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In this article, we consider what the best contracting model may be in order to deliver New Zealand’s significant renewable construction projects in an expedient and effective way, and to minimise the likelihood of disputes arising. To do so, we examine the more traditional international approach using an EPC form of contract and whether New Zealand’s approach to being more collaborative may be suitable.

Introduction

New Zealand’s government is required to set five-yearly emissions budgets to decarbonise its economy and reduce greenhouse gas emissions (excluding biogenic methane) to zero by 2050.^[1] Electricity will play a major role in achieving this obligation. The current government’s aim is to move away from generating electricity from fossil-fuel based energy sources and towards having it produced solely from renewable energy by 2030.^[2]

New Zealand already has one of the lowest emission electricity systems in the world, and it is highly dependent on renewable generation which has been dominated by hydrogeneration.^[3] The issue with this is that in dry years (where there is less rainfall than average) other sources are required to supplement generation, and this is currently provided by fossil fuels, including gas and coal.^[4] To make the emissions target a reality, a number of obstacles need to be addressed including:

• investigating other potential energy generation and storage solutions such as pumped hydro,^[5] biomass, biogas and green hydrogen;

• overbuilding renewable generation capacity and investing in additional wind, geothermal and solar plants; and

• expanding existing infrastructure for generation, transmission and distribution of electricity.

International approach: EPC

Traditionally, electricity projects have been procured internationally employing an EPC structure either through a conventional approach using a standard-form contract such as the FIDIC Silver Book (1999 or 2017 update) or on a bespoke basis. This has been driven by the demands of project financiers who prefer a single contractor under a fixed lump sum contract to deliver a turnkey solution.^[6]

The FIDIC Silver Book approach to the pre-allocation of responsibilities for risks which might occur during the project delivery phase between the Principal and Contractor is different than what is seen for risk allocation under other standard-forms such as FIDIC’s Red and Yellow books.^[7] Indeed, on its introduction in 1999 the FIDIC Silver Book was seen as being most controversial as, rather than balancing risk between the parties, it instead imposed a risk profile heavily weighted in favour of the principal.^[8] The explanation for doing so was that mixing together design, construction and operation demanded a fixed, lump sum contract with little or no risk of an increase in cost if and when unexpected events took place.^[9] Of note, the update to FIDIC Silver Book in 2017 was seen as being less flexible, more complex and less user friendly being 50 per cent longer than the 1999 Book.^[10]

Advantages of EPC?

For electricity projects, which are often large in scale and complex, the perceived key advantage of an EPC contract is that the contractor is solely responsible for the main project risks being time, cost and output performance.^[11] By way of example, and within the original 1999 FIDIC Silver Book, risks transferred to the contractor include errors in set-out data (sub-clause 4.7), site-data (sub-clause 4.10), unforeseeable difficulties or costs (sub-clause 4.12), responsibility for all design (sub-clause 5.1) and any errors arising from that design (sub-clause 5.8), limitations on recovery of extensions of time (clause 8.4), and consequences flowing from use or occupation of the principal^[12] (sub-clause 17.3) and any operation of the forces of nature which is unforeseeable (sub-clause 17.3). It was expected that a contractor would either price these risks and/or carry out extensive due diligence to mitigate the risks.

Another advantage of EPC is that the principal can choose both how much control it wants to retain or be involved in over the design; and time for delivery of the project, including whether it should be executed on a normal sequential or a fast-track schedule, or with early contractor involvement.

But is risk transfer complete?

It has been suggested that risk transfer to the contractor is not as complete as may be indicated by the use of ‘turnkey’ to describe the FIDIC Silver Book. For example,^[13] the risk of adverse ground conditions is allocated to the contractor, with it being deemed to have obtained all necessary information such that it accepts ‘total responsibility’ and with no addition to the contract price payable.^[14] The only caveat to this normally is that the principal is responsible for certain data provided to the contractor so that an extension of time can be claimed for error in certain circumstances, although without additional payment.^[15] However, and usually with negotiation this is amended to revert to a more traditional test of foreseeability, and the risk remains with the principal.^[16]

With the FIDIC Silver Book 2017 update came the strong recommendation that the five ‘Golden Principles’ be strictly adhered to.^[17] These Golden Principles change the overall position of risk transfer under the 2017 FIDIC Silver Book (as compared to the previous version) in favour of the contractor, which has measurable consequences in relation to principal risk/cost and bankability as:^[18] one of these Golden Principles is a requirement that the duties, rights, roles and responsibilities of contracting parties be as implied in the General Conditions and as appropriate to the requirement of the particular project; and another requires that the Particular Conditions must not change the balance of risk and reward allocation provided for in the General Conditions.^[19]

Is EPC fit for purpose?

