An Operation and Maintenance agreement is an agreement between the project owner and an operator for the management, operation, and maintenance of a project. The operator is responsible for ensuring that the project is operated in line with all applicable contractual and legal obligations. The Operation and maintenance (O&M) contract have a substantial impact on the outcome of any project finance transaction, as it is one of the most important contracts.
In this article, operation and maintenance agreement, we take a look at the process involved and the options available to you.
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What are the first things to consider with an O&M agreement?
When considering operation and maintenance, it should be immediately apparent whether the contractor is also connected to the project in some other way. Under the conditions of the engineering, procurement, and construction contract (EPC), for example, is the contractor a member of the same group of enterprises as the construction provider?
If so, the interface between the O&M and the EPC must be considered and back-to-back provisions must be incorporated into each contract to prevent the contractor and the construction provider from relying on:
- the acts or omissions of the other as a defence to its own delay, or non-performance of the relevant contract; or
- delays or underperformance by the other in order to obtain relief from the customer under the relevant contracts.
Inattention to the integration of the front end legal terms and the services scope outlined in the O&M schedules can result in a misalignment between the parties’ service expectations and, in the worst case scenario, a complete contradiction leading to a lawsuit. This is due to the fact that the description of the contractor’s services duties will be complicated and will require project-specific technical competence, which must be encased in competent legal wording.
Owners obligations
During the term of the Agreement, the owner’s primary obligation should be to pay the operator. Payment will be made out of the proceeds of the offtake agreement and, if at all possible, should be limited to these quantities.
However, there will likely be additional significant ongoing commitments, such as the provision of electricity, fuel, water, and other consumables. In addition, the Agreement shall stipulate additional obligations relevant to the Owner. For instance, the owner may be required to furnish an initial inventory of spare parts (which should be identical to the inventory of spare parts to be delivered by the contractor under the building contract). In addition, the owner may be required by the offtake agreement to maintain records regarding the operator’s compliance with specific topics (such as fuel use and waste disposal), which may impact the owner’s payment obligations under the Agreement. The Agreement should also include payment mechanisms (such as mechanisms for payment of owner-supplied spare parts, major overhaul expenses, costs resulting from work performed by the operator outside the scope of services described in the Agreement, changes in the law, and other potential factors that may necessitate adjustments to payment provisions).
Performance obligations
The Agreement shall outline the operator’s performance requirements during the term of the Agreement. Depending on the nature of the project, the performance requirements should normally include availability, outages, production levels, and other technical, quality, safety, and environmental protection performance criteria. The Agreement shall also indicate the levels of performance that may give rise to rights to damages and/or termination if performance falls below a specified threshold. In some instances, there may also be a gain share mechanism that provides bonuses for operators whose performance exceeds a certain threshold. Additionally, the performance levels attained by the construction contractor at handover should be mentioned. With appropriate changes (such as degradation curves), these levels should serve as a baseline for the operator’s performance expectations. Moreover, on a power project, for instance, it is crucial that the technical and legal advisors confirm that the performance testing and performance guarantee and liquidated damages schedules to the Agreement comply with the respective schedules to the construction contract.
Mechanisms for payment, incentives, and liquidated damages
The payment mechanism in an O&M agreement can be arranged in a variety of ways. The operator may be compensated with a predetermined fee, reimbursement, or, more commonly, a combination of the two.
Controlling O&M expenses is a top priority for the project firm and the lending institution. The most efficient method for them to accomplish this is to agree on a fixed cost for operating and maintaining the facility. However, operators rarely accept this, and it is unlikely to offer the best value. Key to the payment arrangements is the incentive for the operator to maximise the project’s revenue. This is typically accomplished by allowing the operator to receive more compensation or a bonus for superior performance.
Typically, an operator will be required to pay liquidated damages to the project firm if it performs poorly and the project is not operated or maintained to the agreed standards. Usually, these payments are set so that the project business may satisfy any obligations incurred under the concession contract or offtake agreement. However, these are often limited to a percentage of the costs charged to the O&M operator. The implementation of the liquidated damages regime relies on the nature of the project.
Impact Of Force Majeure
A crucial question is whether the Agreement effectively addresses the repercussions of a force majeure incident.
During the negotiation of the project contracts (where the owner’s obligations are mostly confined to payment, as is the case with operation and maintenance agreements), the force majeure clauses should be standardised throughout all documents. If such clauses are not aligned and there are significant liability gaps kept by the owner, lenders will typically want some type of sponsor support.
The parties should be aware that the effects of a force majeure event during the construction phase are serious but likely manageable, as even a prolonged force majeure event will only increase construction costs and postpone completion. This risk can be distributed amongst the parties to the project before to the project’s initiation and accounted for when assessing the project’s economics and contingencies.
However, a protracted force majeure occurrence during the operation time may result in an insurmountable problem. In such a case, the operator may be unable (even if it were willing to increase its financial contribution, which it often is not) to meet the performance level outlined in the Agreement. This will have a direct impact on sales
Indemnities
As with other commercial contracts, indemnity clauses are prevalent in O&M contracts and play a crucial role in distributing risk between the operator and the project company. An indemnity is a contractual agreement to assume responsibility for another’s loss. It is particularly applicable as a risk allocation technique when one party creates a risk that causes the other party to suffer or incur a loss as a result of a third-party claim. However, indemnities are not limited to third party claims, and a party may agree to indemnify the other party for the consequences of the first party’s violation of contract.
There are several indemnity provisions, and the particular phrasing of an indemnity is crucial since it determines its scope and the amount of the remedy. An indemnification may cover a variety of topics. For instance, it may cover solely third-party claims, “all losses” originating from any claim related to the subject matter of the contract, or simply those arising from a certain range of services. Typically, an indemnity covers death, injury, or disease to persons, property damage, and other consequential losses; however, it is crucial to identify precisely which losses are meant to be covered or excluded under each of these categories.
One of the primary purposes of an indemnity in an O&M contract is to protect the indemnified party from the risk of third-party claims arising from the indemnifier’s breach. The indemnity clauses must take into account the nature of the operations and maintenance, the specific risks that may occur, and the competence required to manage these risks. Indemnities may be of limited or no value if the indemnifier does not have adequate assets to back up the indemnity; hence, insurance coverage is also crucial. However, not all risks covered by an indemnity are insurable, and the capacity of each party to withstand any potential loss is a crucial factor.
How we can help
We have a proven track-record of dealing with operation and maintenance agreements. Not only does our construction department have extensive legal experience and knowledge of construction law but we also have the benefit of chartered surveying experts. We will guide you through the process and ensure all checks are carried out swiftly and efficiently and we firmly believe that with the right solicitors by your side, the entire process will seem more manageable and far less daunting.
How to Contact Our Construction Solicitors
It is important for you to be well informed about the issues and possible implications of operation and maintenance agreements. However, expert legal support is crucial in terms of ensuring a positive outcome to your case.
To speak to our Construction solicitors today, simply call us on 0345 901 0445, or click here to make a free enquiry. We are well known across the country and can assist wherever you are based. We also have offices based in Cheshire and London.
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