Offshore Floating Production
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CHAPTER 3
Construction contracts
A Introduction
3.1 The construction phase is a crucial part of an FPSO charter. Unlike conventional vessels, an FPSO is not chartered ‘as-is’ i.e. without work being performed in order to make the FPSO fit for the charter operations. A newbuild may be required, or a conversion of a tanker, or the modification of an existing FPSO. Modification work may sometimes be almost as extensive as a full conversion, for example where the FPSO is relocating from one region to another. 3.2 The Company may have decided that for development of the particular field, a newbuild vessel is required, which it would own. If so, the Company may prefer to oversee the construction of the newbuild vessel itself or to subcontract the supervision of construction to an FP Contractor. This may be particularly so for a complex and innovative FLNG. Alternatively, if the FP Contractor is given the responsibility to procure a vessel fit for the charter operations, which it would own, it may have the option of proposing, for the Company’s approval, a newbuild or an existing vessel. 3.3 The reasons for an FP Contractor choosing a newbuild or an existing vessel are covered in which also details particular legal issues relevant to modification and conversion contracts. This chapter deals with the issues that arise in all construction contracts under which the FP Contractor is required to deliver a vessel capable of meeting the charter standards. In this context, the relevant construction contract is a subcontract of the FP Contractor’s responsibility under the FPSO charter. As mentioned in on design issues, the FP Contractor takes on an EPIC contractor’s responsibility under the terms of the FPSO charter, and must determine whether to subcontract this responsibility entirely, or perform certain activities itself, and subcontract only part. 3.4 For example, the FP Contractor may wish to develop the design itself, and subcon-tract only the detailed engineering. It may wish to procure major equipment which would be provided to the construction contractor as OFE.1 It may also be willing to perform transportation and installation work, or delegate this to a specialist T&I contractor.2 Whichever course is taken, it is common for the construction subcontractor to undertake a ‘lump sum turnkey’ obligation. This obligation is inherent in an EPIC contract, but may also occur in a contract where less responsibility is transferred to the construction subcontractor, but it remains obliged to achieve the objectives of the specification: i.e. aPage 47
B Technical requirements
3.6 The contractual technical requirements are normally set out in various appendices to the construction contract, or in some cases incorporated by reference to various standards and technical queries that may have been discussed during contract negotiations. Under English law, interpreting these technical documents follows the same rules applicable to the interpretation of the legal terms in the main contract. English law rules of interpretation may occupy many pages of analysis.4 However, the main rules may be easily summarised. The aim is to ascertain the parties’ intentions when the contract was agreed. This is achieved by referring to the words actually used in the contract documents or incorporated into those documents by reference. Those words must be understood in the context in which they are used. This is especially important when interpreting technical information. Quite often the meaning of a technical phrase may not be clear to lawyers, but obvious to any technical person. Insofar as there are inconsistencies or ambiguities, the contract must be read as a whole; if one requirement is clearly inconsistent with all others on the same topic, it is likely that specific requirement is an error. However, if there are a number of inconsistent requirements, it may not be apparent which were intended by the parties to take priority. 3.7 Some assistance may be had by applying clauses which specifically confirm which documents are to take priority over others. For example, a drawing may be stated to takePage 48
C Legal nature of a subcontract
3.9 Whether the subcontractor is right in its assertion that it has no obligation to meet precisely the technical requirements of the FPSO charter will depend on how its subcontract has been created. The starting position under English law is that the subcontractor is entirely correct. In accordance with the doctrine of privity of contract, a party has no obligations under a contract to which it is not a party.6 In other words, even though a subcontractor may be described in the FPSO charter as the intended party for the performance of the construction work, it is not privy to, or bound to, those contractual obligations unless it gives a contractual commitment to the parties to that contract (i.e. the charter). 3.10 The corollary of the absence of a contractual duty of the subcontractor to perform the obligations of the main contract is that the party delegating those obligations in the form of a subcontract remains responsible for the subcontractor’s performance. Even though the main contract expressly contemplates that specific aspects of a contractor’s work are to be performed by a subcontractor, the consequence of privity of contracts is that, in the event of the subcontractor’s default, the main contractor is liable. This concept fits naturally into the obligations of an FP Contractor under an FPSO charter. ThePage 49
D Typical construction contract terms
3.15 A contract for the construction of an FPSO tends to be a hybrid of a shipbuilding contract for conventional vessels and a construction contract for process plant. The usual structure of the contract often follows more closely that of a shipbuilding contract, primarily because work is performed in a shipyard, using familiar shipbuilding methods. The key features are the completion of the work at the construction contractor’s facility meeting the contractual description, and delivery of the work in the required condition at an agreed location. This may be at the shipyard’s premises, or at the FPSO site. However, the nature of the legal obligations to be performed may follow more closely those found in typical construction contracts, being the performance of all work that may be required to meet the specific requirements of a designated project. The intention is not to produce a ship meeting a description but a unit achieving a particular purpose.
