38
LNG
INDUSTRY
MARCH
2016
Risk allocation
The overriding rule when allocating risk in FLNG contracts is
that risks should be allocated to the party best able tomanage
them, and that such risks should be covered by the appropriate
insurances. If risks are not allocated to the parties in this manner,
then the parties will not be appropriately empowered or
incentivised tomanage or avoid circumstances that could lead
to cost escalation or failure of the project. Often, risks must be
shared in order for the parties to adequately manage the risk. A
key risk best shared by owner and charterer is availability – both
in terms of operating a vessel for 20 years or more and in
terms of daily availability of the vessel tomeet the scheduled
processing, liquefaction/regasification and transfer obligations.
From the outset, the parties must consider project specific motion
criteria based onmetocean data. The hull and topsides process
equipment must then be designed to realistic project specific
parameters. A key design aspect for FLNG/FSRU projects will
be the functionality of loading arms, taking into account reliable
ship-to-ship (STS) connectivity with varying wave conditions. Even
if the topsides equipment functions with 100%availability and
reliability, the reliable transfer of cryogenic liquid products is crucial
tomaintain the overall availability of the vessel. Froma contractual
point of view, risk will be shared in the contracts by specifying
appropriate scheduling of vessel and equipment maintenance
(both planned and unplanned), the delivery and storage of spare
parts, and suitable procedures for scheduling of cargo transfers.
Another provision that requires a consideration of risk sharing
is the indemnity clauses. Knock-for-knock indemnities formpart of
the liability allocationmodel frequently found in contracts in the oil
and gas industry, and they appear in FLNG contracts. Under a
typical knock-for-knock regime, parties agree that the loss lies
with the party best placed to bear it. Damage and loss to people
and property suffered by a member of the owner group is borne
by the owner, and vice versa for the charterer group or other
contractor groups, irrespective of fault and without recourse to the
other party. The knock-for-knock regime is useful in the FLNG
context, in part due to the recognition that an owner’s balance
sheet cannot cope with potential liability for the destruction of the
entire LNG value chain and also because these indemnities assist
with risk allocation at a practical level (i.e. the responsibilities of
different contractors will overlap, making it difficult to determine
fault if an issue occurs).
Risk sharing is also a factor in any limitation of liability clause.
When drafting such a clause, the parties should address whether
they wish to exclude liability for consequential loss (a term that, as
English case law has established, should be expressly defined in
the contracts). In drafting this exclusion, owners should take note
of the recent decision of Scottish Power UK plc vs BP Exploration
Operating Co. Ltd
1
(Scottish Power), which emphasised that the
English courts will interpret exclusion clauses narrowly. The
Scottish Power decision confirmed that, unless the exclusion has
been expressly and clearly agreed and captured in the contract,
the courts will generally seek to ensure that a wronged party is not
denied a contractual remedy in the event that the counterparty
fails to perform. It may be prudent, andmore reliable, to limit
liability by excluding specific identified types of loss, avoiding the
consequential loss classification, or adopting an inclusive
approach whereby specific losses that a party would expect to
recover under the contract are stated to be recoverable, to the
express exclusion of all other remedies.
Commissioning and liquidated
damages
The vessel engineering, procurement and construction (EPC)
contract and TCP will both provide for set delivery dates, which
may be extended by permissible delays, such as variation orders
and forcemajeure events. If the vessel is not delivered by the yard,
or does not arrive at its destination by the contractual delivery
date, or does not pass performance testing within a certain
timeframe, then the yard/contractor (in the case of the vessel
EPC contract) or the owner (in the case of the TCP) will generally
become liable for liquidated damages for delay/failure to start-up.
It is crucial, therefore, that the contractual arrangements are
back-to-back regarding permitted extensions of time, such as
forcemajeure events. Owners will also want to ensure that there
is some parity in the quantumof liquidated damages for delay
under each of their contracts. Back-to-back delay arrangements
should be familiar to participants in an LNG project, potentially
with a negotiated long-stop cancellation right, but the key will
be ensuring that all circumstances (most of which are purely
hypothetical at the time of contracting) are adequately dealt with.
The commissioning period is one of themost heavily negotiated
clauses in the TCP, as the owner will want to pass and start to
get paid as quickly and painlessly as possible, and the charterer
will want to carry out as many tests as possible to ensure that the
vessel functions as required.
Similarly, the owner of the vessel will need to carefully
manage completion obligations and interface risk between the
hull contractor and the topsides engineer to ensure that there is no
gap in liability for delay or performance. A single engineering,
procurement, construction and installation (EPCI) arrangement,
where one contract covers both hull and topsides construction,
may be preferable andmay help to avoid any gap in liability for
performance related damages.
Parties should also pay careful attention to the wording of the
liquidated damages clause. The recent decisions of Cavendish
Square Holding BV vs Talal El Makdessi (Cavendish) and
ParkingEye Limited vs Beavis (ParkingEye)
2
suggest a shift in focus
from the English courts regarding liquidated damages. The
principle established in the Cavendish and ParkingEye judgments
is that liquidated damages must be proportional to the innocent
party’s legitimate interest in enforcing the counterparty’s
obligations under the contract. The court’s decision introduces a
more flexible test for whether a clause will be found to be penal.
Prior to Cavenish/ParkingEye, the courts would focus on whether
Figure 1.
LNG tanker (copyright: Oleksandr Kalinichenko/
Shutterstock).
