argument that the arbitration clause requires the Cabatits to submit to an arbitrator the question whether the clause is enforceable because Sunnova failed to raise that argument to the trial court. The Court of Appeal then examined the clause itself and the surrounding circumstances, providing a two-step analysis in determining that the Agreement was procedurally and substantively unconscionable.

First, the Court of Appeal determined the Agreement was a contract of adhesion that indicated oppression and surprise. The Court quoted Sonic-Calabasas A, Inc. v. Moreno (2013) 57 Cal.4th 1109, 1142, for the proposition that “[o]ne common formulation of unconscionability is that it refers to an absence of meaningful choice on the part of one of the parties together with contract terms which are unreasonably favorable to the other party.” (quotation marks omitted). The Court pointed to the following factors in making its determination, that (1) Sunnova drafted the Agreement and the Cabatits had no option other than to take or leave it; (2) Ms. Cabatit did not understand the Agreement; (3) the arbitration clause was not explained by the salesman, and (4) the Cabatits were not given a copy of the Agreement. The Court of Appeal rejected arguments from Sunnova that (1) Ms. Cabatit signed a statement that she had read the terms of the Agreement; (2) the arbitration clause is conspicuous; (3) there were no facts showing Sunnova had superior bargaining strength or that the Cabatits were without a meaningful choice whether to sign the Agreement; and (4) the Cabatits had the right to cancel the Agreement within seven days.

Second, the Court determined the arbitration clause was substantively unconscionable. In doing so, the Court relied upon Sanchez v. Valencia Holding Co., LLC (2015) 61 Cal.4th 899, 910, for the proposition that substantive unconscionability focuses on whether the terms of an agreement are overly harsh, unduly oppressive, or so one-sided as to shock the conscience. Here, the Court found the arbitration clause to be clearly one sided because Sunnova reserved the right to take most of its claims to court but purported to deny the Cabatits the same opportunity.

Finally, the Court of Appeal rejected Sunnova’s argument that the rule announced in McGill, supra, 2 Cal.5th 945, applied. In McGill, the California Supreme Court held that an arbitration agreement waiving statutory remedies under the Consumers Legal Remedies Act, the unfair competition law, and the false advertising law is unenforceable. (Id. at pp. 951-952.) The Court determined general considerations of unconscionability, independent of the McGill rule, was sufficient to support the trial court’s denial of the motion to compel arbitration.

Cabatit is important for two reasons. First, it demonstrates the high-bar that allows a court to find a contract of adhesion. Second, it demonstrates the need for arbitration clauses not to favor the drafting party.

This document is intended to provide you with information about general liability law related developments. The contents of this document are not intended to provide specific legal advice. If you have questions about the contents of this alert, please contact the authors. This communication may be considered advertising in some jurisdictions.

Power Project Development: Aligning the EPC Agreement and Power Purchase Agreement

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Matthew A. Sanders | Taft Stettinius & Hollister

Power project developers often negotiate the engineering, procurement, and construction agreement (EPC) at the same time as other project contracts. Depending on the project type and contracting paradigm, a developer (owner) must align key EPC terms with some or all of the following: (1) power purchase agreement (PPA), (2) interconnection agreement, (3) major supply agreements, and (4) operations and maintenance (O&M) agreement.

This article will evaluate the EPC as an exercise in risk allocation, and then highlight issues for alignment with the PPA. In future articles, we will identify areas that overlap between the EPC and other project contracts.

I. EPC Agreement and Risk Allocation

Owners must approach major project contracts holistically and allocate risks to the party who can mitigate that risk. A party that accepts a risk must, in turn, protect against it wherever possible. For example, a party might mitigate risk through price adjustments, more insurance, or further risk allocation to third parties. Any gaps in risk allocation between project contracts may create financing challenges. They may also cause schedule delays, additional costs, revenue losses, contractor disputes, or off-taker liabilities.

The owner looks to the EPC contractor to deliver a timely completed, fully operational, legally compliant, on-budget, revenue-generating power project. Invariably, the engineering and construction phase is fraught with risks concerning schedule, cost, and implementation. Among other things, an owner must anticipate incurring significant capital expenses while laboring under tight timing and financing constraints. Early missteps can undermine viability or erode profitability, long before the project begins to generate revenue.

Thus, an owner may look to the contractor to accept such risks by requiring a fixed contract price, guaranteed completion dates, and performance guarantees. At the same time, the owner will impose liquidated damages and other damages for delays and technical shortfalls. Of course, as the owner pushes risk onto the contractor, the contractor may act defensively through price increases, schedule float, and aggressive change order use.

The owner must weigh whether to accept the pricing premium and longer delivery times in exchange for some price and schedule certainty. The owner must also collaborate with its engineering consultant and the contractor to develop a technical specification that provides clear, achievable project outcomes. And if the owner needs project financing, then the owner will work with lenders and equity investors to ensure the risk allocation leads to a bankable project and project contracts that will work as intended.

