Achieved Capacity and Contracted Capacity
Under clause 4.8 of the PPA (save for the Landfill Gas PPA which is discussed in more detail below), if the Achieved Capacity of the Facility on the Commercial Operation Date is less than the Contracted Capacity for the Facility (being the anticipated capacity of the Facility), the Contracted Capacity will be permanently reduced to the Achieved Capacity of the Facility reached as at the Commercial Operation Date. Regardless of any further testing performed, the Seller will not be entitled to increase the installed capacity of the Facility above the new Contracted Capacity at any time in the future for any reason, and accordingly this restriction poses a substantial risk to a project's bankability.
To mitigate this risk, the schedule of the project and the timing of testing should be aligned with the Scheduled COD and Last COD dates under the PPA to ensure that adequate time is allowed for the Facility to achieve the Contracted Capacity by the Last COD under the PPA
The risk of the project company may also be mitigated by ensuring:
- that the performance testing and performance guarantee framework aligns with the Contracted Capacity and the output capacity in the financial model; and
- that the quantum of the Performance Liquidated Damages is sufficient to compensate the project company for the additional costs and lost revenue resulting from the under-performance of the Facility, and should be reviewed by the project technical advisers.
Performance Testing and Performance Guarantees
As a consequence of the PPA providing for the Achieved Capacity to be fixed at the Commercial Operation Date for all Facilities other than landfill gas Facilities (as discussed above), it is necessary to test (among other things) the Achieved Capacity of the Facility at Commercial Operation.
However, a number of types of performance tests, such as power curve tests for wind Facilities, are only able to be performed after the relevant Facility has been operating for a specified period of time (often 1-2 years).
To accommodate this split, it is common under the RE IPP Programme to have a pre-COD and post-COD twostage performance testing process, with corresponding pre-COD and post-COD performance guarantees. There is also a split arrangement in terms of the remedies available if the contractor fails to achieve the pre-COD or postCOD performance guarantees.
The pre-COD performance guarantees are usually comprised of a Contracted Capacity guarantee. As discussed above, the restrictions under the PPA mean that if the Achieved Capacity of the Facility on the Commercial Operation Date is less than the Contracted Capacity for the Facility, the Contracted Capacity will be permanently reduced to the Achieved Capacity of the Facility reached as at the Commercial Operation Date. If the Contracted Capacity of the Facility is reduced, the Facility will not be able to generate energy at the rate that has been included the financial model for the project. To avoid creating a revenue shortfall, an appropriate remedy for a failure to meet the pre-COD performance guarantees is a reduction in the contract price paid to the contractor that is proportional to the amount by which the Contracted Capacity has been reduced.
As with other types of performance guarantees, performance liquidated damages are an appropriate remedy for a failure of the contractor to achieve the postCOD performance guarantees.
We have included sample testing, performance guarantee and liquidated damages schedules in Appendix 2 that indicate this split between pre-COD and post-COD testing, performance guarantees, reduction in contract price and performance liquidated damages.
Site risk
Under clause 3.2 of the PPA, all risk in relation to the project site (including hydrological, geotechnical and other risks) rests with the Seller.
Lenders will expect that this risk is fully passed through to the contractor under the EPC Contract. However, depending on the specific conditions or circumstances relating to a particular project site, the lenders may be able to obtain some comfort from appropriate site investigations being carried out before and after the Preferred Bidder selection process. If the contractor does not accept the full pass through of pre-existing site risk, the project company may need to provide some form of additional sponsor support.
Application of insurance proceeds
Under clause 19.2 of the PPA, the proceeds of any insurance claim (other than claims under any loss of revenue policies) must be applied by the Seller towards the reinstatement or repair of the Facility unless the Buyer otherwise agrees.
