Epc Contracts For Wind Energy Projects - South African Re Ipp Programme - Lessons Learned From Phases 1 And 2 (October 2012) Part 5 - Construction & Planning

Development and environmental considerations

The responsibility for the environmental issues surrounding the construction and operation of the Facility must be set out clearly in the EPC Contract. Renewable energy projects have a range of environmental impacts which need to be considered and managed properly. The sponsor or project company will have to investigate if any aspects of the project are likely to be subject to scrutiny under the National Environmental Management Act 1998 (No. 107 of 1998) ("NEMA") or other relevant legislation and policy.

The type of environmental and other development impacts that a renewable energy project may have will depend on a number of factors, including the technology being used, the size of the project and where the project is sited.

Environmental and related impacts associated with renewable energy projects generally include:

noise from the operation of the plant and/or mechanical noise associated with noise from the generator;
the impact on threatened species that inhabit the nearby area, whose habitat or surrounding ecological community may be impacted by the development;
effects on areas of high conservation and landscape values, such as national and state parks and World Heritage properties, which may limit or prevent development;
effects on particular locations of high amenity or tourist value, which may limit or prevent development;
the required clearance of native vegetation and revegetation during construction;
construction issues such as the impact of construction traffic and the construction of access road; and
archaeological and heritage issues including the impact on cultural heritage values and sites of significance to indigenous peoples.

There are also particular impacts associated with specific technologies. Impacts particularly associated with wind farms include:

concern for the visual impact of wind energy development, which is usually a concern prior to development;
the effect of shadow flicker and blade glint which must be avoided or mitigated by design and siting;
noise from the swishing of the blades;
the impact on migratory species that may fly or move through the wind farm area, even if they do not inhabit the area, through collisions with turbines; and
potential electromagnetic interference with microwave, television and radio signals.

Many of these issues will be most relevant at the stage of seeking approval for the development of a Facility and will be the responsibility of the sponsor or project company. The list of development permits, approvals and licences which must be obtained by the project company should be clearly identified in the EPC Contract, with the balance of construction permits and approvals being the responsibility of the contractor. However, responsibility for adherence to the conditions attached to the development approvals, permits and the risks identified in the environmental impact assessment, must be passed on to the contractor. For instance, in the case of wind energy, planning approvals for wind farms are generally subject to permit conditions about noise limits. The contractor must adhere to the required noise specifications and provide warranties that the wind farm will comply with the noise curves required by the specifications.

If the environmental assessment has identified areas of ecological or archaeological importance, then these preconstruction site conditions must be documented in the EPC Contract and accepted by the contractor.

The contractor must also develop an environmental management plan to identify risks, mitigation and monitoring processes during construction of the Facility. This should take into account factors such as erosion, dust and sediment control, storage of hazardous materials, weed control and waste management.

Independent certification of key equipment

The provision of design certificates or a statement of compliance from an independent certifying body is essential for the project company to ensure that critical items of equipment (such as wind turbines ) provided by the contractor have been designed in accordance with industry standards and will fulfil the required design parameters.

Certification of wind turbines has a history of almost 25 years. In recent years, other countries, as well as financiers, have realised the necessity of a thorough evaluation and certification of wind turbines and their proposed installation. The certifications are commonly divided into type certification and wind turbine certification. The certification is usually required to be carried out by an independent certifying body, such as Germanischer Lloyd Industrial Services GmbH (an international operating certification body for renewable energy equipment, including wind turbines), and is performed in accordance with that body's rules or regulations. Where possible, the certification should encompass confirmation on the design life of the wind turbines.

Wind turbine certification involves a complete third party assessment and certification of specific wind turbines from design assessment to commissioning, witnessing, site assessment and periodic monitoring. Wind turbine certification can only be carried out for type certified wind turbines and on locations for which the necessary data is available.

