Standby Compensation for Force Majeure? [Gaille Energy Blog Issue 85]

Standby Compensation for Force Majeure? [Gaille Energy Blog Issue 85]

  • Posted by scottgaille
  • On April 30, 2020

“Time, no money,” are words commonly spoken by project owners when negotiating force majeure relief in construction and services contracts.  It means that while a contractor can receive schedule extensions (more days to complete the work), no additional compensation will be paid due to force majeure.  In response, a contractor may seek to shift the risk of force majeure costs to the project owner.  The contractor may do so by proposing that it be paid either (i) the actual costs or delay/standby or (ii) an amount of liquidated damages (e.g., $X per day) for the duration of a force majeure event.

These alternative approaches can impact the price paid for the work:

  • Time, no money = each party absorbs its own costs of force majeure. Contractor manages the risk of incurring delay costs by including an amount of contingency in its compensation.  This translates into somewhat higher lump sums, unit prices, or time and materials rates.  If the risk fails to materialize, the contractor’s profit increases (because the unused contingency moves over into the profit column); if the risk materializes and exceeds the planned contingency amount, then the contractor’s profit declines (as it moves dollars out of the profit column to cover its force majeure costs).  Project owners also bear their own costs of force majeure, including paying their project personnel and possibly incurring lost revenues from a project coming on-line later than planned.
  • Delay fees = owner bears both parties’ costs of force majeure. If the owner bears the risk of delay costs, then the contractor should not include a delay contingency amount in its compensation—leading to somewhat lower lump sums, unit prices, or time and materials rates.  If the risk fails to materialize, the owner pays less for the project than it would have otherwise paid.  If the risk does materialize, the owner ends up bearing both its own costs and a portion of the contractor’s costs.

Note that if a contractor wants the delay payment to apply in cases of force majeure, then the contract should explicitly provide so.  Delay and standby clauses that are silent as to whether they apply in cases of force majeure are likely only applicable to delay caused by the owner.  In such cases, the force majeure clause can be invoked by the owner to escape the obligation to pay standby or delay amounts.

Both approaches represent a form of (partial) business interruption insurance for the contractor.  In the “time, no money” approach, the contractor is self-insuring by charging more for the work (and hopefully, maintaining a rainy day fund to cover those times when force majeure delay exceeds the contingency built into the contract).  In the delay fee approach, the project owner is insuring the contractor for a portion of its delay costs (in exchange for paying less for the work).

As a practical matter, the selection of these two regimes often is driven by the variability of the force majeure risk at the duration, time, and place of the work.  The longer the project, the easier it is for a contractor to bear the risk of several days of delay and spread those costs across the overall project.  For example, if a vessel is laying a pipeline over the course of 25 weeks, even if a storm shuts down work for a week, that is ~4% additional cost; if a vessel is undertaking a two-week repair operation, and a storm shuts down work for one week, that is ~50% of additional cost.  Further, bad weather is more likely to strike at certain times of the year and in certain locations.  For example, offshore work is more vulnerable to prolonged shutdowns (due to sea conditions) than onshore work.

Whichever party bears the risk, both must be mindful of mitigation.  Neither the owner nor the contractor should be responsible for indefinite standby.  When the costs of demobilization (and remobilization) are less than paying for personnel and equipment to standby, the contractor should furlough personnel and demobilize equipment to mitigate its own—or the owner’s—standby costs.

Some contracts handle delay costs with liquidated damages.  These provisions require that an owner pay a fixed dollar amount per day of standby, irrespective of what the contractor’s underlying actual costs are.  These types of liquidated damages clauses may be vulnerable to challenge in a force majeure situation because they fail to take into account reasonably anticipated mitigation, such as furloughs and demobilization.

How do the two standby regimes address prolonged shut-downs (such as those arising from COVID-19)?

  • Time, no money. Contractors manage the risk of prolonged delay by demobilizing and furloughing personnel.  The contingency (and contingency from prior projects that did not incur delays) gets used to cover some of these costs.  To the extent that the owner wants to retain key personnel or maintain equipment on-site—for purposes of rapidly starting-up the project after force majeure ends—the owner can agree pay the actual costs of doing so.
  • Delay fees. The owner is likely to examine the force majeure and delay provisions closely to determine whether the contractor is entitled to delay or standby fees.  Even if a contractor is so entitled, the contractor’s obligation to mitigate may require prompt demobilization.  The owner also will likely examine the contract’s termination provisions, looking for termination rights for prolonged force majeure—or, alternatively, for termination without cause.  It may be less expensive for an owner to terminate the contract altogether than to pay for delay or standby.  This makes delay fees a potential “lose-lose” scenario in a prolonged force majeure.

One further option is a suspension agreement, pursuant to which both parties agree to suspend the work for either the duration of the prolonged force majeure or a set period of time.  The suspension agreement can provide for the owner to make payments to retain certain key personnel or equipment, with the balance being demobilized.  These types of arrangements have the advantage of avoiding disputes over force majeure clauses—or worse, terminations.  See Suspension Agreements as an Alternative to Force Majeure [Gaille Energy Blog Issue 82], March 31, 2020.

Looking forward, though, drafters of construction and services agreements should consider how their standby or delay clauses can be better drafted to address prolonged shutdowns, including:

  • Cap on duration of standby. If the owner is responsible for actual standby or delay costs, consider placing a cap on the maximum duration of any individual standby period (or standby time cumulatively over the course of the contract).  This ensures that the contractor is covered for finite periods of time when demobilization would not make sense—but prevents the owner from being the contractor’s insurance company in the event of prolonged force majeure.
  • Declining liquidated damages. If the owner is responsible for fixed (liquidated) payments for standby periods, then the amount of the liquidated damages should be calibrated to include anticipated furloughs and demobilizations.  For example, the first two days of an event might assume full standby, but thereafter, the amounts should decline to account for demobilization.
  • Limit standby or delay to certain types of anticipated events. Construction and services agreements have often treated weather differently from force majeure.  Some even differentiate between typical adverse weather and named storms (or other declared weather disasters).  Consider whether standby or delay should be limited to only certain types of weather events that would be unlikely to give rise to a prolonged force majeure.  For example, “adverse weather” might be subject to standby payments, but not major events such as a hurricane or COVID-19.
  • Add a prolonged suspension provision. This provision would be similar to a built-in suspension agreement that either the owner or contractor could trigger in the event of a prolonged force majeure event.  The owner would have the opportunity to designate certain personnel or equipment as standby (and agree to pay for it), with neither party being able to terminate the contract during the pendency of the suspension.

While COVID-19 is currently triggering standby and delay clauses, it is not the only type of prolonged force majeure facing the North American energy industry.  Owners and contractors also face greater risks of extended shutdowns due to climate change—including more frequent protests and government permits taking longer to obtain.  This is a good time for all energy companies to revisit their standby and delay clauses with longer durations of force majeure in mind.

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Yard Sign in Bunker Hill Village, Texas

About the Gaille Energy Blog. The Gaille Energy Blog (view counter = 133,224) discusses issues in the field of energy law, with periodic posts at Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of three books on energy law (Construction Energy Development, Shale Energy Development, and International Energy Development), and the co-author of Strange Tales of World Travel.

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