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How and when to terminate solar project contracts

  • United Kingdom
  • Construction and engineering - Foundations

06-06-2018

Solar projects have increased in popularity in recent years. This is due to a number of factors:

  • greater demand for renewable energy;
  • the fact that solar is the easiest of the renewable technologies to install; and
  • the ROC subsidy for solar projects completed before March 2017.

As a result there have been a large number of solar projects constructed and sold on in recent years. This rapid expansion in the solar market over a short period placed greater pressure on developers, contractors and suppliers whilst driving down prices.

Whilst most projects have performed well, a small percent are experiencing issues. This, combined with the changing commercial backdrop, raises questions as to whether a solution is to terminate contracts, in particular long term O&M contracts which are usually put in place on such projects. However, termination can present pitfalls for the unwary. This is particularly the case as many solar projects and their SPVs have been sold on. As part of that process the ultimate owners may have inherited EPC and O&M contracts which they did not negotiate and which it was not possible or which it was commercially impractical to amend during that acquisition process.

Consequently, there are two important questions which anyone contemplating termination must ask:

    1. Can I terminate?
    2. Should I terminate?

    These questions are considered below. Although they are discussed in the context of solar projects many of the issues will also be applicable to other projects constructed and operated under EPC and O&M contracts.

    Can I terminate?

    Of the two questions this is often the more straightforward. Any EPC or O&M contract should set out the grounds on which the parties may terminate the contract.

    Usually the grounds will be fault based so it will be for the terminating party to establish that the other party has committed one or more of the breaches of contract (and to the extent stated in the contract) which gives rise to a right to terminate. In some O&Ms there may be a right to terminate for convenience, but often:

    • this may only arise after a certain period;
    • there may be restrictions on when it can be exercised e.g. on specific anniversaries of the commencement date; and/or
    • this may trigger a break payment.

    The EPC or O&M contract will probably also set out a procedure which must be followed in order to terminate the contract e.g. notice must be given in a certain form and delivered to a specified person and address. It is important any such procedure is followed to the letter if the termination is to be valid.

    Terminating a contract if the relevant grounds have not been made out or failing to follow the correct contractual procedure is likely to render the termination invalid and could place the terminating party in repudiatory breach itself.

    In reality once a party gives a termination notice, the contract will for all meaningful purposes come to an end irrespective of the validity of the notice because:

    • a contractor cannot perform its obligations if the employer does not allow it access to site; and
    • the employer cannot compel the contractor to come to site and perform its obligations (a court is unlikely to order specific performance).

    Should I terminate?

    Assuming that the right to terminate exists the question remains: should you terminate?

    The commercial picture based on performance or cost may seem clear cut but there may be other factors within the contracts which could change the picture. A decision to terminate will generally need to be made quickly as, if you wait too long to terminate following a breach by the other party which gives rise to the right to terminate, the other party may be able to argue that you have waived the right to terminate. What period of time will amount to a waiver may depend on factors such as the background circumstances, whether the contract includes a no waiver provision and whether or not steps have been taken to reserve the right to terminate (to allow time to consider the wider position).

    If the grounds for terminating are not clearly made out or the termination procedure is not as clear as it should be this will introduce risks which should be accounted for in the decision whether or not to terminate. Generally liabilities incurred by a party prior to termination will survive termination but the relevant contract should be checked to ensure that it does not amend this position.

    Other factors which may need to be considered are:

    • termination of linked contracts;
    • payments;
    • manufacturer warranties;
    • defects and the defects liability period;
    • performance guarantees; and
    • delivery up of documents and information/intellectual property.

    Linked contracts

    It is all too easy to look at EPC and O&M contracts in isolation but they should be considered together, especially given their overlap during the defects liability period.

    Does either contract provide that if it is terminated the other contract is automatically terminated?

    It is common for O&M contracts to provide that if the EPC contract is terminated the O&M contract is also terminated. This is desirable if the EPC is terminated prior to completion, commonly referred to as provisional acceptance (“PAC”), but raises practical issues in relation to post PAC terminations, where the employer will wish to have a new O&M contract in place on termination to ensure the plant is properly maintained.

    It is less common for termination of an O&M contract to trigger termination of the corresponding EPC. However, such provisions should be checked for as if the O&M is terminated before the end of the defects and guarantee period, commonly referred to as final acceptance (“FAC”), this could result in the loss of some benefits under the EPC e.g. the defects liability period, performance guarantees etc.

    Payments

    Payment structures under EPC and O&M contracts may influence not just whether to terminate but also when to terminate (though see the discussion above regarding waiver).

    If all payments under the EPC are to be made by PAC this may make termination post PAC less attractive for the employer. Similarly under the O&M contract if the fee payments are made in instalments in advance, the termination provisions should be checked to see if any part of the fee is refundable on termination. If not, this may make termination at the end of an instalment period more attractive, than termination at the beginning of an instalment period. However, given the level of O&M fees this should not be the determining factor in whether or not to terminate.

    Manufacturer Warranties

    The obligation to obtain and assign manufacturer warranties to the SPV is typically addressed in the EPC.

