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How to Secure Projects: The Significance of Insurance in Project Finance

17 February, 2019

Extended liquidated damages insurance

In the last 5 or 6 years some projects have had the benefit of insurance which is designed to pick up the risk after the contractor's liability has been exhausted, these kind of policies mirror the construction contract provisions in relation to time and put the insurer on risk after the date for mechanical completion (as extended pursuant to the EPC contract) and contain an excess which is usually equal to the extent of the liquidated damages which the contractor has agreed to pay for delay. Additionally, these policies are relatively unusual and bespoke as well. The insurers will engage in an exercise of due diligence. They will be particularly interested to understand the quality of the contractor and its previous performance. Therefore, insurance is more likely to be obtained if the contractor is an international organization of repute and they will be particularly interested to understand the extent to which the contractor has accepted liability for the losses due to the delay in relation to the design. Any bankability studies by independent engineers are of assistance, but the insurers will usually engage engineers to do a further review; moreover, they will be keen to establish that there is no novel or experimental engineering associated with the project finance. They will seek disclosure in proposal forms relating to this issue. They will also seek to make it a warranty to the effect that the project does not contain any such novel or experimental technology.

Commissioning and ramp up

Each process plant is unique. Accordingly, it is always anticipated that it will take some time from mechanical completion to commission the plant and ramp it up to full production.

At this stage of the project, the owner invariably wants to be in control of the plant. However, particularly with inexperienced owners, there is significant risk that it will not have the technical or other expertise to effectively ramp up the plant to full production or educate its operators as to how to operate the plant. For these reasons, where, firstly there are inexperienced owners; or the project is financed on a limited recourse basis.

The owners will sometimes enter into an agreement whereby the EPC contractor or perhaps the process provider, provides commissioning and ramp up assistance.

Such contracts often stipulate a ramp up curve and liquidated damages for failure to achieve production levels anticipated at the time of contract.

Usually, the liquidated damages stipulated are a cap on the contractor's liability. The prevention principle is very important. If the production levels set are not achieved as a consequence of an act or omission of the owner then, pursuant to the prevention principle, it is highly arguable that the liquidated damages payable pursuant to such a ramp up agreement will be unenforceable. When coupled with an exclusion of all consequential loss liability the owner will arguably be left with no remedy. This outcome is a distinct possibility in circumstances where the owner has taken over responsibility for the operation of the plant. Accordingly, it is recommended that there be a mechanism, similar to an extension of time provision under a conventional construction contract, whereby the thresholds stipulated in the contract can either be adjusted or the period in which performance is to be achieved can be changed to take account of acts or omissions of the owner. Again, it is also important to ensure that the liquidated damages clause is not a penalty and is a genuine pre-estimate of the loss.

Works insurance

Works insurance or Construction All Risk (CAR) insurance is a fundamental component of risk mitigation in process engineering projects for both the owner and the EPC contractor. However, it should be noted that this type of insurance has significant limitations. In addition, there is a marked difference between the risk that is covered by policies that cover projects occurring offshore and those occurring on-shore.

The primary purpose of CAR insurance is to insure the physical works or facilities being constructed against loss or damage arising from an "occurrence". In other words, this type of insurance is an event-based insurance where the insurance will trigger if an "occurrence" happens which causes physical loss or damage to the works. "Occurrence" will be defined by the policy wording but in general it will include events such as fire, natural disaster as well as the negligence of or mistake made by one of the parties. Both the owner and the EPC contractor are named as insured and it is common for either the owner or the EPC contractor to take out the insurance. With such policies care should be taken, where a party to the construction contract give indemnities to the other party which are also given by an insurer, to: avoid creating coordinate liabilities between the indemnifying party and the insurer which would give the insurer the right to seek contribution from the indemnifying party; ensure that the policy of insurance taken out in the joint names of the parties has a waiver of subrogation clause, to avoid the insurer subrogating to the non-indemnifying party's right and seeking to recover from the indemnifying party

Finally, exclusions of liability can become problematic. The extent and nature of the exclusions will have a significant impact on the risk allocation that will be agreed as between contractor and owner. In this regard there is a major difference between the likely approach for an on-shore project finance and an offshore project given that the nature of exclusions in offshore CAR policies has undergone significant recent change.

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