Splitting the risk: Key considerations for Split Contracting Models in Australia’s energy sector

Introduction

Full-wrap, turnkey EPC contracting models have traditionally been the prevailing approach for project-financed renewable energy projects in Australia, reflecting lender preference for a single point of responsibility across design, procurement, construction and performance. However, as explored in the first part of our contracting models series, the market has shifted to favour split and hybrid contracting models, in part due to the lack of contractors offering full EPC capability. This shift towards split and hybrid delivery models is increasingly evident across solar PV and BESS projects, including in circumstances where BESS is integrated into existing projects with established EPC and O&M arrangements.

In this article, we examine:

• the key interface risks under split and hybrid contracting models, including the potential for contractor disputes and delays in achieving commercial operation;
• the principal risk mitigants required by financiers; and
• emerging approaches to risk allocation in solar PV and BESS projects.

Key interface risks and principal risk mitigants

(Interface management) In a split or hybrid contracting model, EPC works are divided between multiple, and often unrelated, contractors, who must work together to deliver the project. To manage these various workstreams, a project developer may consider implementing:

1. a consolidated program;
2. coordination deeds or responsibility matrices; and/or
3. clear specifications as to the time, cost and quality of each contractor’s scope.

Having robust management processes in place is key to avoiding overlapping scopes, ensuring no key aspects of the works are neglected, maintaining project quality and achieving project milestones.

Overlapping scopes and multiple interface points tend to complicate contractor claims, as ultimate responsibility is often difficult to determine. The resulting disputes further delay works and create additional risk to recovery for contractors.

To mitigate these risks, stakeholders expect to see a stronger emphasis on contractual interface protocols and coordinated claim regimes.

(Commercial Operation Date (COD)) Significant risk exposure sits in coordinating the timely achievement of commercial operation where multiple contractors contribute to critical path activities (including energisation, commissioning and grid compliance), but no single contractor wraps the responsibility for completion. Accordingly, there is no single point of recourse for the project developer if the intended COD is missed.

(Warranty and Defects Liability Period (DLP)) In split or hybrid delivery models, contractors are less likely to accept the project COD as the commencement date for their warranty and DLP periods if COD is contingent on completion of third-party contractor works. Rather, contractors may negotiate for their warranties and DLPs to start running from the completion of key milestones within their sole control. This can create inconsistencies in the duration of contractor DLPs following the project COD, affecting the project developer’s ability to call on contractors to remedy defective works.

To mitigate these risks, financiers typically expect to see alignment in warranty and DLP periods following project COD.

(Financing and bankability pressure) In the absence of the full-wrap model’s single point of accountability, lenders require a clear risk allocation and strong security mechanisms to cover potential liability and ensure continuity of works. These include:

1. tripartite deeds or direct agreements with key contractors to preserve the lenders step-in rights, alongside enhanced security packages such as parent company guarantees and performance bonds;
2. aggregated liability caps and downside modelling, as lenders assess whether capped exposures are sufficient to cover worst-case scenarios; and
3. other evidence that the project developer has internal technical and financial capability to manage multi-package delivery risk.

(Contractor default and insolvency risk) In a split contracting model, contractor insolvency can have broader project-wide impacts due to the interdependency of work packages. Where a replacement contractor is required to take over partially completed works, this will invariably lead to adverse pricing outcomes. Incoming contractors will typically price a premium to reflect the additional risk of assuming responsibility for incomplete or non-conforming works, and uncertainty around the condition and status of installed equipment. This is often compounded by reduced competitive tension in a re-procurement scenario and the need to mobilise on an accelerated basis.

These pricing impacts are unlikely to be fully offset by available security from the insolvent contractor. While step-in rights and security instruments provide some financial protection, they do not address the broader integration and re-performance risk associated with introducing a new contractor into an existing delivery structure.

As a result, developers face increased project management complexity, including re-sequencing of works and coordination across multiple contractors, with consequential impacts on cost to complete and the timing of COD. In this context, contractor creditworthiness and ability to deliver becomes critical. Financiers will typically seek appropriate controls around the appointment of replacement contractors for key scopes.

Emerging approaches for risk allocation

The following approaches have emerged to allocate risk appropriately for split or hybrid contracting models:

1. (Interface agreements) Sophisticated interface agreements are increasingly adopted to clarify roles, define boundaries, and apportion risk within complex works.^[1]
2. (Standardised DLP regimes) There is a growing emphasis on standardising and aligning DLP regimes to mitigate the inherent risks of delays and variations in interdependent projects and preserve a clear window for defect rectification.
3. (Performance risk) Projects are moving away from a single, holistic performance guarantee traditionally given by EPC contractors and are instead relying on long-term service agreements and manufacturer warranties for performance reliability.
4. (Creditworthiness) There is greater emphasis on contractor creditworthiness, as demonstrated through historical performance and the ability to provide diverse securities, including bank guarantees, performance bonds and parent company guarantees.
5. (Contract alignment) Stronger alignment of technical design and performance requirements in construction contracts against the requirements under offtake agreements during early planning stages allows for construction, delivery and financial risks to be identified and managed proactively. ^[2]
6. (Staggered delivery) In the context of hybrid solar PV and BESS projects, delivery is increasingly staggered between solar COD and BESS COD with separate performance and delivery regimes to ensure a proportionate allocation of risk until the project is fully operational.

Conclusion

By utilising split contracting models, developers are seeking to balance flexibility, cost efficiency and risk certainty. These models have redistributed the traditional project risk allocation, with a portion of the project management and delivery risk now remaining with the project developer.

To ensure the bankability of a split-contracted project, project developers (now more than ever) need to ensure a realistic risk allocation, strong security mechanisms and clear coordination to give stakeholders comfort in a model that no longer wraps risk.

[1] Infrastructure Australia, A National Study of Infrastructure Risk (Report, October 2021) 10.

[2] Ibid.