Pinsent Masons Urgent Briefing header image

Use of FIDIC in water projects - 10 key points to consider

August 2006

 

 

This article was written by Sarah Thomas , Partner, Pinsent Masons.

 

It has been forecast that by 2025, 3 billion people in 48 countries will face a water shortage.  The World Bank recently acknowledged that an investment of between US $600 to US $800 billion was required over the next 10 years mainly to bring water and waste water services up to acceptable standards.  Thus the potential scope for major water infrastructure projects worldwide is huge.  On the international scene, the FIDIC rainbow suite of contracts remains the most commonly used international standard form for major infrastructure projects, particularly in Africa, the Middle-East and, increasingly, the new accession and pre-accession countries in south-eastern Europe.

This article explores the use of FIDIC forms in water and waste water treatment projects.  It focuses principally on the EPC Turnkey form (or "Silver Book") and the design and build form ("Yellow Book") and the ways in which these two forms deal with what I shall term "my top 10 issues" particular to water or waste water projects.  Essentially, there are 2 key differences between the Silver and Yellow Books.

Firstly, under the Silver Book (unless otherwise stated) the Contractor is responsible for the correctness of Employer information (both Employer's Requirements and any Site Data) including any Employer design.  Secondly (and possible more controversially), the Contractor is deemed to have included in his Contract Price for any eventuality that may arise (whether foreseeable or not) including unforeseen physical conditions whereas under the Yellow Book the Contractor will obtain time and money for "Unforeseeable" physical conditions.

Issue Number 1:  Flows and Loads, Influent Parameters

Flows and loads data or 'influent parameters' determine the design "envelope" for any water or waste water treatment plant.  Under FIDIC, who takes responsibility for the accuracy of such data or correctness of any design assumptions based on this data?  If flows and loads or influent parameters are included in any Employer provided design (the "envelope") or if it forms part of the Employer's Requirements, the position is different under the Yellow and Silver Books.

Under Yellow, the Employer is responsible for its own design and the correctness of Employer's Requirements.  Under Silver on the other hand, design responsibility lies solely with the Contractor including for any outline design provided by the Employer (unless expressly carved out).  In addition, the Contractor is responsible for the correctness of the Employer's Requirements (clause 5.1).  There are carve outs but these are confined to definitions of the intended purposes of the works, testing and performance criteria and data that cannot be verified by the Contractor.  Thus, it is important to expressly carve out, as the Employer's responsibility, any calculations for flows and loads.

Issue Number 2: Provision and Accuracy of Data

Another issue to consider is whether flows and loads information is "Site Data" as defined under FIDIC – as all Site Data must be made available to the Contractor (both before and after the Base Date, being the last date for submission of the Contractor's tender).  But this is unlikely as "Site data" is confined to data on sub-surface or hydrological conditions at the Site.  In any event, under the Silver Book the Contractor will still be responsible for interpretation of such data.

Issue Number 3: Dealing with key kit suppliers

Water and waste water projects, by their very nature, often require the design, manufacture and installation of major process kit to be subcontracted to single source specialist suppliers.  It is important that the contractual documentation makes adequate provision for the Employer's control over such key kit suppliers – both in terms of approval of sub-contract terms (including in particular any performance specification or performance guarantees) and also to allow the Employer to sue the key kit supplier direct in the event of non-performance (affecting performance of the plant as a whole).  In my view, neither the Silver nor Yellow Books adequately protect the Employer where there are single source suppliers to whom a large element of the works are subcontracted.

Whilst under Yellow, the Engineer's prior consent for suppliers of materials or subcontractors is required unless the subcontractor is named in the Contract, under Silver there is no facility for approval of major/design subcontractors or subcontracts by the Employer.  Presumably the rationale is that this is in keeping with a Turnkey "hands off" philosophy - the Contractor is responsible for delivery of the Works and therefore it is up to him as to how he delivers.  In both forms the Contractor remains responsible but would an employer or a funder of a major water treatment plant wish to take the risk of the Contractor's solvency in relation to key elements of design, process or kit?  Equally, some contractors may themselves want to carve out risk in relation to certain design elements or key kit (particularly where it is state of the art and the technology is untested).  They may therefore be looking for more robust protection (in the form of direct collateral warranties, performance guarantees to the Employer) rather than providing this themselves.  This is particularly the case where a key kit supplier is effectively a nominated subcontractor.

There is also no standard form FIDIC subcontract – a lacuna that the FIDIC organisation itself readily admits.  For these reasons, the subcontracting provisions under FIDIC need further consideration.  Collateral warranties to the Employer or funder should be added to the FIDIC package, particularly regarding provision of spares, design life guarantees and performance guarantees.  In addition I would expect the Employer or funder to approve subcontract terms where a key element of design and/or kit is being sub-contracted.

