The contractual landscape that governs renewable energy projects is changing, with split contracting models now at the forefront of this transition.
But what are these models and how are they being used?
In this article we examine the surge in split contracting models, particularly for hybrid solar photovoltaic (PV) and battery energy storage system (BESS) projects. We also look at some of the associated challenges and potential mitigation strategies.
What is Split Contracting?
The traditional contracting model for renewable energy projects is one in which an engineering, procurement and construction (EPC) contractor (EPC Contractor) takes full responsibility for the design, engineering, procurement, delivery, construction, installation and commissioning of a renewable energy project under a single contract (Full Wrap Model).1 The project owner will then typically engage the same EPC Contractor under a separate operation and maintenance (O&M) contract to provide operation and maintenance services for a period that aligns with the duration that the EPC Contractor is liable to correct defects arising under the EPC contract.
The market has recently started to trend towards a split contracting model (Split Model), whereby the project owner, and not the EPC Contractor, engages the construction contractor and the key equipment suppliers under separate contracts. An example of this is where, in a solar PV and BESS hybrid project, the project owner engages the designer and supplier of the BESS (BESS Supplier) under one contract and the balance of plant contractor for the solar farm and non-BESS components (BOP Contractor) under another.
There are multiple options available to project owners for the O&M phase. The preferred option is typically determined by commercial considerations such as the term, price, how to best manage performance and availability guarantees and whether the project owner has an internal O&M provider who can provide the relevant services.
Why the Shift to Split Contracting Models?
Escalating project costs are encouraging a greater uptake of Split Model contracting. The escalation is in part due to increased “wrapping” costs, being the premium charged by the EPC Contractor for “wrapping” the risk of delivering the project on time and on budget.
The increase in EPC premium can be ascribed to increased risk profiles, a shortage of EPC Contractors and technical complexities when integrating PV and BESS technologies.2
Many project owners are now electing to remove the “wrapped” component from the contractual framework and are engaging directly with contractors and suppliers.
What are the Challenges of Split Contracting Models?
Limitations on Liability
Contractual caps on liability, delay and performance liquidated damages in renewable energy projects are generally expressed as a percentage of the overall contract price (typically 100%). In a Split Model context, the sum of the separate contract prices will be lower than would have been the case under a traditional EPC contract. This can significantly limit the project owner’s recourse against a defaulting supplier or contractor unless the loss or claim pertains to an issue expressly excluded from the liability cap (e.g. claims covered by project insurance).
While project owners in a Split Model arrangement will advocate for higher liability caps, push back should be expected from suppliers and contractors who will argue that any liability cap amount should be no greater than the total value of the relevant goods or work. In such instances it will be the project owner who needs to assume the gap risk.
Bankability
Financiers in this sector are familiar with providing project financing under a Full Wrap Model. Further, financiers have comfort that there is one party under Full Wrap Model agreements (the EPC Contractor) responsible for the delivery of a project under a single EPC contract on a turnkey basis. Although there may be other key subcontractors, for the most part, the financiers’ due diligence will be focussed on the EPC contract and the EPC Contractor. Accordingly, the financiers will likely only require a direct contractual arrangement (via a tripartite deed) with the EPC Contractor.
Split Model contracts, on the other hand, present additional challenges from a due diligence and bankability perspective. The financiers’ due diligence will be spread across multiple contracts and contractors, and financiers will likely require a direct contractual arrangement (via a tripartite deed) with each of the counterparties to the Split Model contracts. The financiers will also focus on appropriate risk allocations and the interface between each of the contracts to ensure there are no gaps. As a result, transaction costs are likely to be higher, and the lending terms will likely be more stringent. Pricing may also be higher due to the perceived increased risk. Project owners can expect additional security and documentation requirements to address these additional risks (including tripartite deeds, conditional deeds of novation, performance bonds and parent company guarantees).
Workplace and Employment
Workplace health and safety (WHS) obligations are likely to become more complex under Split Model scenarios. Specifically, it will be important to establish which party holds ultimate responsibility for WHS matters, i.e. who will be the principal contractor on the project site. Generally, this should be the party who will be on-site for the duration of, and who is performing, the construction works. These responsibilities will also need to be managed in a practical sense, such as clear on-site lines of authority.