The project company may also require a site certification to be provided by an independent certifying body confirming that the real site conditions of the wind farm as a whole (including factors such a wind, climate, topography and WTG layout) complies with the design parameters of the relevant international standard. The real climatic conditions of the relevant site will be provided to the certifying body for assessment of factors such as the wind conditions prevalent at the site as compared with standard wind conditions and the calculation of loads for the site conditions compared with the design basis.

Staged completion and handover to operator

For some types of renewable energy facilities, such as wind, components of the Facility may be completed at different times. As each wind turbine generator is usually constructed sequentially, each wind turbine generator may be taken over by the project company as it passes the required tests on completion. While the taking over of each wind turbine and associated equipment as and when it is installed and commissioned is not unusual, it is important to ensure that the issue of a Taking Over Certificate for each individual component does not affect the contractor's obligations under the EPC Contract. Issues such as the management of staggered defects liability periods, the method of calculation of the availability guarantees and the point at which performance security held by the project company should be released are among the important issues that must be considered carefully by the project company when contemplating staged taking over of components of the Facility.

Despite taking over individual wind turbine generators or solar arrays, the performance security held by the project company should only be reduced or released when the relevant Facility has passed all tests required for commercial operation of the entire Facility. Factors such as the time period between taking over of each component and the generation of electricity by components taken over by the project company will influence the point at which it is reasonable to reduce the performance security held by the project company. If the operation and maintenance obligations of an operator of the Facility commences on the taking over of each component, the performance security to be provided by the operator can be increased in accordance with the number of components taken over.

The issue of a Taking Over Certificate for individual components will also trigger commencement of the defects liability period for that component. For example, if a wind farm has between 20 and 25 wind turbines, this could mean that the project company will have to administer defects liability periods equivalent to the number of wind turbines on the wind farm. If there is a substantial gap between taking over of the first wind turbine and the last wind turbine, this could also result in the defects liability period for the first wind turbine expiring substantially earlier than the last wind turbine taken over and could affect the contractor's defects rectification or warranty obligations for defects affecting the entire wind farm. The ideal position would be to require the defects liability period to commence on taking over of each wind turbine but to expire only from a set time from taking over of the entire wind farm. If this proves too onerous for the contractor, the wind turbine generators could be divided into circuits of wind turbines, for instance, 2 or 3 circuits of wind turbines each comprising a separable portion. A taking over certificate will therefore only be issued in relation to each circuit, making it easier to administer the defects liability periods or to manage other issues such as the reduction of security.

The availability guarantee provided by the contractor in each operating year of the Facility should ideally commence from commercial operation of the entire Facility and not from the time revenue is generated from commercial operation of each component of the Facility. However, as with the defects liability period, whether or not this is acceptable to the contractor will depend on the length of time during which the project company has commenced generation of electricity from individual components taken over prior to commercial operation of the entire Facility. In some contracts, the availability guarantee in the first operating year has been calculated from the average date of completion of the individual components.

Another important consideration is to ensure that the delay liquidated damages imposed for failure to complete the entire Facility by the required date for practical completion takes into account any revenue that may be generated by the project company from individual components that are taken over and operated prior to commercial operation of the entire Facility. This is to ensure that the delay liquidated damages represent a genuine pre-estimate of the project company's loss.

As discussed in this paper above (under the heading 'Early Operation and Staged Completion'), staged completion is not available under the RE IPP Programme.

KEY PERFORMANCE CLAUSES IN RENEWABLE ENERGY EPC CONTRACTS

Rationale for imposing liquidated damages

Almost every construction contract will impose liquidated damages for delay and impose standards in relation to the quality of construction. Most, however, do not impose PLDs. EPC Contracts impose PLDs because the achievement of the performance guarantees has a significant impact on the ultimate success of a project. Similarly, it is important that the Facility commences operation on time because of the impact on the success of the project and because of the liability the project company will have under other agreements. This is why DLDs are imposed. DLDs and PLDs are both 'sticks' used to motivate the contractor to fulfil its contractual obligations.