Issue number 4: Intellectual Property Rights or IPR

If I were a contractor, I would have some concerns that the drafting of clause 1.10 is not sufficiently tight to protect my Intellectual Property rights or "IPR".  As with any process plant, the preservation of know-how is precious to the Contractor (particularly for state of the art technology, e.g desalination or water filtration technology or waste to energy technology where extensive R&D budgets have been used to ensure a competitive edge over rivals).  Contractors may be surprised to see that the definition of Contractor's Documents in clause 1.1.6.1 is very widely drawn and includes not just the usual menu of drawings and manuals but also extends to "computer programs, other software and models".  Software and programs may in fact be owned by third parties.  Does the Contractor have back-to-back arrangements? 

Programmes, software and models would also be capable of being used for other projects and therefore it is important to see the extent to which the Employer can use such documentation strictly limited.  Whilst the Contractor does retain copyright in IPR in the Contractor's Documents themselves (clause 1.10), the Employer is granted a wide "non-terminable, transferable royalty fee" licence to use Contractor's Documents including the right to copy, use, communicate and modify such documents.  As drafted, it is not entirely certain that this licence is limited "for the purposes of completing, operating, maintaining, altering, adjusting, repairing and demolishing the Works" (in the second part of the clause).  Whilst the intent of the drafting was clearly to limit such use to modifying or altering the Works themselves, it is not clear that the drafting achieves this.  Therefore a Contractor may wish to revisit clause 1.10 and ensure it is watertight.  While the Contractor retains the IPR and its documents and is concerned the Employer cannot re-use these documents for other projects without paying a fee, the Employer's need for flexibility should also be considered.  The Employer needs to be able to copy, use and modify these documents for long-term maintenance, modification, extension etc without fear of infringing IP rights.

Issue Number 5: Testing, Commissioning and Completion

Both Silver and Yellow Books provide for a 3-stage commissioning process before take-over (Tests on Completion):

Pre-commissioning tests, including "dry" functional tests;

Commissioning tests, including operational tests to demonstrate that the Works or relevant section operate safely, as specified and under all operating conditions;

Trial operation to demonstrate that the Works or section perform reliably and in accordance with the Contract.

Tests should be tailored to the plant being built, their purpose being to show that the Works conform with the Employer's Requirements and that the plant operates to the standards specified.  It is in the interests of both parties to ensure that testing criteria is drafted in such a way that it is clear, precise and a pass or fail is objectively provable.  The basic structure of FIDIC allows for this as Performance Guarantees/Schedule of Guarantees can be included.  There are no limits as to the length of time in which testing is to take place so the basic structure in FIDIC also allows for continuous wet line commissioning.  Of course the detail will need to be included in the relevant schedules and particular conditions.

The legal significance of passing Tests on Completion is threefold:

Risk in the Works passes to the Employer (ie insurance);

Liability for delay damages ceases for the Contractor;

Defects liability period starts.

What often delays completion of water projects is a failure to pass the Tests on Completion themselves, especially continuous wet line commissioning.  Failure to pass tests can lead to rejection of the Works by the Employer (one should consider the implications where the test failure is minor or is a systemic failure that is effectively irremediable) and the Contractor must promptly remedy the defects.  The Employer can order further repetition of tests and if failure deprives the Employer of substantially the whole of the benefit of the Works or relevant Section, the Employer can terminate.  The Employer does have an option to take over and reduce the Contract Price to reflect reduced value.  But in practice, how can this reduced value be calculated in a waste water treatment plant context?  One might possibly consider increased operating costs or the cost of additional consumables although there are a number of scenarios where the flexibility of this option is unlikely to benefit.

The option contained within clause 12 for tests after completion should also be considered.  This allows guaranteed performance to be demonstrated under normal operating conditions and also for performance liquidated damages in the event of failure.  These types of provisions are common in other standard forms of contract used for process plants, such as IChemE.

Issue Number 6: Contamination or Pollution Incidents (during Testing and Commissioning Process)

Everyone agrees that the Contractor should not take the risk of third party contamination or pollution incidents over which he has no control, but what happens if such contamination or pollution occurs during the testing and commissioning process itself?

There are a number of issues to consider.  Aside from problems of causation and the burden of proof which the Contractor would have to overcome (i.e. to demonstrate that it is contamination or pollution that is causing the plant to fail rather than defective design or construction), who is taking the risk of the influent parameters in the first place?  This comes down to the definition of "contamination" or "pollution incident".  Understandably, the FIDIC basic standard form does not deal with contamination or pollution incidents (not caused by the Contractor as such).  Therefore there is an issue as to how an incident should be defined.  A starting point would be to list maximum and minimum concentrations of pollutants within the influent parameters and specify who takes the risk should influent parameters fall outside these maximum/minimum concentrations.  If there is an extreme event, the force majeure provision could be used – with time and cost allowances for the Contract (see clause 19.4).  But what about the more run of the mill industrial contamination/pollution which are eminently foreseeable and so do not fall into a force majeure category?  As such an incident probably does not qualify as an Employer's risk, it will therefore need to be separately provided for, including relief from sanction (an extension of time to avoid delay and liquidated damages) and the Contractor's costs insofar as he has been disrupted or the works or his equipment have been damaged.