Where the project owner enters into direct contracts with multiple parties under Split Model arrangements, this also increases the potential for duplication of roles and responsibilities in relation to employment matters. Therefore, stipulating which party is responsible for employment matters, such as payment terms for subcontractors, will need to be settled upfront in Split Model agreements to avoid downstream disputes. Additionally, it will be beneficial for project owners to confirm the same matters for general policies and procedures, including discrimination, harassment and other compliance materials.
Clearly defining responsibilities and policy documents has important implications for industrial relations. Reputational risks are high priority agenda items for corporates and multinational project owners and unionised workforces are increasingly attentive to deviations from employment and WHS obligations. It is important that project owners have certainty that their Split Model agreements are accurately drafted to reflect the true intention and responsibilities of the parties. In doing so, project owners may be more confident that potentially disruptive union activity can be addressed promptly and appropriately through robust response plans.
Dispute Resolution Procedures
Litigation versus Arbitration
The inherent nature of Split Model contracts lends itself to complex dispute resolution risks, starting with how to deal with disputes in respect of overlapping contentious issues. For example, where a project owner considers delays to commissioning have been caused by both the BESS Supplier and BOP Contractor, it is preferable that both parties be subject to a single dispute resolution process (i.e. litigation or arbitration). Otherwise, the project owner risks being faced with different factual findings or assessments of critical path delays – resulting in a potential gap risk for the project owner to bear.
One benefit of litigation as the ultimate dispute resolution process in each contract under a Split Model arrangement is that it limits the abovementioned risk as most courts and tribunals across Australia have simple processes for the joinder of issues by way of cross-claims or concurrent proceedings. An additional benefit is that if a subcontractor of the BOP Contractor in the above example contributed to a delay, they could also be drawn into either the same or concurrent proceedings. All concerned would then be bound by the same findings of fact.
Arbitration can provide the same protections, but only if that subcontractor of the BOP Contractor in the above example also had a joinder and arbitration clause in their subcontract. Ensuring mandatory pass through of such dispute resolution provisions to key subcontractors is critical in Split Model arrangements. Arbitration also has the benefits of confidentiality and superior enforceability in more jurisdictions.
Security of Payment Adjudication
Under Split Model arrangements, over the course of a project (albeit on an interim basis), security of payment legislation in each state and territory has the effect that a project owner is at risk of different findings of fact under different contracts. This could occur as a result of different adjudication processes, as adjudication under such legislation does not have the benefit of joinder arrangements that can be adopted in litigation and arbitration.
For example, it is possible that a project owner may have a finding in an adjudication brought by the BOP Contractor that the BESS Supplier caused a delay entitling the BOP Contractor to an extension of time and delay costs, while the opposite finding may be held in a separate adjudication brought by the BESS Supplier. While litigation and arbitration can hear such matters de novo on a final basis, this is a potential gap risk for the project owner arising from progress claims.
Key Considerations
Project owners should assess whether a Full Wrap Model or Split Model is most appropriate for their renewable energy project. Relevant questions to consider are:
- Can internal resources with the requisite technical skillset and project management expertise be appointed to ensure alignment, integration and appropriate interface between separate agreements?
- What equipment technology is right for my project?
- Which contractor is best placed to carry out the relevant scope?
- What are the various interface points between the contractors? This will be key to each contract, as this is where the potential for project delays and gap risk for the project owner will be most acute.
- What contractual rights do I need if there is delay, disruption or damage?
- How might the proposed structure impact my ability to secure finance and what steps can I take to manage that impact?
As Split Models require increased involvement form project owners, it is crucial to engage experienced advisors early on to ensure success.
For more information, please contact Matt Baumgurtel, Veno Panicker, Tricia Moloney, James Simpson, Adriaan van der Merwe or David O’Carroll.
1Lukas Duldinger, ‘EPCM vs EPC agreement – what’s the difference?’ (Web Page, 2 August 2023) <https://courses.renewablesvaluationinstitute.com/pages/academy/what-is-an-epc-agreement>.
2Matthias Simolka, ‘The evolving BESS market in 2024: A key year for safety, new technologies, and long-duration energy storage’ (Blog Post, 19 February 2024) <https://www.energy-storage.news/the-evolving-bess-market-in-2024-a-key-year-for-safety-new-technologies-and-long-duration-energy-storage/>.
