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Managing Construction Schedule Risk

By John Eustermann
Today's push to bring biomass energy projects on line and the seemingly never-ending death grip on project financing dollars has resulted in greater risk aversion by all contractual participants. Regardless of the feedstock being used and whether the project involves a stoker boiler, pelletization or torrefaction, completion and performance risk, among others are perceived to exist. As such, when the markets loosen up and opportunities surface, negotiating and allocating risk among transaction participants will require substantial consideration.

Considering that the biomass project developer is the party paying for the construction, expecting the project to be completed on time within a stipulated budget and according to the quality and performance levels specified seems reasonable. In light of unforeseen issues related to technology, site and location, multiple cost components and the layers of skill deployment to which a project is exposed, however, the engineering, procurement and construction (EPC) contractor understandably will adjust the bid price. At the end of the day, the parties understand that allocating and managing risk directly impacts the productivity, performance, quality and financial modeling of a biomass project. Thus, to ensure project success, each party should analyze what risks are likely to arise and the consequences of such risks, what can be done to avoid the occurrence of such risks, what party can prevent or control such risk, and finally, can the parties insure against such risk. The goal is to have the party with the most control (avoidance or mitigation), as much as may be negotiable, contracted to assume such risk.

The following briefly presents a couple of issues in EPC contracts that, among others, tend to be focal points when discussing/negotiating project completion of schedule risk.

In addition to the time value of money and reaching the commercial operation date to generate revenues as quickly as possible, a lot of pressure around construction timing has resulted from certain grants and incentives in the stimulus package.
Understandably, the developer and construction contractor seek certainty as to a project's construction schedule and contract completion. Owners want completion as per an agreed schedule to avoid additional costs and the contractor does not want to be held accountable for delays caused by the owner or other contractors. In light of the fact that biomass projects involve layers of skilled workers performing distinct activities that require specific sequencing, avoiding any domino effect delays benefits everyone. Implementing completion milestones throughout the project, in addition to reasonable liquidated damages, presents a couple of opportunities, if negotiated reasonably, that the parties can use to manage a project schedule and some of the associated risk.

By agreeing to completion milestones throughout the construction, the developer can ensure that the project remains on track. Generally, such milestones are tied to certain installment payments due the contractor or adjustments to the EPC contracts retainage percentages. Thus, if the contractor fails to hit a milestone, the developer may hold back such payments or portions thereof until the contract is completed. To the extent the contractor finishes the project on time by "catching up," then those monies withheld may be tendered to the contractor as part of the final payment.

In the event the contractor fails to finish the project as per the agreed upon schedule, the developer may seek to apply the payments that were held back to any applicable liquidated damages negotiated in the EPC. Liquidated damages refers to the money, as agreed upon by the parties, that represents the dollar amount of damages caused by a contract default as to timely completion. Such damages are triggered by an inexcusable delay that extends contract completion beyond the completion date and are generally expressed in terms of a fixed dollar amount for every day that the contract extends beyond the completion date.

It has been established that to be enforceable, liquidated damage provisions amounts must: roughly approximate the damages likely to be incurred by the party seeking relief in the event of failure; and be sufficiently difficult to calculate at the time the contract is executed that both parties recognize the significant benefit of being spared any future difficulty of estimating those damages.

Finally, in light of the multiple layers of third parties involved in large-scale projects, equitable schedule adjustments should be negotiated to accommodate for delays not caused by the EPC contractor.Again, the above discussion addresses only a couple of the risk allocation tools that are worthy of note.

John Eustermann is a partner at Stoel Rives LLP. Reach him at jmeustermann@stoel.com or (208) 387-4218.
 

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