The law of liquidated damages

As discussed above, liquidated damages must be a genuine pre-estimate of the project company's loss. If liquidated damages are more than a genuine pre-estimate they will be a penalty under South African law. This penalty is capable of being enforced, but may be reduced by a court at its discretion where it considers that clause to be out of proportion to the prejudice suffered by the project company. The court can reduce the penalty to such extent as it deems equitable in the circumstances. . There is no legal sanction for setting a liquidated damages rate below that of a genuine pre-estimate, however, there are the obvious financial consequences.

In addition, liquidated damages can also be void for uncertainty or unenforceable because they breach the prevention principle. Void for uncertainty means, as the term suggests, that it is not possible to determine how the liquidated damages provisions work. In those circumstances, a court will void the liquidated damages provisions.

The prevention principle was developed by the courts to prevent employers i.e. project companies from delaying contractors and then claiming DLDs. It is discussed in more detail below in the context of extensions of time.

Prior to discussing the correct drafting of liquidated damages clauses to ensure they are not void or unenforceable it is worth considering the consequences of an invalid liquidated damages regime. If the EPC Contract contains an exclusive remedies clause the result is simple – the contractor will have escaped liability unless the contract contains an explicit right to claim damages at law if the liquidated damages regime fails. This is discussed in more detail below.

If, however, the EPC Contract does not contain an exclusive remedies clause the non-challenging party should be able to claim at law for damages they have suffered as a result of the challenging party's non or defective performance. What then is the impact of the caps in the now invalidated liquidated damages clauses?

Unfortunately, the position is unclear in common law jurisdictions, and a definitive answer cannot be provided based upon the current state of authority. It appears the answer varies depending upon whether the clause is invalidated due to its character as a penalty, or because of uncertainty or unenforceability. Our view of the current position is set out below. We note that whilst the legal position is not settled the position presented below does appear logical.

Clause invalidated as a penalty
When liquidated damages are invalidated because they are a penalty (i.e., they do not represent a genuine preestimate of loss), the liquidated damages or its cap will not act as a cap on damages claims at general law.

We note that it is rare for a court to find liquidated damages are penalties in contracts between two sophisticated, well advised parties.
Clause invalidated due to acts of prevention by the principal
A liquidated damages clause will cap the contractor's liability where a liquidated damages regime breaches the prevention principle because this gives effect to the commercial bargain struck by the parties.
Clause void for uncertainty
A liquidated damages clause which is uncertain is severed from the EPC Contract in its entirety, and will not act as a cap on the damages recoverable by the principal from the contractor. Upon severance, the clause is, for the purposes of contractual interpretation, ignored.

However, it should be noted that the threshold test for rendering a clause void for uncertainty is high, and courts are reluctant to hold that the terms of a contract, in particular a commercial contract where performance is well advanced, are uncertain

Drafting of liquidated damages clauses

Given the role liquidated damages play in ensuring EPC Contracts are bankable, and the consequences detailed above of the regime not being effective, it is vital to ensure that liquidated damages clauses are properly drafted to ensure contractors cannot avoid their liquidated damages liability on a legal technicality.

Therefore, it is important, from a legal perspective, to ensure DLDs and PLDs are dealt with separately. If a combined liquidated damages amount is levied for late completion of the works, it risks being struck out as a penalty because it will overcompensate the project company. However, a combined liquidated damages amount levied for underperformance may under compensate the project company.

Our experience shows that there is a greater likelihood of delayed completion than there is of permanent underperformance. One of the reasons why projects are not completed on time is that contractors are often faced with remedying performance problems. This means, from a legal perspective, if there is a combination of DLDs and PLDs, the liquidated damages rate should include more of the characteristics of DLDs to protect against the risk of the liquidated damages being found to be a penalty.