(i)
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Description/scope of work
3.16 The agreed technical specification for a shipbuilding contract is usually detailed and appended with drawings to the main contract. Little design development post-contract is required. In contrast, the specification for an FPSO may require substantial development, either from the basic requirements of a functional specification or from a preliminary basis of design, outlining the intended capabilities of the unit.8 As a consequence, it may be less easy to determine in the case of the FPSO construction whether the construction contractor has met fully the contractual requirements. There may be scope for disagreement on the standard of work required; should that be the bare minimum or some higher ‘industry’ standard? Further, a construction contractor’s performance is determined by a series of acceptance tests, mirroring those required under the FPSO charter. Ideally, an FP Contractor would wish these to be back-to-back, being performed simultaneously. However, if acceptance is to occur under the construction contract prior to the vessel departing for the field, which is normally the case for a conversion or modification contract, it would be impossible to prove at that stage that all work required to deliver a fully functioning FPSO had been successfully achieved; the most obvious reason being that the processing of hydrocarbons from the reservoir cannot be demonstrated until those hydrocarbons are flowing into the FPSO.
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(ii) Price and payment terms
3.17 Even though the precise scope of work may not be finalised at the time of contract award, the price for work to be performed may nevertheless be on lump sum terms. Thus, the construction contractor takes the risk of omissions and uncertainties in estimates and calculations of the work to be performed. However, there may be some scope for adjustments of price, for example by reference to estimates of steel weights; if the estimate is exceeded for reasons outside the construction contractor’s control, additional compensation may be payable at agreed rates. For conversion or modification contracts, the Company/FP Contractor may be required to take the risk of increases in steel and other quantities, taking account of the risk of unknown work to be performed, but the construction contractor would in turn be required to take the risk of costs, by agreeing a schedule of rates for performance of the work, similar in form to a schedule applicable to variation works.9 3.18 Payments are aligned more closely to achieving milestones, reflecting the expected volume of work to be performed, but, in the same way as for shipbuilding contracts, there may be agreed percentages payable on achieving certain events, rather than payment of the value of the work performed. This would be relevant in the event of premature termination, and any assessment of the performance of carry over work, and the costs of completing elsewhere. It may not be assumed in either case that the payments already made reflect the volume of work achieved, nor that they give an indication of the remaining work to be performed. An agreed method of valuing either the work performed orPage 51
(iii) Variations
3.19 In the main contract and the subcontract, the Company/FP Contractor would usually reserve an unlimited right to impose changes to the scope of work with or without the construction contractor’s consent. This would include the right to introduce changes late in the process, for example requirements to meet the standards of the oilfield inspectorate. The variations would usually be performed in accordance with agreed schedules of rates, although these may not in all circumstances be sufficient to cover the actual variation work, due to not being sufficiently detailed, or due to the scale of the additional work.(iv) Mechanical completion/commissioning