The main issue that arises is that lenders will want to control the application of insurance proceeds, particularly if those proceeds are of a certain threshold and if repairing the Facility is not economically viable. Steps that could be taken to mitigate this risk are to ensure that the lender is identified as a loss payee under the all risks insurance policy in relation to the project, and to provide the lender with a priority security interest over all assets of the project company including insurance proceeds.
Economic Development Obligations
The Seller must meet all Economic Development Obligations placed on it in relation to the project. These are set out in schedule 2 of the IA, and relate to job creation, local content, ownership element obligations, social development, preferential procurement and management control obligations.
If the Seller does not comply with the Economic Development Obligations, the Seller may have to pay an amount (set out in schedule 2 of the IA) to the DOE or accrue Termination Points. If the Seller accrues more than 9 Termination Points in a consecutive 12 month period, DOE may terminate the IA, which will also allow the PPA to be terminated.
Again, to avoid any gaps in liability arising the project company should seek to ensure that all relevant Economic Development Obligations are passed through to the contractor under the EPC Contract to the extent relevant, including exclusions from the cap on liability and from the exclusion of consequential loss in respect of liability arising out of any failure of the contractor to comply with the Economic Development Obligations that results in the project company being in breach of a Project Document.
In addition, the lenders will generally require a buffer period under the EPC Contract whereby a process will be triggered if the Owner accrues a certain number of Termination Points (for example, six Termination Points in a 12 month period) as a result of the Contractor failing to comply with the Economic Development Obligations. This threshold number should be set lower than the number of Termination Points that provide the DOE a right to terminate the IA, in order to provide a step in or cure period for the project company and/or the lenders to ensure that the relevant Economic Development Obligations are met.
Corrupt Acts
Under the IA, the Seller is required to warrant that, in entering into the Project Documents, that it has not committed any 'Corrupt Act', defined as any offence in respect of corruption or corrupt activities contemplated in the Prevention and Combating of Corrupt Activities Act, 2004. The consequence of the Seller (or any shareholder, contractor or affiliate of the Seller) admitting to or being convicted of a Corrupt Act is very serious, with the DoE having an immediate right to terminate the IA, which will have the effect of simultaneously terminating the PPA. As a result, the project company should require the EPC Contract to contain back to back termination rights and, given that the lenders will generally expect to be kept whole, exclusions from the cap on liability and from the exclusion of consequential loss in respect of liability arising out of Corrupt Acts.
Liability
Contractors will generally require a 'cap' or limit to be placed on their aggregate liability under the EPC Contract and for liability in respect of consequential or indirect loss to be excluded.
In our experience under the RE IPP Programme, such caps have generally been subject to number of exceptions, including where the liability arises as a result of (among other things):
- a breach of any Project Document by the project company as a direct result of a breach by the contractor of its obligations under the EPC Contract (including in relation to a failure to meet the Economic Development Obligations or committing a Corrupt Act);
- death, personal injury or cases of third party property damage, unless attributable to any negligence, wilful act or breach of the EPC Contract by the project company;
- a breach of various indemnities provided by the contractor to the project company, including a breach of the requirement to obtain and maintain all necessary consents or of any of the warranties provided in respect of intellectual property;
- a breach of the confidentiality provisions of the EPC Contract; and
- the fraud or wilful misconduct of the contractor, its personnel or its subcontractors.
Exclusion of special or consequential loss
Clause 28.1.2 of the PPA provides that neither party shall be liable to the other party for any Special Loss suffered as a result of any act or omission of the first party. 'Special Loss' is defined as any loss or damage which does not constitute a direct loss, including indirect losses, consequential or special losses and wasted or increased overheads.
In some instances, contractors may seek a broader exclusion of special or consequential loss than that provided under the PPA. To minimise the risk of gaps in liability arising, the project company should ensure that any exclusion provided is back to back with what is provided under the PPA.
