Power projects: Dealing with defects

We have already looked at how power projects construction contracts work (27 July, 2012) and some operational and performance risks (12 October 2012). This last article in the series looks at how defects are dealt with post completion.

The plant will be required to pass a specified regime of testing and failures will result in the application of liquidated damages or, theoretically, in extreme situations, the right to reject the plant. Alongside any testing regime that applies both immediately before and after completion, the contractor will be required to make good any identified defects in the plant.

There are two obvious stages to this:

• Defect correction period

This will be 12-24 months. During this period the contractor must rectify defects identified to it, or by it, as defined under the contract. The issues are what a defect is and how the correction regime operates.

The definition of “defect” does not always get paid close attention at contract drafting stage. Is it a failure to meet the employer’s requirements, for example, regarding performance or availability? Is it limited to defects that are found to be the contractor’s fault? An employer or plant operator does not have time to find out who has caused a problem before it is fixed. The likelihood is that the contractor’s obligation is to correct it, regardless of cause.

The problem arises where the failure identified is one of performance and the underlying defect is not immediately known. The performance or availability guarantees may have been called on - which are usually capped - but nobody has identified exactly what is causing the poor performance. It may be a combination of factors. This is where the defect correction regime fails. The contracts are silent on how to resolve this impasse, other than dispute resolution.

Those procuring power plants will have preferred time frames and procedures for correction of defects depending on the severity or nature of the defect. Mechanical or operational issues may have a separate time frame for resolution. Sometimes defects cannot be repaired until the next planned shutdown. In those situations contracts are likely to provide for recovery of consequential loss if there is an unplanned shutdown.

Operator error or simply a failure to operate a plant in an optimum fashion may well give rise to problems that are initially identified as defects

Operator error or simply a failure to operate a plant in an optimum fashion may well give rise to problems that are initially identified as defects. Similarly, failings of mechanical parts in the plant are likely to involve specialist suppliers or subcontractors. The contractor may have some form of “carve out” excluding its liability for defects provisions for this, if not its responsibility.

There is likely to be a provision that extends the defects period for parts of the plant repaired or replaced during the defects correction period. The value of this may be limited unless the defect is a discrete piece of kit for which one can see the value of an extended “guarantee”. There may also be a requirement to repeat certain tests to show the defect has been rectified.

• After the defect correction period

Most contracts contain a period of liability for latent defects after the expiry of the defects correction period. They do not leave it to the underlying law to assess the period of liability. This can be expressed in two ways. Firstly, positively, by a provision that says the contractor shall be liable for defects appearing for a period of X years post expiry of the defects correction period, or secondly, negatively, by way of cut-off, stating that the contractor’s liability under the contract will cease X years from the end of the liability date, unless notified or taken to formal proceedings before then. The term “liability date” is how NEC expresses it but it may simply be an ascertainable cut-off date.

Where it is expressed as a positive obligation on the contractor, the provision will normally cover whether the contractor will be expected to carry out these works - such an obligation after the defects correction period is not implied. It will also spell out when the employer may pay others to do so and recover the costs from the contractor.

• A final certificate

If there is no latent defects cut-off period, one relies on the underlying law. A contractor’s liability for defects may be brought to an end where the contract provides for and where a final certificate has been issued. The wording of the provision may shut the door to further claims.

The argument is that this makes commercial sense, against the background of a contract that provides for a stringent completion and performance/acceptance regime when the contractor is under very onerous obligations to rectify defects. This is not a view that prevails with current contract draftsmen and - not least - funders. Their aim is maintain as lengthy a latent defect period as possible.

Lindy Patterson QC is a partner in Dundas & Wilson