DBO - Gold Dust for Build-Operate-Transfer (BOT) Contracts?

The second in a series of legal columns to bring the industry up to speed with regulatory changes, Sarah Thomas addresses the challenges with water or wastewater treatment build-operate-transfer contracts adapting the FIDIC's Design, Build Operate form.

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The second in a series of legal columns to bring the industry up to speed with regulatory changes, Sarah Thomas addresses the challenges with water or wastewater treatment build-operate-transfer contracts adapting the FIDIC's Design, Build Operate form.Sarah Thomas- Partner with Pinsent Masons LLP

It was at the end of 2008 when many in the water industry questioned whether there would be a new era of standardisation for water/wastewater BOT projects. This was a result of the FIDIC (International Federation of Consulting Engineers) first launching its Design, Build Operate form, which combined design & build and a 20 year "Operation Period" within a single contract. Such a contract was particularly ground-breaking as FIDIC was already considered such an established brand internationally for design and build.

The form itself adopts the "Green Field Model" - a potential downside for water projects that are more typically a mix of upgrades to existing facilities, alongside new builds. But FIDIC too has since recognised this limitation and plans to issue guidance which will make the DBO form usable for Brownfield projects. Another limitation is that it has no financing element - there is no responsibility either for the financing of the project or its ultimate commercial success (which means that payment cannot be tied to tariffs). But even with these limitations, is it suitable for water BOTs?

Operation and maintenance provisions

The design build obligations more or less replicate FIDIC's Yellow Book (Design and Build) – albeit now improved to introduce flexibility into the time period for giving notice of claims. Under clause 10, the contractor has to operate and maintain the completed plant as set out in the Employer Requirements. This is as well as comply with the procedures and requirements for operations and maintenance, provided by the Employer Contract Data (the Operation Management System), the O&M Manuals and his own O&M plans. He is paid the amount in the Contract Price for Operation and Maintenance.

This includes funds payable from an "Asset Replacement Fund" (ARF) but with two essential catches. He cannot access this fund either if the item was not identified in the fund in the first place (even if replacement was "unforeseeable", to coin a FIDIC term).

The Contractor is incentivised to outperform the ARF as payout of any excess (according to agreed share percentages) and also of the Employer's additional security, the "Maintenance Retention Fund" (or a Maintenance Retention Guarantee) are released at the end of the term, following issue of the "Contract Completion Certificate".

In DBO projects with a financing element, the problem of fitness for purpose liability over a 20 year period is solved by the introduction of special purpose vehicle. This makes a return on its equity and effectively "wraps" the risk between the end of the D&B contractor's liability (say 12 years in English law) and any cap on the operator's liability. But there is no suggestion that this structure is envisaged under the Gold Book because there is no financing element. This will cause particular problems for water projects where typically, the DBO contractor employs specialist suppliers to supply plant and equipment and these contracts often have express liability expiry dates that don't extend beyond a three year warranty period post completion – let alone 20 years.

Fitness for purpose Taking a wastewater treatment plant as an example, there is the employer's obligation to supply raw sewage within a defined catchment to allow the plant to operate. This would require amendment of the FIDIC Clause 10.4 (Delivery of Raw Materials) under which the Employer is responsible "for the free issue and supply and delivery to the Site… of the raw materials, fuels, consumables and other items specified in the Employer's Requirements". The clause goes on to say that the Employer is responsible that "all such items are fit for purpose and comply with the requirements of the Contract in respect of quality, purpose and function". Obviously we would need to include a provision for both influent quality and capacity parameters. This is the sewage equivalent of fitness for purpose!

Equally, there would a need to be more extensive provision for relief during the Operation Service Period. The provisions in the Gold Book are somewhat unusual, certainly when compared with typical water BOTs. Clause 10.6 simply says that if delay, interruption or any failure to achieve outputs is "caused by… or due to a cause for which the Contractor is responsible" - in other words, is not down to an "Employer Risk". The Contractor is responsible for the consequential losses of the Employer (ie. any losses including loss of revenue, loss of profit and overhead losses).

Apart from the uncertainty of what those consequential losses might be, where the employer is say, a municipality, there may not be any losses at all. I would suggest a return to the more traditional combination of KPI measures which weigh performance failures according to their significance.

Technology

Another point relevant to a water treatment plant and long-term operation is innovation and the use of new technology or new materials. The employer's representative may instruct the contractor to use new technology, new products or new materials but what if those inputs have an impact on the quality of the Operational Service? The contractor can only object if the instruction "will have" an adverse effect on operations, not if it may, or is likely to have such an impact.

Ultimately protection to the operator may arise simply from the fact that he is not obliged (during the Operation Service Period) to proceed until the adjustment to the contract price has been agreed. But there is no mechanism for arriving at that adjustment. This raises the prospect of a running dispute where the employer may be very keen to proceed (perhaps to ensure consistency with a wider network) and the contractor is not happy with the price adjustment. This is obviously not healthy in the context of a 20 year relationship.

So is this DBO form genuinely "gold dust" for water BOT's and the shape of things to come, or is the "price of gold" too high? It is probably the only standard form around at the moment and may have potential for use where procurers are not seeking financing and simply want design & build and operations & maintenance combined within the same contract. However, there is still a long way to go to adapt this form for use on water or wastewater treatment BOT's.

Sarah Thomas is a partner with Pinsent Masons LLP specialising in water and mining projects and can be contacted: sarah.thomas@pinsentmasons.com

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