An EPC form of contract (whether FIDIC Silver or bespoke) may not be the best fit for delivery of these renewable projects given the inevitable complexities of these difficult and large projects and the decreased risk appetite of contractors both globally, and in New Zealand.^[20] Unless extensive negotiations take place prior to the award of the contract and parties understand where the risks have been shifted and why, and accept an increase in price to compensate, this form may not be as attractive.

Many commentators have speculated that the FIDIC Silver Book 2017 missed an opportunity to be tailored to renewable energy projects, particularly at a time when principals were moving away from a turnkey model in order to improve returns.^[21] However, it may be possible to find other solutions with comprehensive and well-structured risk mitigation packages. What would work?

A move towards greater collaboration in contracting in New Zealand

The increase in high profile struggles and failures of experienced New Zealand contractors over the past decade drew attention to the practice of contractors increasing their competitiveness at tender by under-pricing contracts, with major project risks often ignored, misunderstood or underestimated. Competition post the global financial crisis had pushed contractors into the ‘race to the bottom’ to take on projects with all risk transferred in order to ‘win’ revenue rather than obtain profit. These under-priced contracts essentially bankrolled construction for the principal while risking the contractor’s ability to operate and complete projects. Contractors could only restore profitability during delivery of the contract through claims and variations. This approach led to delayed completion, cost overruns, wasted resources, an increase in disputes and some high profile insolvencies. ^[22]

Under previous governments, a common procurement approach in New Zealand to deliver significant vertical and road projects was to use the public private partnership (PPP) model.^[23] However, PPPs have come under increasing scrutiny and criticism in New Zealand. Concerns have been raised with pricing, transparency and poor risk management, and the perception that there are poor outcomes for the public due to projects being delayed. ^[24] PPPs are now also viewed with scepticism by the contracting market due to significant increases in scope and cost leading to large losses being suffered by contractors. This mode of delivery is now considered to be out of favour with the current Labour Government, and there is a drive to having more collaborative contracting.

Given the large number of project failures using traditional procurement models, there is some scepticism in the New Zealand market about the effectiveness of traditional procurement approaches to drive successful outcomes for projects. The New Zealand Government has taken positive steps to ensure that projects are procured on the basis that the risk sits with the party best placed to control, manage and mitigate it – to try and improve outcomes across government projects and influence change across the private sector.

In October 2019, the New Zealand Government published its Construction Procurement Guidelines which included advice on risk management as an attempt to change the focus away from lowest cost, to instead achieving optimum value across the whole of life for the asset, of which cost is only one factor. It was a conscious attempt by the government to avoid the ‘race to the bottom’, which it saw as being critical for successful project delivery and delivering public value.^[25]

Another example was the development of the Construction Sector Accord (‘the Accord’) in April 2019. The Accord is a commitment between government (ministers and agency chief executives) and senior construction industry leaders to transform New Zealand’s construction sector to address the culture of shifting risk.^[26]

The Accord set out a primary challenge to transform the sector into a high performing and more productive industry. In order to achieve this objective, four principles were set out to effect the culture change needed, these being to: ‘build trusting relationships’, ‘value our people’, ‘be bold’ and ‘act with collective responsibility’.^[27] Notably, the Accord is accompanied by the Construction Sector Accord Network (CSAN),^[28] through which organisations can register openly to signal their commitment to the Accord by taking the Accord Pledge and committing to provide a high standard of behaviour based on the Accord principles. Since its inception most businesses, agencies and industry organisations within New Zealand’s infrastructure sector have joined.^[29] To attract wider commitment CSAN has instigated a reward/incentivisation scheme, which includes the use of an accredited member’s scheme, which provides concrete benefits (such as preferred supplier status) to exemplary performing organisations.^[30]

While the introduction of the Accord has not, to date, resulted in a universal sea-change in the way risk allocation is adopted by the public sector, it has resulted in more constructive discussions about appropriate risk allocation and brought about some change to the way in which certain government procurement agencies approach construction contracts. The general trend is positive, and the principles centred on communication and relationships proved particularly valuable during Covid-19 lockdowns in 2020. The Accord was able to release guidance quickly on how the New Zealand Standard form contracts should address relief during the lockdown (which was a hard lockdown that stopped construction projects), largely avoiding disputes over Covid-19 variations and extensions of time in both the public and private sector.^[31]

