This article was originally published in POWER Magazine on April 1, 2025.
Power and energy construction projects face unique challenges that make effective risk allocation critical to their success. A well-crafted contract serves as the foundation for managing these risks, helping project participants avoid costly disputes while navigating the complex regulatory, technological, and market uncertainties inherent in these ambitious undertakings.
All construction projects involve risk, but power and energy projects are some of the most challenging, facing complex and changing regulatory issues, rapid growth in U.S. electricity consumption, and concerns with evolving technology. Add uncertain markets for materials and long timelines to the mix, and the allocation and management of risks become even more critical to the success of these construction projects.
With so much at stake, it’s clear that effective risk allocation and management are crucial for avoiding pitfalls and ensuring project success. Using a comprehensive understanding of the risks involved to carefully plan, draft, and negotiate the project contract is a critical first step in the best practices for managing those risks and executing a successful project.
Contracts Are Fundamental to Success
The contract serves as the primary mechanism for managing project risk. A contract is a compilation of formulas for the assumption of risk, reflecting the conflicting interests of the participants and allocating risks between them.
The standard contract format used for power and energy projects is the engineering, procurement, and construction (EPC) contract, which provides a single point of responsibility for the entirety of the project. It’s no coincidence that the EPC contract provisions related to risk allocation are frequently the subject of claims and disputes. Therefore, it’s essential to carefully consider these issues, rules, and provisions when drafting your contract.
Some key provisions in an EPC contract for risk allocation and management include:
- The contractor’s standard of performance.
- Project schedule.
- Mechanical, substantial, and final completion.
- Liquidated damages for delay and performance.
- Limitation of liability.
- Changes.
- Warranty.
- Indemnification.
- Suspension, termination, and default.
- Disputes.
Project participants should strategically analyze the risks associated with these issues and provisions, and negotiate and draft them carefully to protect their interests, limit their risks, and increase the project’s chances of success without disputes.
Setting Goals
Claims and disputes often occur when the project schedule, budget, or both are unrealistic and do not adequately address the project’s requirements. To mitigate this risk, EPC contractors are best served by agreeing on an achievable and realistic schedule. Owners and contractors should also develop a budget that sets feasible expectations for project costs. Overpromising by the contractor or impractical demands by the owner related to time or cost during contract negotiations inevitably lead to disputes during project execution.
The contract should define the types of delays: excusable delays, which allow the contractor time but not money; compensable delays, which grant both money and time; inexcusable delays, where the contractor may be liable for damages; and concurrent delays, which are overlapping delays of any of the previous three types. Owners should consider agreeing to an early completion bonus to incentivize finishing ahead of schedule, as well as negotiating a contractual right to begin generating power before substantial completion, if it’s safe for one or more generator units to do so.
Delays can have serious repercussions for both owners and contractors and increase costs and exposures for both parties. For example, an owner with a “back-end” power purchase agreement (PPA) obligation that requires power generation by a specific date will incur liquidated damages under the PPA if it does not generate power timely. Similarly, contractors will incur significant additional costs daily, the longer it takes to achieve project completion.
To reduce the risk of the economic impact of delays as the owner, EPC contracts typically incorporate provisions for liquidated damages when the EPC contractor fails to achieve substantial completion by the agreed-upon deadline. Additionally, EPC contractors should limit their exposure to liquidated damages by carefully vetting and limiting the definition of inexcusable delay and insisting on a limitation of liability cap to set a maximum amount of liquidated damages for which it can be liable.
The careful drafting of delay liquidated damages provisions should include documenting the development of the liquidated damages amounts and their relationship to the consequences of the delay. This step helps ensure that the liquidated damages are not considered a penalty in the event a dispute over delay does occur.
Creating a realistic schedule and budget is an essential step to developing successful project controls to manage risk, but it shouldn’t end there. Project controls are a set of techniques, processes, and tools that are used to help measure and manage schedule, cost, scope, quality, and risk. A prudent owner will set up their own set of project controls to assist in monitoring construction progress and costs.
Monitoring progress in the field improves the chances of catching conflicts early and helps prevent minor conflicts from becoming major disputes. Active involvement in the process, providing real-time project management, and conducting thorough quality assurance and quality control inspections to ensure the contractor meets contract requirements increase the likelihood of a successful project with minimal disputes.
Contract Format Options
Another important consideration in the planning and drafting of the EPC contract for proper risk management is the selection of the project delivery system and pricing model that will best allocate the risks involved in the project. EPC contracts can be adapted into many formats, including different pricing models and project delivery systems.
The most traditional EPC project delivery system, known as a “full wrap,” gives the EPC contractor responsibility for engineering and constructing the project; procuring and installing the major equipment, such as turbines and generators; and providing the desired performance of the plant and equipment to the owner. In contrast, in a “partial wrap” system, the EPC contractor may be responsible for all engineering, procurement, and construction except for certain equipment procured by the owner and installed by the EPC contractor. Other systems, including an EPCM contract that utilizes a construction manager, are also possible.
Selecting the right price model from the many available options is another choice to make when allocating risks. These models include more traditional fixed-price or firm-price models, a nonbinding target price, or a guaranteed maximum price (GMP) structure. It’s crucial for participants to carefully consider the advantages and disadvantages of different EPC contract formats before selecting the most suitable approach for the specific project.
Resolving Differences
The EPC contract should contain at least one mechanism to facilitate dispute resolution. A dispute procedure that simply states parties will resolve disputes in litigation or arbitration without further guidance encourages a lengthy and costly legal battle rather than creating a meaningful process to de-escalate and facilitate resolution of disputes outside of the courtroom.
We recommend that EPC contracts require both executive-level negotiations and mediation before litigation is allowed. A meaningful mechanism for executive-level negotiations in an EPC contract requires decision-makers to conduct multiple in-person meetings over a set amount of time to discuss claims or disputes. To foster open dialogue, it also ensures that these discussions are privileged settlement discussions that are not admissible in subsequent adjudicatory proceedings.
Mediation is a process where parties meet with a neutral and experienced third party (typically a lawyer) who is knowledgeable about construction to facilitate settlement. Discussions and settlement offers during mediation are confidential settlement discussions and not admissible in subsequent binding adjudicatory processes. Mediation is nonbinding, low cost, and a very effective way to resolve disputes.
While certain claims and disputes may be unavoidable, proper planning for and allocating of risks in an EPC contract can help participants avoid pitfalls in power and energy projects, saving time and money in the long run.
—Judah Lifschitz (jlifschitz@barclaydamon.com) co-chairs Barclay Damon’s Power & Energy Construction and Construction & Surety practices and is a partner in the firm’s Washington, D.C., office. Kelley Halliburton (khalliburton@barclaydamon.com) is also a partner in Barclay Damon’s Washington office and has nearly 15 years of experience working on power and energy construction disputes.