As mentioned above in relation to caps on liability, typical exceptions to the broad exclusion of consequential loss provided under the RE IPP Programme include:
- liability which arises from a breach of any project document by the project company as a direct result of a breach by the contractor of its obligations under the EPC Contract (other than liability for Special Loss as defined under the PPA);
- wilful misconduct;
- delay liquidated damages;
- performance liquidated damages;
- recovery of insurance proceeds;
- a breach of various indemnities provided by the contractor to the project company, including a breach of the requirement to obtain and maintain all necessary consents or of any of the warranties provided in respect of intellectual property; and
- a breach of the confidentiality provisions of the EPC Contract.
Grid connection and Self-Build
A key issue for the consideration of project companies is the extent to which additional works may be required to enable a Facilities to obtain adequate access to the Transmission System or the Distribution System, as relevant. These additional works may be comprised of connection works to be performed by Eskom and/or connection works to be performed by the project company (known as 'self-build' works). Some project companies in the RE IPP Programme have elected to pursue the selfbuild option due to a need to accelerate project works in line with the schedule.
The connection works are governed by a set of standard form documents. For example, the key documents for the connection of a Facility to the Distribution System are:
- the Budget Quote (containing the terms and conditions for the connection works to be performed by Eskom to connect the Facility to the Distribution System);
- the Distribution Connection Use of System Agreement (containing the terms and conditions of the connection of the Facility to the Distribution System, the access and use of the Distribution System and the delivery of electrical energy from the Facility); and
- if applicable, the Self-Build Agreement (containing the terms and conditions for the self-build of Eskom Distribution Connection Assets by customers).
In selecting the self-build option, project companies need to consider the additional risks that may arise, including:
- additional delays and costs incurred in procuring access land required to complete the self-build works;
- delays in completing the self-build works that may delay other elements of the project works and potentially impact on the project company's right to receive compensation in respect of System Events under the PPA; and
- other risks that may arise under the Self-Build Agreement itself.
Project companies also need to be aware that under the Self-Build Agreement there is a requirement that all 'Contract Works' (as defined in that agreement) are performed only by an Eskom Accredited Contractor.
Project companies should also be aware that the definition of Force Majeure provided under the Self-Build Agreement is broader than the definition of Force Majeure under the PPA, which creates a potential gap in liability.
Early Operation and Staged Completion
The PPA provides a process for the 'early operation' of one or more units of the Facility to occur before (but no more than 180 days before) the Scheduled COD. Early Operating Energy Payments are available for any energy produced during the Early Operation Phase at a rate of 60% of the Commercial Energy Rate that is available after Commercial Operation of the Facility is achieved.
Although the project company is permitted to operate one or more units of the Facility under the 'Early Operation' provisions of the PPA, it is not permitted to have phased or staged completion or commissioning of the Facility. Although this is not specifically stated in the Project Documents, it has since been clarified by the DoE in Briefing Note 4.
Accordingly, the project company will not be entitled to apply for certification or to achieve Commercial Operation in respect of the Facility before the Scheduled COD. These limitations need to be taken into account in preparing the financial model and in considering any early completion bonuses that may be payable to the contractor.
Dispute resolution
Clauses 26 and 27 of the PPA set out the dispute resolution process to be followed in respect of any dispute arising in relation to or in connection with the PPA. It provides an escalating process from internal referral to litigation in the High Courts. It also provides for a 'fast track' dispute resolution process for disputes to be determined by an independent expert.
Given that many of the parties involved in the RE IPP Programme projects are international, in our experience there has been a strong preference for the use of arbitration (rather than litigation) as the preferred dispute resolution mechanism under EPC Contracts. In these circumstances, the project parties need to consider the implications of this potential mismatch and the extent to which the EPC Contract can be aligned with the PPA to allow the joinder of disputes where required. These issues should be considered on a case by case basis, depending on the identity of the relevant parties,
Other issues
In addition to the issues set out in this section that are specific to the RE IPP Programme, many of the issues set out in Part 2 are also relevant in the context of the RE IPP Programme.
© DLA Piper
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