As a result, achieving a fair allocation of risk has become a critical consideration in New Zealand when procuring large and complex projects. This has led to a shift towards using more collaborative contracting, shown by the uptake in use of alliance contracting on large infrastructure projects, and the upcoming review of New Zealand’s standard-form construction contract NZS3910:2013.^[32]

Use of the Alliance model

The rise in the use of alliancing can be attributed to the attitude of the New Zealand Government and its agencies (eg, the NZ Transport Agency, Auckland Transport)^[33] to use it for highly complex or large infrastructure projects where it would otherwise be difficult to scope effectively, price and deliver the project under a more traditional model.^[34]

An alliance is a collaborative commercial and legal framework between a principal/owner and one or more parties delivering the services for the project. The benefits of an alliance include:

• A project can go out to market early, before the scope and details of the project are finalised. This can led to innovation and improved efficiency particularly where the project is highly challenging from a technical perspective.

• Flexibility across all aspects of delivery can enable fast-tracking to meet any time constraints in scheduling and programming. Instead of strict time obligations with liquidated damages and few relief/EOT events, there are soft time obligations (a ‘best endeavours’ to complete on time with general damages for breach) and other incentives for timely completion like early completion bonuses.

• Parties develop a detailed understanding of scope, pricing and cost due to the open-book and transparent processes and joint development of a target out-turn cost agreed between the participants.

• The ‘no-sue’ mechanism except for wilful default or insolvency drives the alignment of commercial interests and project culture allows people to be free to innovate and work together.

• Employees remain employed by their home organisation but leave this ‘hat’ at the door and operate under a shared project umbrella with common branding, email addresses and the like. This means that there is a fully integrated team working on a ‘best for project’ basis.

• Parties are incentivised to work together to achieve time and cost targets with pain/gain share arrangements where costs below and above the target out-turn cost are shared between the parties based on a pre-agreed percentage split.

However, there are concerns that alliances are expensive as they are effectively a cost-plus contract, with margin at risk. While this may simply reflect what projects actually cost, it is becoming increasingly common for procurement processes to require alliances to be tendered on a competitive basis, to introduce price tension into the setting of the target out-turn cost. If alliances are to become accepted for renewable energy projects, consideration may need to be given to introducing other ways to manage the build cost within the target out-turn cost.

Moreover, an alliance is not necessarily suitable if an owner wants to use project finance on a limited recourse basis. Financiers looking to the cashflow and assets of the project to secure repayment, and not to the balance sheet of the owner may not be comfortable with using anything other than a traditional fixed price and time contract with transferred risks.^[35] It would not be impossible to use alliances, if:

• the alliance agreement had a well-structured gain/pain share regime, a prescriptive subcontracting regime, and reserve power and deadlock breaking mechanisms in favour of the owner;^[36] and

• extensive due diligence was carried out in relation to technical issues, project risks and the capabilities of the participants; and

• tailored insurance policies were obtained.^[37]

Internationally, the use of alliances has been seen as potentially problematic in technically complex engineering and industrial engineering project contexts as its liability clauses, conflict resolution practices, and incentivisation schemes may not be sophisticated enough to deal with the complex issues that may arise, and there may be a reduction in the principal/owner involvement.^[38]

Admittedly, alliance projects in New Zealand have largely been in road and rail infrastructure. A redevelopment of Auckland Airport’s domestic terminal was procured on an alliance, and was the first vertical project to be procured on this basis in New Zealand, but this project was deferred due to Covid-19. Auckland Airport has advised that the first stage of the project is expected to get underway in early 2022.^[39]

Other successful examples of alliances used in New Zealand include the Northern Canterbury Transport Infrastructure Recovery (NCTIR) and Auckland’s City Rail Link (CRL).

NCTIR was set up to rebuild road and rail networks in the South Island, as a result of substantial damage caused by the Kaikoura earthquake on 14 November 2016.^[40] The project was unique as it posed specific geospatial issues.^[41] It was located in a remote area, which made resourcing constrained and data collection difficult. Notwithstanding the large scope of work, the alliance exceeded expectations from a timing point of view, demonstrating what can be achieved in a collaborative contract.

CRL is being delivered through the Link Alliance^[42]. It was formed to transform the manner in which public transport operates in Auckland, which has been encumbered with overcapacity. The project encompasses construction on two new inner-city underground stations, upgrading the existing Mount Eden station, and completing tunnel construction. The project was procured on an alliance model after the initial failure of the procurement process under a traditional D&C model due to unacceptable levels of risk for the contracting market.^[43]

The Alliance model is very different from the traditional EPC model, as they are effectively at opposite ends of the risk spectrum. Alliances have shown to be successful when there is uncertainty of scope and risk and the project benefits from the collaboration between the design team and the contractor. If it is accompanied by a mechanism for managing costs that gives the owner confidence it is still receiving value for money, the Alliance model may also assist parties in managing technological risk associated with renewable energy projects, particularly if the project is of a kind where it is being attempted for the first time in New Zealand. This might lead to more successful projects outcomes than those experienced in New Zealand in recent years.