3.20 Unlike shipbuilding contracts where the owner’s representatives are simply observers of tests performed by the construction contractor, the handover following mechanical completion (i.e. the completion of the FPSO construction phase) and the performance of pre-commissioning and commissioning, in preparation for acceptance tests, may be performed by the FP Contractor. The reason for the FP Contractor performing the commissioning work would be that, in its role of operating the FPSO and to demonstrate successful completion of acceptance tests under the FPSO charter, the FP Contractor would wish to be in control, and have direct engagement with key vendors and subcontractors. There may also be aspects of work performed by the FP Contractor itself, alongside the construction contractor’s work, which would require commissioning, with the construction contractor providing assistance. 3.21 A significant amount of commissioning can be performed only once the FPSO reaches its location. The contractual responsibility matrix will identify commissioning to be performed onshore/inshore, as distinct from offshore. It may in practice be convenient for some of the onshore/inshore commissioning to be performed alongside offshore work, in order to avoid delay to sailaway, but in that event the parties would need to be clear before sailaway on the extent of incomplete commissioning.(v) Acceptance
3.22 A conventional shipbuilding contract requires the owner to accept the work, acknowledging that it complies with the specification, before proceeding to handover of the vessel by way of a formal delivery process. 3.23 However, to accommodate completion of commissioning preparation for acceptance testing under the FPSO charter, the Company/FP Contractor may require handover of the FPSO prior to completion of such acceptance testing and delivery. This procedure may cause confusion viewed from the standpoint of a conventional shipbuilding contract unless the obligations of each party under both the main contract and the construction subcontract are clearly defined by reference to each stage of the procedure. This is particularly important when addressing the remedies available if contractual targets are not met, including the point at which liquidated damages accrue.
(vi)
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Acceptance testing
3.24 The performance testing required before acceptance under the FPSO charter terms would ordinarily require proof of full functioning of all main systems. For a full EPCIC10 newbuild contract, the construction contractor may be required to undertake the same level of testing, back-to-back with the FPSO charter requirements, before completion. This would provide some protection for the Company/FP Contractor against the risk of accepting completion of the construction contractor’s work without being able to oblige the Company to do likewise under the FPSO charter. However, many FPSO construction contracts, particularly those for modification or conversion works, do not require back-to-back performance testing, and may oblige the Company/FP Contractor to accept the work after mechanical completion.
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(vii) Rights of termination
3.25 If the construction work does not proceed according to plan, the FPSO owner would wish to have extensive rights of termination, allowing it to discontinue the construction work and have it completed elsewhere. Termination in the sense of cancellation would not normally be commercially attractive as the FPSO will have been designed and built for a particular purpose and therefore unlikely to be taken on by other parties for different projects. The reason for termination is to prevent a slow or incompetent construction contractor prejudicing the overall success of the project. The FPSO owner’s right to take over the work requires detailed provisions. Whether these are enforceable or in practice valuable may be uncertain – usually a consensual termination is negotiated in order to avoid the inevitable disruption surrounding any dispute.11 The owner would also wish to ensure that it has rights to take possession of work being performed in the construction subcontractor’s yard. 3.26 Liability for the consequences of termination would need to be carefully addressed. The owner may wish to be compensated for the consequences of the construction contractor’s default, whereas the construction contractor may consider that it should be responsible for no more than its own losses as a consequence of termination. 3.27 Termination of the construction contract once the offshore commissioning stage is reached may of course be of little practical significance, as at that point the FPSO and performance of outstanding work may be in the hands of the Company/FP Contractor. Nevertheless, there may be significant legal consequences, such as the basis of the construction contractor’s remuneration and exposure to indemnify the additional costs of completion.(viii) Defects rectification
3.28 The construction contractor’s responsibility to rectify defects, and to compensate the FPSO owner (i.e. the FP Contractor) for the consequences of defects, may be less predictable than found in a normal shipbuilding contract. There, once delivery occurs,Page 53
1 OFE – Owner Furnished Equipment.