TURNKEY PROJECTS

Turnkey contracts: getting it right from the start

Ellis Baker, partner and head of Construction and engineering practice group, White & Case, London, presents the legal aspects behind turnkey projects

legal issues which have to be dealt with The work on site started on 9 June can be summarised in the following 2000. Prior to that, no contract check-list form (the list refers to a power documents had been prepared, no station, but many of the issues are tendering process had been undertaken. generic): The contract documentation would be produced and agreed and a contract entered into as work proceeded. Payment This snippet of narrative describes the Usually, 10-15 per cent payable in beginning of a construction project. advance to support contractor's initial Given the scenario presented, it comes as mobilisation and orders, against a bank no surprise that the story is told as part guarantee from the contractor of equal of a judgment of the Technology and amount. Monthly interim payments linked Construction Court being heard on appeal to achievement of identified milestones, in the Court of Appeal. If ever there was often with significant final payment on a scenario likely to lead to litigation, completion of work. surely that was it. The project in question was not The function of the turnkey contract is: a power project. On the whole, the power industries cannot afford to express the contractor's basic obligation to to operate like that. The produce the power station to the client's relationship between specification, by the specified time and for an client/purchaser/owner and agreed price. The facility must be free from defects contractor/supplier has to be for a specified period following completion; and regulated from the outset, so that to set out in detail the parties' position in both parties are clear about rights relation to payment, quality and time, and obligations. It is a question of anticipating and providing for certain, probable and getting it right from the start. even possible events.

event of a specified sub-contractor's failure.

Adjustment to price and completion date

Contractor will be entitled to claim extra payment and/or extension of time for matters outside its control, such as changes in legal requirements, force majeure and undisclosed ground conditions, although what is included is purely a matter of negotiation. The claim will have to be made by a specified procedure, which will be a 'condition precedent' to entitlement.

Warranty periods

Again subject to detailed negotiation but generally the warranty periods for Civils work will be longer than for the Mechanical and Electrical elements. In a cogeneration project, obviously the gas turbine warranty period is critical.

The turnkey contract

Design and build, whereby the contractor is responsible both for producing the design and constructing it, is increasingly used in most sectors of construction and engineering. In the power sector, the use of this method is well-established; for example, a power station would typically be procured by means of a turnkey contract, a version of design and build. The name derives, obviously, from the contractor's obligation to provide all work, materials and services necessary to enable the client to turn the key and take over an operational facility.

Timely completion

Provision for liquidated damages at a specified rate in the event of time overrun; the amount and purpose must be realistic compensation of the owner, not penalising the contractor. The contractor will usually require a cap (maximum amount) on these; the client will want to have the right to terminate on reaching this.

Contractor will assess owner's financial status when bidding but in independent power projects, the owner under the turnkey contract may have no assets, being a special purpose vehicle created for the project. The contractor may then be paid by direct disbursement of the project loans, directly from the project lenders. The contractor usually has to give a bank guarantee of at least 10 per cent of contract price (five per cent during warranty period), payable on certification of contractor's default.

Security

Performance standards

Limitations of liability

Check-list of contractual issues

Plenty of work in the power sector is done using standard form contracts, such as the Institution of Mechanical Engineers form (or ICE for Civils work) or, in the case of international projects, the Fdration Intenational des Ingenieurs Conseils (FIDIC) Conditions of Contract. However, a turnkey contract for a power station will almost certainly be tailormade for the project. The legal team will sit down with their clients and address the issues. At a risk of over-simplification, the key

There will be performance guarantees to be satisfied for contractor to achieve completion and others where failure is compensated by liquidated damages. A minimum threshold of performance will typically be 95 per cent of guaranteed power output and 105 per cent of guaranteed heat rate, with the shortfall compensated by liquidated damages. There will be a detailed testing regime.

A power station turnkey contract is regarded as high-risk for contractors, who usually require a limit of financial liability of 100 per cent of contract price and a limit on liquidated damages. The precise terms reached are thus negotiable; the outcome depends on the strength of the parties' bargaining position, the state of the market and the requirements of lenders. Specialist lawyers can advise on what is achievable in the light of these factors and then help to achieve it. What will never change is the need to get it right from the start.

Sub-contracting

Owner will wish to control what subcontracting (especially Mechanical and Electrical) is permitted and to whom. Contractor will need some flexibility within this, to provide alternatives in the

Internet Links
www.whitecase.com

WIP
E125

24

WORLDWIDE INDEPENDENT POWER JANUARY/FEBRUARY 2004