Issue Number 7: Liquidated Damages

There is no provision for liquidated damages for failure to pass performance tests unless you use the optional provisions in clause 12 (Tests after Completion).  As with any standard form construction contract FIDIC provides for damages for delay in clause 8.7 (linked to Take-Over).  These are sole damages (although not a sole remedy so termination would still be available to the Employer).  Whilst this does provide certainty there may still need to be a genuine pre-estimate (depending on the jurisdiction). 

However the Contractor should not (certainly in an English jurisdiction) hold out too much hope of invalidating liquidated damages provisions on the basis of a penalty unless the level is manifestly unreasonable.  Liquidated damages can be subject to a cap although this will need to be expressly stated in the Particular Conditions.  Limitation of liability is also dealt with more generally at clause 17.6 and it should be noted that consequential loss is excluded – often an issue (particularly for Contractors) in a water treatment context where the risk of third party losses/damage (in terms of non-compliance with legislative obligations/standards/consents), non-performance of third party users, liability for contamination of pollution are often an issue.

Issue Number 8: Defects Liability Period

What is termed in FIDIC the Defects Notification Period is 365 days unless otherwise stated in the Particular Conditions/Appendix to Tender.  The expiry of the Defects Notification Period where sectional completion is used is the key issue in a water plant context.  This is because a large waste water treatment plant may have a number of component parts (eg waste water treatment, gasification/waste energy, sludge treatment) and so be taken into use by the Employer in stages.  Under FIDIC, the defects liability period is calculated from the date of completion of a Section or of the Works (but not both).  It can be extended by the Employer if, following taking over, the Works, a Section of the Works or a major item of plant are unusable.  Thus the Defects Notification Period for different sections of the plant will not necessarily be aligned.  An employer will want to revise the definition to extend the periods for earlier Sections so that none expire until expiry of the Defects Notification Period for the last remaining Section.  Under FIDIC, the period cannot be extended by more than 2 years although it is common in a water treatment context to have a Defects Notification Period or extended maintenance warranty for anything up to 5 years.

Issue Number 9: Regulatory Backdrop

In an international context it is of course important to know your local law as a Contractor is required to comply with all applicable Laws (clause 1.13), technical standards (of the "Country" in which the Works are being carried out) and other standards in Employer's Requirements (clause 5.4).

The broad definition of "Laws" includes national and state legislation, statutes, ordinances and other laws and regulations and bye-laws of any "legally constituted public authority".  However it may not be wide enough to include all consents and non-binding requirements eg non-mandatory guidelines of, in the UK context, the Health and Safety Executive or Environment Agency, etc).  Other amendments to consider are the addition of a definition of "Good Industry Practice" (there is no defined term in FIDIC), particularly when operating in a jurisdiction where no clear national standard is apparent.  If kit is being sourced from outside the "Country" (ie the country in which the Works are carried out), references to British, European or other national or international standards in the Employer's Requirements themselves should also be considered.

For long term projects, a change in Law may lead to an adjustment of the Contract Price as well as an extension of time under FIDIC (clause 13.7).  Of course this only refers to a change in the laws of the Country in which the Works are carried out, not any change in law in a country from which key elements of kit may be supplied. 

 

Issue Number 10: Operations and Maintenance Interfaces

In a water project context there is a growing awareness of the need to involve the operator from the beginning to the end of a project given that water treatment projects by their very nature are not replaced for 40 to 50 years and therefore the kit and equipment needs to be maintained properly, efficiently and sustainably in the interim.  Unsurprisingly, as FIDIC is standard form, neither the Silver nor Yellow Books provide for specific requirements such as particular design life or lifecycle requirements.  Neither do they provide for any significant operator input into design.  There is scant provision for Employer/Engineer review of Contractor's Documents (including drawings, calculations and other documents of a technical nature) but only to ensure "compliance with the Contract" (clause 5.2).  The review therefore only identifies non-compliance; it is not intended to "improve" the design.  Further the standard period is only 21 days, too short a period to allow for a more sophisticated, iterative process that may be appropriate in a water plant context.  These issues would therefore need to be covered off in the Employer's Requirements or in the Particular Conditions.

So what can be said in conclusion about the use of FIDIC for water projects?  FIDIC remains a sound starting point for any major infrastructure project and this includes water projects – it has a flexible structure and its risk allocation is (aside from some elements of the Silver Book) evenly balanced.  However, in a water project context there are a number of water or process specific issues that will need to be addressed specifically in the Particular Conditions and tailored, not just to the individual project, but also to the nature and type of jurisdiction in which the Works are being carried out.

Sarah Thomas is a partner in Pinsent Masons' International Construction and Energy division specialising in major infrastructure projects, particularly in the process, water and energy sectors and in the regulatory backdrop against which such projects are carried out.  Sarah can be contacted on +44 207 490 6273 or at sarah.thomas@pinsentmasons.com.

 

For media enquiries contact :

Lakhbir Rakar
CM PR Advisor
Pinsent Masons
Direct Dial +44 (0)121 260 4005
Fax +44 (0)121 626 1040
E-mail lakhbir.rakar@pinsentmasons.com