Early action on UK energy project defects can limit downtime and protect revenues

Defects on energy projects are a major source of outages and periods with plant offline that can quickly lead to lost generation and significant revenue losses for developers and owners. A proactive and structured approach to identifying and rectifying defects as they arise can minimise downtime and protect revenue. 

Notifying the defect

When a defect is discovered, the initial reaction is often to notify the responsible party as quickly as possible. While time is often of the essence with regard to defects, any initial communications should be followed up with a contract-compliant notice. 

Before any notice is issued, it is important to review the provisions in the relevant contract. Engineering, procurement and construction (EPC) and operations and maintenance (O&M) contracts are typically prescriptive about how and when defects must be notified and remedied. 

Points to check include time limits for notifying defects, the required form and content of any notice, the correct recipients and the agreed methods of service.

EPC and O&M contracts often contain time-bar clauses and conditions precedent for claims relating to defects. These may require an initial notice within a set period, further detail or substantiation within an additional period, and completion of specified procedural steps before any entitlement to payment arises.

Failure to follow these steps can mean a defects claim fails at the first hurdle. As soon as a defect is suspected, it is important to map out the key dates under the contract and, where in doubt, consider issuing protective notices.

Rectification and defects liability

Most EPC contracts include a defects liability period (DLP), during which the EPC contractor is typically obliged to return to site and remedy notified defects.

Confirming the expiry date of the DLP and ensuring defects are notified before that date, in line with the contract, are important early steps. Late notification may leave the employer reliant on more complex and costly routes, such as a breach of contract claim.

Alongside this, it is important to establish whether the contractor has an ongoing obligation to complete rectification works after the DLP for defects properly notified within time.

It is also important to check how defects interact with other certificates under the EPC; for example, performance certificates and notices of making good defects, and whether the release of those documents (and associated payments) is conditional on defects being resolved. Issuing certificates before all defects have been rectified can disincentivise the contractor from completing remedial works and may be used by the contractor to argue that the employer has accepted the works despite known problems.

Root cause analysis

Progressing a defects claim under the contract needs to be supported by a clear technical understanding of the defect. As an initial step, a structured root cause analysis (RCA) should be commissioned.

A thorough RCA undertaken as early as possible will help determine whether the defect is a design, manufacturing, workmanship or operation and maintenance issue; who is responsible for rectifying the defect, whether the EPC contractor, O&M contractor, manufacturer or another party; and whether the defect is an isolated issue or part of a wider systemic problem. 

In the first instance, it will often be advantageous for the employer or owner to ask the EPC or O&M contractor to commission the RCA. If the contractor is failing to progress the RCA, commissioning an independent expert may need to be considered.

In either case, project owners should protect their position by putting parties on notice that a defect has been identified and investigations are under way, and asking the contractor to confirm that relevant insurers have been notified. Communications with express reservations of rights make clear that participation in or funding of investigations does not amount to acceptance of liability and that the owner reserves the right to recover investigation costs from the party ultimately found to be responsible. Manufacturers should be notified promptly of any potential warranty claims, in line with warranty terms, as late notice can prejudice those rights.

The aim throughout is for the owner to preserve their position until the root cause has been determined and the appropriate fix is understood.

Step‑in rights

Once the cause of a defect has been identified and the appropriate fix is understood, the focus must shift to managing the timely completion of remedial works. 

Many EPC and O&M contracts include step-in rights that allow the employer to intervene and resolve defects if the contractor fails to do so.

Before exercising step-in rights, it is important to check: when step-in can be triggered; the notice requirements for exercising step-in and any cure periods that must be afforded to the contractor; and how this interacts with retention, bonds, liquidated damages and payment.

Consideration should also be given to how exercising step-in rights may affect liability if further defects arise.

Retention and security

On many EPC contracts, retention and/or bonds, often in the form of a performance bond, are the main security available in the event the employer needs to step in and rectify defects. 

Where retention is held, owners should check the amount retained, confirm when retention is due for release, including any staged release between completion and the end of the DLP; and identify the circumstances in which retention may be withheld for defects.

If there is a performance bond or other form of bond, the wording should be reviewed carefully. Key points to check include whether the bond is on-demand or conditional, when it expires, whether the contractor must renew or extend the bond; who holds authorised signatory status for any demand; and whether the issuing bank requires authentication of signatures or specific demand formats.

Understanding the security available and the steps needed for its release is key to ensuring that the monies are available when they are needed.

Osborne Clarke comment

While defects remain a risk on any energy project, taking early, structured action significantly improves the prospects of a swift resolution and reduces the risk of costly outages.

Our team regularly supports clients with defect claims in a way that supports long-term portfolio performance, including advising on the position under EPC and O&M contracts, mapping out a strategy for promptly identifying the root cause of defects, using levers under the contract to maintain the contractor’s focus on swift resolution, and advising on step-in rights and the release of security.