This article is written by Aryan Mohindroo, here he discussed features of a model operations and Maintenance Agreement.
Introduction
The Operation and Maintenance Agreements (“O&M agreements”) used to be among the more insignificant documents among the project contracts.[1] From a document which often only turned in negotiations after all the other documents were discussed, the O&M agreements have really come of age and are the focal point of various services delivered to projects and other organizations. This is however obvious since if the project concerned is not properly operated and maintained, no cash flow can be expected of the same.[2] Essentially for projects with service delivery motive, a well-backed O&M is critical to the smooth functioning.
The term operation and maintenance agreement can be put under the ambit of a “Management Contract” which cover a wide range of contracts like O&Ms and technical assistance contracts. The common features of the two include engagement of an operator or a manager company to manage a range of activities for a relatively short period of time. This time period extends from two to five years. Here, while O&Ms focus on the output-oriented goals of a project, the management contracts, in general, are input focused.
O&M agreements establish a contractual relationship between the project company and a qualified management company which serves as an operator of the project. It may also be said that an O&M agreement serves the same purpose in the operations phase, which is served by an Engineering, Production, and Construction (EPC) Contract in the construction phase of the Project infrastructure.[3] However, while an EPC contract may apply to all project construction phases, an O&M agreement may not apply to every deal, as project companies often elect to operate the project themselves, without going through an O&M deal.
The construction and framing of the O&M agreements should be well engineered so as to ensure the avoidance of any unnecessary implication of a liability on a stakeholder. Consequently, it is extremely important to choose the words throughout the agreement carefully, ensuring that the O&M agreement is Fully Wrapped.
This paper aims to deal with the ideal features of a Fully Wrapped O&M Agreement. While the deeper obligations in an O&M always vary depending upon the arrangement between the specific Project Owner and the Project Operator, certain features of the O&Ms are crucial to the smooth functioning of the outsourced operations phase of the project. The first part of this paper focuses on the basics of the O&M agreements, followed by the advantages and disadvantages of opting for an O&M Outsourcing in the operations phase of the project. Further, the author focuses on the major features of an O&M Agreement and looks into real-world examples to illustrate the same. The author concludes with an analysis of the features and their reflection on the smoother functioning of a project.
Structure of an Operation and Maintenance Agreement
Signatories to the agreement
An O&M agreement may be structured in various ways.[4] First, the project company may carry out their operation and maintenance of the project during its operations phase by itself. Typic road concession projects function on this O&S structure when there are relatively low Operations and Maintenance obligations involved. Second, the project companies may enter into an O&M agreement with a third party who is related to the project company. These may include the project company’s shareholders or an affiliate of the company’s shareholders. Fossil fuel based energy infrastructure projects in non-liberalised markets work on this model. Another example may be the Attica Tollway in Greece where the “ATTIKI ODOS S.A.” is the concession company of the tollway awarded by the Greek Government. Holding 59.249% stake in the project, its subsidiary “ATTIKES DIADROMES S.A.” carries out the operations and maintenance of the tollway.[5] Third, the project company can enter into an O&M Agreement with an arm’s length third party. An arm’s length third party, as the name suggests is sufficiently close to the owner company while it does not hold any stake in the functioning of the same. Fourth, the project company can get into an arrangement for the operation and maintenance of the project with a third party. This third party may be related or unrelated to the project company. The owner company may even enter into this agreement with the third party to provide a workforce which would work under the project company’s directions. For example, the Wood Group GTS signed a three-year O&S agreement with Apex Bethel Energy Centre for the Bethel Energy Centre, Texas, USA. Spanning for a period of three years, this was also considered a more viable O&M solution for Apex’s needs.[6] Additionally, the operating function may also be split from the maintenance function of the project to allow for additional efficiency. The Delhi Metro Rail Corporation for example, carries out the operations of Delhi metro by itself while tenders are released for IT maintenance or project development.[7]
Elements of a model O&M agreement
An O&M agreement is a crucial document for the operations phase of a project. And the whole output of the project depends on the compliances required under the O&M agreement. While a project’s O&M agreement varies significantly across industries and signatories, there are certain elements of an O&M which cannot be overlooked. This section of the paper explores those elements which may also be called the backbone of the O&M agreement. Referring to a model O&M agreement provided by the Pennsylvania Land Trust Association,[8] it may be said that an O&M agreement consists of five major elements, title, opening recital, background, the agreement and closing. The title is the major opening heading of the agreement and any title may be chosen based on the nature of the project, ranging from the mainstream “operation and maintenance agreement” to “co-operative agreement” or “facility operations agreement”, any title may be chosen fit according to the purpose and may be accompanied with a subtitle. Further, the recitals include the names of the parties, their addresses and relevant dates.