NZS3910:2013 under review

NZS3910:2013 is New Zealand’s most commonly used standard form construction contract. It has not been updated since 2013^[44] and in recent years its use has been characterised by a proliferation of special conditions.

Its two key issues are: the increased complexity and bespoke nature of each contract means the benefit of having a universally understood standard form is reduced; and the effect of the special conditions is almost always to increase the risk transfer to the contractor and in many cases, the contractor has not appreciated the effect of the amendments and the extent of the risk transfer leading to poor understanding of risks assumed (and risks not priced).

The review is being commissioned by the Construction Sector Accord and the New Zealand Infrastructure Commission, Te Waihanga. The purpose of the review is to revise the standard form so that it is widely accepted and fit for purpose without the need for substantive amendment and allocates risk fairly. It is not a ‘patch and update’ but remaking it root and branch to make it properly fit for purpose.

It remains to be seen whether the revisions to NZS3910 will be innovative and introduce any principles from collaborative contracting. The detail on the proposed amendments has yet to be considered, although submissions have been sought from industry participants, with nominations for the committee who will carry out the review only closing at the end of November 2021.^[45]

Innovation

Internationally, there have been two developments which may be of assistance in selecting the appropriate contracting model for New Zealand’s upcoming renewable electricity projects.

The first is that there may be an attractive alternative to EPC in the adoption of ‘EpCM’ (engineer, procure, and construction management) for waste to energy projects as it allows a more granular approach to risk.^[46] The EpCM contractor is not directly involved in construction, making this more akin to a professional services contract, but the contractor retains responsibility for the detailed design and overall management of the project on behalf of the principal. It is much more collaborative in nature. The principal has the opportunity to be involved in decisions, but as part of the construction management role, the EpCM contractor supervises, manages and coordinates construction interfaces in accordance with a detailed schedule, and establishes contractual arrangements with other contractors, original equipment manufacturers and subcontractors.^[47] Cost, time and performance risks are therefore reduced as the party most familiar with the plant/project has the most significant stake.^[48] This type of model would work well between experienced parties with established relationships.

The second is that new standard-form collaborative contracts are being introduced.

In June 2018, NEC released its Alliance Contract as part of its NEC4 tranche of agreements to inspire and enable better project collaboration.^[49] The NEC Alliance Contract has an integrated risk and reward model, with all parties engaged under single contract, and as a result the success of a project becomes each parties’ prerogative.^[50] The principal plays a central role and an active part in the alliance. The alliance board is made up of a representative from each party and it is this Board which is responsible for setting strategy, decision-making and resolving disputes.^[51] As risks are shared equally, claims are barred except for limited events such as wilful default.^[52]

FIDIC is also creating a collaborative form of contract. FIDIC’s board agreed to the setting up of a working group by the FIDIC contracts committee in May 2021 to develop this contract.^[53] The working group would research the current collaborative contracts in the market to put together a framework of the approaches taken and allow consideration of the preferred FIDIC collaborative contract solution.^[54] This development is encouraging particularly as it may be more acceptable to the multilateral development banks and multinational private sector clients who have tended to adopt FIDIC contracts as their preferred standards.

Conclusion

It is well accepted that the equitable distribution of risk ‘is the essential ingredient to increasing the effective, timely and efficient design and construction of projects’^[55] as it leads to ‘a reasonable price, qualitative performance and the minimization of disputes’.^[56] These outcomes are imperative for the large and complex renewable energy projects to come – if we are to successfully decarbonise New Zealand’s electricity system in a short time we need contract models that produce best for project outcomes while avoiding parties being locked into disputes over time, cost and the like.

We are of the view that a pure EPC model is outdated and not the most appropriate model to be used for the renewable energy projects we need to develop in New Zealand. This is even more so given the current Covid-19 climate, uncertainty around global supply chains and the New Zealand Government’s aim to create jobs quickly and stimulate the economy through infrastructure, while meeting its target of electricity being generated through 100 per cent renewable energy. The future for collaborative contracting looks bright.

Katrina Van Houtte is a partner at Dentons Kensington Swan and can be contacted at katrina.vanhoutte@dentons.com. Ariana Stuart is a senior associate at Dentons Kensington Swan and can be contacted at ariana.stuart@dentons.com.