II. EPC Agreement and Power Purchase Agreement (PPA)

A PPA is a long-term electricity supply agreement between a power producer and a buyer, or “off-taker.” Ordinarily, this contractual mechanism provides a project with stable cash flows following the commencement of commercial operation.

The off-taker is typically either a load-serving utility, a large commercial or industrial end user, or a power marketer. The off-taker signs up to buy all or a portion of a project’s output for an extended term. To ensure the project will meet the buyer’s power and pricing requirements, the project developer may commit to provide the off-taker with schedule guarantees, expected energy guarantees, and capacity guarantees.

For projects that anticipate construction activities, the PPA addresses two distinct phases: the pre-Commercial Operation Date (COD) construction phase and the post-COD operation phase. The interface between the EPC and the PPA is keenly experienced during the pre-COD period when the schedule is at risk and project performance must be assured.

a. Schedule Milestones – EPC’s Substantial Completion Date and PPA’s Commercial Operation Date

The EPC guaranteed substantial completion date often aligns with the PPA guaranteed commercial operation date. EPC substantial completion usually means that a project is available to begin operation and has met a suite of conditions. Ordinarily, all that remains are “punch list” items, final testing, and other project close-out activities.

PPA commercial operation usually means that the owner has completed all commissioning activities and that the facility is operating at or near its nameplate capacity and expected facility output.

If the owner misses a guaranteed milestone under the PPA or the EPC, each project contract may impose schedule liquidated damages until the milestone is satisfied. A delay that continues for too long may mature into a default, leading to termination rights and other remedies.

To ensure that guaranteed milestones in both agreements reinforce each other and do not create any gaps, an owner should consider the following:

  1. The EPC guaranteed substantial completion date and PPA guaranteed COD should either match or require delivery prior to the guaranteed COD. For example, if the PPA has a June 1st guaranteed COD, then the EPC guaranteed substantial completion date must occur either on June 1st, or some earlier date. An EPC milestone that occurs later than the guaranteed COD may lead to lost revenue and schedule liquidated damages.
  2. The EPC should narrowly define change order conditions. Change orders may allow a contractor to extend delivery beyond the guaranteed COD. Since an owner must typically grant change orders for owner-caused delays, the owner should ensure its own prompt performance and that of its other contractors, major suppliers, agents, and personnel.
  3. The EPC should include a clearly drafted and internally consistent technical specification, scope of work document, and project schedule. These documents are crucial for minimizing contractor confusion and disputes as well as lessening change order risk and delays.

b. Schedule Liquidated Damages

If the contractor misses the EPC guaranteed substantial completion milestone, then schedule liquidated damages will likely accrue under both contracts. The owner should align the liquidated damages amounts under both agreements so that PPA damages will flow through to the contractor.

Otherwise, the owner must absorb liquidated damage payments payable to the off-taker, while not recovering the amount from the contractor who accepted the schedule risk. And since the contractor likely priced in contingency to account for schedule liquidated damages, without a flow through provision, the owner risks double payment.

c. Project Performance – Substantial Completion Conditions, Capacity Testing, and Performance Guarantee

Under both agreements, the performing party must satisfy conditions before the other party will certify the milestone. Thus, performance criteria comprising EPC substantial completion should align with the relevant COD conditions under the PPA. Chief among these EPC conditions is the satisfaction of commissioning, testing, and turnover obligations.

The owner relies on the contractor’s capacity and energy output tests to certify PPA compliance. Thus, technical personnel for both the contractor and the owner should scrutinize procedures and results to ensure accuracy, consistency, and transparency. And if the PPA requires it, a third party should provide an independent assessment to confirm the project is operational.

For PPAs that authorize commercial operation at some capacity threshold less than 100 percent, the parties may negotiate a post-COD cure period. During this time, an owner may keep working to achieve up to 100 percent contracted capacity.

If the owner – through its contractor – fails to achieve 100 percent contracted capacity, then the PPA may impose a capacity shortfall payment for each megawatt below a specified threshold. This one-time payment represents an owner buy-down for lost production capacity over the PPA term. The PPA should also set a lower boundary of acceptable project capacity, below which would be a default.

To support that PPA requirement, the EPC should require recovery plans following the initial capacity test, assigning cost responsibilities and establishing damages or other remedies. If the off-taker is willing to accept a range of performance under the PPA, the EPC could make the post-COD recovery plan optional.

By allowing the contractor either to elect a capacity shortfall payment or to make good on its delivery obligation at 100 percent, the contractor may be able to minimize cost overruns. If the contractor can meet a range of acceptable performance outcomes, then the contractor could save the other parties money by building less contingency into the fixed price.

The owner, off-taker, contractor, and facility lenders must all coordinate to align financial incentives, capacity shortfall payments, and minimum acceptable performance outcomes. To do this, the parties must synchronize the parallel terms of the PPA and the EPC to avoid any gaps.

In the end, the EPC should flow through the PPA performance guarantees, capacity shortfall payments, and default provisions wherever possible. Just as the owner should avoid being “caught in the middle” when it comes to schedule delays, so also should the owner ensure that the contractor accepts the risk of underperformance if it cannot deliver a project at 100 percent.