If a combined liquidated damages amount includes a NPV or performance element the contractor will be able to argue that the liquidated damages are not a genuine preestimate of loss when liquidated damages are levied for late completion only. However, if the combined liquidated damages calculation takes on more of the characteristics of DLDs the project company will not be properly compensated if there is permanent underperformance.

It is also important to differentiate between the different types of PLDs to protect the project company against arguments by the contractor that the PLDs constitute a penalty. For example, if a single PLDs rate is only focused on availability and not efficiency, problems and uncertainties will arise if the availability guarantee is met but one or more of the efficiency guarantees are not. In these circumstances, the contractor will argue that the PLDs constitute a penalty because the loss the project company suffers if the efficiency guarantees are not met are usually smaller than if the availability guarantees are not met.

Drafting of the performance guarantee regime

Now that it is clear that DLDs and PLDs must be dealt with separately it is worth considering, in more detail, how the performance guarantee regime should operate. A properly drafted performance testing and guarantee regime is important because the success or failure of the project depends, all other things being equal, on the performance of the Facility.

The major elements of the performance regime are:

testing;
guarantees; and
liquidated damages.

Liquidated damages were discussed above. Testing and guarantees are discussed below. In addition, a sample testing, guarantee and liquidated damages framework in respect of a wind Facility in the context of the RE IPP Programme is set out in Appendix 2 of this paper.

Testing

Performance tests may cover a range of areas. Three of the most common are:

Functional tests – these test the functionality of certain parts of the key components of a Facility, such as, in the case of wind facilities, wind turbine generators, SCADA systems, power collection systems and meteorological masts. These are usually discrete tests which do not test the Facility as a whole. Liquidated damages do not normally attach to these tests. Instead, they are absolute obligations that must be complied with. If they are not complied with, the Facility will not reach the next stage of completion (for example, mechanical completion or provisional acceptance).

Guarantee tests – these test the ability of the Facility to meet the performance criteria specified in the contract.

Given that the performance guarantees will differ by technology, so will the relevant guarantee tests. For example, in the case of wind technology, a power curve test will generally be conducted, in addition to an acoustic emissions test . A sample testing framework for a wind Facility in the context of the RE IPP Programme is set out in Appendix 2 of this paper.

The consequence of failure to meet these performance guarantees is normally the payment of PLDs. If minimum performance guarantees are provided, satisfaction of these minimum guarantees is generally an absolute obligation. In some cases, if minimum performance guarantees are not met the project company will have a right to terminate the EPC Contract and to reject the Facility and (in some circumstances) require the contractor to repay all amounts paid to it in respect of the Facility and dismantle and remove the Facility at its own cost and restore the site to its original condition.

The performance guarantees should be set at a level of performance at which it is economic to accept the Facility. Lender's input will be vital in determining what this level is. However, it must be remembered that lenders have different interests to the sponsors. Lenders will, generally speaking, be prepared to accept a Facility that provides sufficient income to service the debt. However, in addition to covering the debt service obligations, sponsors will also want to receive a return on their equity investment. If that will not be provided via the sale of electricity because the contractor has not met the performance guarantees, the sponsors will have to rely on the PLDs to earn their return.

In some projects, the guarantee tests occur after hand over of the Facility to the project company. This means the contractor no longer has any liability for DLDs during performance testing.

In our view, it is preferable, especially in project financed projects, for handover to occur after completion of performance testing. This means the contractor continues to be liable for DLDs until either the Facility achieves the guaranteed level or the contractor pays PLDs where the Facility does not operate at the guaranteed level. Obviously, DLDs will be capped (usually at 20% of the Contract Price) therefore, the EPC Contract should give the project company the right to call for the payment of the PLDs and accept the Facility. If the project company does not have this right the problem mentioned above will arise, namely, the project company will not have received its Facility and will not be receiving any DLDs as compensation.

