September 28, 2016

Five Key Considerations for Drafting Warranty Terms in Engineering, Procurement and Construction (EPC) Agreements in Alternative Energy Projects

Owners and contractors frequently negotiate the warranty terms in their engineering, procurement, and construction (EPC) agreements for alternative energy projects. This article highlights five key issues that parties should consider when negotiating warranty terms.

1. Scope and Length of Warranty

Project owners and contractors must first determine the scope and length of the warranty. Most EPC agreements include a one-year warranty that covers the design, construction and equipment provided by the contractor. Additional – and longer-term – warranties may be provided by the original equipment manufacturer (OEM) for the major components of the project. The OEM warranties often apply to the PV modules, wind turbines or other similar components of an alternative energy project. The OEM warranties are usually provided by the OEM in the equipment purchase agreement between the owner and the OEM or, if the owner requires that the contractor hold these agreements, by the contractor, who assigns the OEM warranties to the owner.

Owners will need to ensure that the OEM providing the warranty will remain in business and is able to stand behind its warranty obligations. This is especially important in cases where the OEM provides a warranty in excess of ten years, which is common for some components of alternative energy projects. Owners should ensure that they include parent guarantees, credit support, or insurance terms that help protect against the risks of an OEM default.

In some cases, project owners will require that the contractor provide more specific warranties, including warranties related to technology. Contractors should be cautious when agreeing to specific warranty terms, especially ones that involve technology. If, for instance, the owner is designing technology that must be incorporated into the project, the contractor should ensure its warranty does not cover the newly designed technology or any errors arising out of the technology. The contractor should also ensure that the owner-required technology does not limit the subcontractors and suppliers that the contractor may utilize. Appropriate revisions to the EPC agreement may need to be made to allow the contractor to utilize other technology or to limit the contractor’s warranty for the owner-designed technology, especially if the owner-designed technology requires the contractor to use suppliers and subcontractors with whom the contractor has no prior experience or confidence.

2. Remedies for Breach of Warranty

Contractors and owners must consider the remedies that may be available in the event of a defect. Parties negotiating warranty terms should consider the following: Will the contractor have the option to repair or replace the defect? Who gets to determine whether repair or replacement is required? Will the repair or replacement of the defect be the owner’s sole and exclusive remedy? Who pays for the delivery of the replacement parts? Who pays for the costs to remove any non-defective components of the project to facilitate the repairs? How long does the contractor have to repair the defect? All of these questions should be addressed in the warranty terms, which will reduce the litigation risk and clearly identify the rights and responsibilities of both parties.

In cases where hundreds of individual components will be supplied (such as modules, gear boxes, conductor wires, etc.), a project owner could consider including a serial defect clause, which allows the owner to reject the entire batch of goods if a certain percentage of goods is found to be defective. These clauses may include additional warranty rights, such as requiring the equipment supplier to perform a root-cause analysis of the defect and to draft a recovery plan associated with the serial defect.

Owners and contractors should also ensure that the remedies for breach of warranty are consistent with any applicable operation and maintenance (O&M) agreements. This is especially important when the entity providing the warranty is also being hired to operate and maintain the equipment under an O&M agreement. The failure to make these documents consistent could lead to disputes.

3. Disclaimers or Limitations of Liability

Parties must also consider the disclaimers and limitations of liability that may be incorporated into warranty clauses. Contractors, for instance, may include provisions in the warranty clause that state the only remedy available to the owner in the event of a defect is the repair or replacement of the defective part. This term could have major implications on other areas of the contract and could be interpreted to bar the owner from recovering any damages resulting from the defect, even if the defect caused major property damage or delay. Other limitations and exclusions – such as disclaimers of the implied warranties of fitness for a particular purpose and merchantability – are more common, though they should also be carefully reviewed by both parties to ensure that they do not eliminate or reduce the expected warranties provided under the EPC agreement.

4. Commencement of Warranty

All warranty provisions should state when the warranty begins to run. The failure to include this term will often lead to disputes over whether a particular defect arose within the warranty period.

Warranties typically commence upon mechanical or substantial completion of the project. The definitions of the completion terms must be carefully reviewed by the parties. Contractors, for instance, should ensure that the definitions of “mechanical” and “substantial” completion are not tied to the owner’s discretion, meaning the owner is the sole entity allowed to determine when the contractor is complete. Owners should ensure that the definitions of these terms adequately capture all components of the work that must be complete. In the case of mechanical completion, owners should ensure the definition states that all components of the work have been fully constructed, installed, connected and are ready for commissioning, including any training obligations that the owner may impose upon the contractor. In the case of substantial completion, both parties should ensure that the definition adequately captures the performance metrics that the project must satisfy prior to completion.

5. Definition of Defect

Finally, the parties should ensure that they adequately address what it means for the contractor’s work to be “defective.” Broad definitions of “defect” will be unfavorable to the contractor, while narrow definitions of the term will be unfavorable to the owner. A common definition would be to state that any work that fails to satisfy the requirements of the EPC agreement will be considered “defective.”

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