    Before terminating it should be checked that the contractor has provided executed assignments of the manufacturer warranties, any documents required to claim under them (e.g. invoices, receipts, proofs of delivery etc.) and that the assignments become effective automatically on termination of the relevant contract (if not already assigned). If the EPC (or any resulting executed assignment) does not provide the assignment is effective on termination, or only requires the executed assignment to be produced on termination (or post termination on FAC) this may mean losing the ongoing protection of the manufacturer warranties, which are common on solar projects. It is unlikely that a contractor will co-operate on or after termination to ensure the manufacturer warranties are assigned.

    Defects

    The EPC contract should provide for a 2 year defects liability period running from PAC and a process for notifying defects to the contractor. Terminating the EPC contract before or during the defects liability period may result in the loss of the balance of the defects liability period.

    Following the expiry of the defects liability period the contractor’s liability for defects continues for the remainder of the limitation period (unless expressly provided otherwise) but is reduced to a liability in damages, rather than an obligation to rectify the defects itself.

    Usually the defects liability provisions in the EPC work relatively well as the O&M contractor will usually be the same company as the EPC contractor or a group company. As a result, the contractor (or its group) will be responsible for addressing issues with the plant during the defects liability period at its own cost as defects under the EPC contract or corrective maintenance under the O&M.

    Terminating the O&M and bringing in a new third party O&M contractor during the defects liability period under the EPC can add some complications to this principle. Having unrelated EPC and O&M contractors increases the tension between EPC defects and corrective maintenance under the O&M. It will be in:

    • the EPC contractor’s interest to claim issues are corrective maintenance under the O&M or caused by the O&M contractor’s failure to carry out preventative maintenance; and
    • the O&M’s contractor’s interest to claim they are defects under the EPC.

    This can result in deadlock with the employer caught in the middle of its EPC and O&M contractors, with neither contractor prepared to undertake remedial works at their own cost

    Performance guarantees

    Typically the EPC contract should contain performance guarantees which run in parallel with the defects liability period and which are based on the plant’s average performance ratio (“PR”) at the one year and two year anniversaries of PAC. However, occasionally they can be found in the O&M contract. The performance guarantees are typically backed by a liquidated damages liability if they are not met.

    Before terminating either the EPC or O&M contract the impact of termination on the performance guarantees should be considered:

    • does the termination of a contract extinguish the performance guarantees within it?
    • does termination of the O&M invalidate any performance guarantees in the EPC contract?
    • are the performance guarantees under the EPC contract linked to performance under the O&M contract?

    The above provisions are often expressly dealt with in the EPC and O&M contracts. If a plant is underperforming the effect may be significant, as termination before the completion of the tests during the second year of operation could result in the loss of the liquidated damages payable at the end of the second year. The calculation of the liquidated damages in the second year is typically set to reflect the loss of revenue not just in the second year but over the balance of the plant’s lifetime. Therefore, if termination results in the loss of these liquidated damages this may have a material financial impact.

    Even if termination of the O&M does not expressly invalidate the performance guarantees, consideration needs to be given to the potential impact of bringing in a new third party O&M contractor during the defects liability/performance guarantee period. If the plant is underperforming, this may allow the EPC contractor to allege the O&M contractor has not properly maintained the plant and:

    • that any periods of underperformance fall within the exclusions to the performance guarantee (typically for items outside the EPC contractor’s control such as grid outages, third party actions etc.) and potentially avoid liability for liquidated damages; or
    • avoid the performance guarantee altogether.

    Delivery up of documents and information/intellectual property

    It is likely that any EPC or O&M contractor will have documents which are necessary for the operation and maintenance of the plant and which record its performance. Before terminating any such contract a check should be undertaken to establish what documents have already been delivered by the contractor and whether or not the contractor is obliged to deliver up documents on termination. If there is no such delivery up obligation, and if the contractor refuses to voluntarily deliver documents and data, the employer may find itself without information it requires to operate and maintain the plant and meet its obligations under other associated contracts.

    This also needs to be considered in relation not just to documents but also information, in particular electronic data and monitoring systems. If the plant is monitored and/or data gathered and processed using the contractor’s proprietary monitoring system and/or software it should be considered if access to this and the right to use it will continue post termination. Even if it does, there may be compatibility issues with the systems of any new O&M contractor which will need to be overcome. In the worst case, termination could result in a new data monitoring and/or data processing system and software having to be purchased and installed.

    Conclusion

    Termination of any contract is a not a decision to be made lightly and termination of EPC and O&M contracts is no different.

    Even if a party feels it has no alternative course of action other than to terminate it should consider the wider picture and the potential eventualities which may flow from the termination before it makes the decision to do so.

    Not only does such an assessment allow a party to make a fully informed choice and assess the potential risks, it also gives the party the opportunity to:

    • manage the process should it decide to terminate, so it does so at the best possible time; and
    • put in place risk management measures, irrespective of whether it terminates.

    However, in many instances the parties will be best served discussing the issues which are of concern and seeking to resolve them amicably, if necessary by formally amending the contract. If termination is unavoidable it is still in both parties’ interests to try to deal with the consequences in as amicable and professional a manner as is possible, objectively following the contractual processes. Every effort should be made to avoid issues under the EPC or O&M contaminating the performance of the other contract as this will be costly for both parties, in terms of time, money and other resources.

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