It is often the case in renewable energy projects that the contractor or operator of a Facility will not accept liability for availability PLDs beyond a limited period. In a power plant, the PLDs are calculated to enable the project company to recover the amount it will lose over the life of the power plant in the event the guarantees are not satisfied. The PLDs on a power plant are usually calculated using the NPV of the project company's loss based on the life of the plant. For example, on wind farm projects, the contractor will pay power curve PLDs but will often not accept responsibility for availability PLDs beyond the warranty period or in the case of the operator, the term of the operating and maintenance agreement. The contractor or operator, as the case may be, will simply pay the yearly availability PLDs for failing to meet the stipulated availability guarantee over the warranty period specified in the contract or for the period during which the operator has control over the operation and maintenance of the Facility.

It is common for the contractor to be given an opportunity to modify the Facility if the Facility does not meet the performance guarantees on the first attempt. This is because the PLD amounts are normally very large and most contractors would prefer to spend the time and the money necessary to remedy performance instead of paying PLDs. Not giving contractors this opportunity will likely lead to an increased contract price both because contractors will build a contingency for paying PLDs into the contract price and because in most circumstances the project company will prefer to receive a Facility that achieves the required performance guarantees. The right to modify and retest is another reason why DLDs should be payable up to the time the performance guarantees are satisfied.

If the contractor is to be given an opportunity to modify and retest the EPC Contract must deal with the question of who bears the costs required to undertake the retesting. The cost of the performance of a power curve test in particular can be significant and should, in normal circumstances, be to the contractor's account because the retesting only occurs if the performance guarantees are not met at the first attempt.

Technical issues

Ideally, the technical testing procedures should be set out in the EPC Contract. However, for a number of reasons, including the fact that it is often not possible to fully scope the testing program until the detailed design is complete, the testing procedures are usually left to be agreed during construction by the contractor, the project company's representative or engineer and, if relevant, the lenders' technical adviser. However, a properly drafted EPC Contract should include the guidelines for testing.

The complete testing procedures must, as a minimum, set out details of:

Testing methodology – reference is often made to standard methodologies, for example, the IEC 61-400 methodology.
Testing equipment – who is to provide it, where it is to be located, how sensitive must it be.
Tolerances – what is the margin of error. For instance excluding wind conditions in excess of specified speeds or excluding solar radiation in excess of certain levels.
Ambient conditions – what atmospheric conditions are assumed to be the base case (testing results will need to be adjusted to take into account any variance from these ambient conditions).

In addition, for renewable energy facilities with a number of components, such as wind farms with multiple wind turbine generators , the testing procedures must state those tests to be carried out on a per turbine or per solar array basis and those to be carried out on an average basis.

An example of the way a performance testing and liquidated damages regime can operate is best illustrated diagrammatically. Refer to the flowchart in Appendix 3 for an example of how the various parts of the performance testing regime should interface in the context of wind farms.

Long term performance guarantees

The project company should be aware that guarantee tests are only a snapshot of the Facility's capacity and reliability, and the long-term capabilities of the Facility under varying conditions remain unproven.

The project company may wish to incorporate long-term performance guarantees from the Contractor into the EPC Contract to cover this. These performance guarantees may operate past the hand-over of the Facility to the project company or operator and up to the expiry of the defects liability period. Such guarantees can include guaranteed generated output in MWh per year. In general, contractors will not wish to enter into such long-term performance guarantees. As an inducement, the project company may offer performance bonuses for where guaranteed generated output is exceeded.

This publication is intended as a general overview and discussion of the subjects dealt with. It is not intended to be, and should not used as, a substitute for taking legal advice in any specific situation. DLA Piper Australia will accept no responsibility for any actions taken or not taken on the basis of this publication.

DLA Piper Australia is part of DLA Piper, a global law firm, operating through various separate and distinct legal entities. For further information, please refer to www.dlapiper.com

Australia: Epc Contracts For Wind Energy Projects - South African Re Ipp Programme - Lessons Learned From Phases 1 And 2 (October 2012) Part 5