The background follows the recitals and includes information necessary to understand the subject-matter of the document. It may provide the location of the project, its purpose as well as the goals of the parties involved. The agreement is the fourth element of the O&M agreements and happens to be the most crucial one. This part lists the O&M mandates and compliances which the parties consent to. For example, the World Bank prescribed model O&M agreement provides for the terms from Section 3 onwards.[9] Lastly, the closing clauses provide for the relevant signatories and their assent to bind themselves to the O&M agreement.
Advantages and disadvantages of the O&M agreements
Advantages
The primary question that arises here is about why companies and project owners are willing to transfer the control of the management of the projects to third parties. This section of the paper deals with the same. The primary reason why the option of O&M is considered is that if it is proposed that the project company may carry out the operation and maintenance roles of the project by itself, it will need to have appropriate staff to carry out the same. Further, these staff must be of appropriate qualifications and experience. Additionally, these might not be the core service areas of the project owner and consequently, indulging in the same may deviate the owner from its core economic goals.[10]
Time and resource saving
The idea of creating O&M outsourcing is based on timesaving, operational continuity and knowledge.[11] Delineating operations and maintenance tick out the business’ to-do list of performing functions, thereby assisting the owner to focus on more important areas.
Staffing flexibility, work standard and expertise[12]
When outsourced, the operators can provide flexibility in delivering the required level of expertise and work quality with much more ease while incurring less cost and time. It provides more flexibility to utilize specialized services and costs based on money and time in developing in-house competencies.
Disadvantages
Loss of control
Outsourcing maintenance may be cost-effective, however, there are drawbacks like loss of control of the owner company or to instruct the workforce.
Response time
While dealing with large scale projects, response time may be handled more rapidly in-house as opposed to when through a call by the operator. Especially crucial in industrial projects, the project company may need to balance the operation outsourcing and negotiate an efficient response time. Essentially because longer response time equates to lost production and waste of time.
Consequently, the owner should determine cost-effectiveness, control, and flexibility and focus on the needs of the project to properly manage the O&M agreements. Engaging may relieve the owner of their responsibilities, however, dedicated management and strict enforcement of the agreement are always need of the hour.
Features of an O&M agreement
Understanding the main structure of the O&M agreements is not sufficient and each agreement needs to be tailored according to the needs of the stakeholders as well as the industry. Consequently, apart from the skeletal structure of the agreement, certain aspects, which are extremely crucial for the longevity of the contractor-contracted relations, as well as to ensure no undue liability on any party need to be included in the contractual clauses. This section lists those features of the O&M agreements which must, in all circumstances be abided by.
Operator’s obligations
The most crucial obligations of the operator include the operation and maintenance of the project infrastructure.[13] The question of whether the responsibilities of the operator are listed in the agreement or not is of paramount importance. Therefore, issues like operating procedures, maintenance, and overhauls, spares procurement, performance guarantees and term extension must be well addressed in the agreement. The operator may also have the obligation to ensure compliance with the regulatory needs and requirements of the industry, like environmental safeguards, industry participation requirements etc.
Compliances and obligations of such nature require substantial care and caution. The approach generally taken is to provide for the operator obligations and relating them to the performance results required, incidental to the obligations. Further, the obligations of technical nature must be specifically listed so as to ensure that oversimplification does not expose the company to claims for compensation for works beyond the needs and scope of the contract.[14] Parties should also be aware that changes to the contract are possible in the longer term which may affect the long-term nature of the contracting parties. These changes may include political changes, economic changes as well as changes in management of the contracting parties.
Owner’s obligations
The primary obligation of the project owner, party to the O&M agreement is to pay the project operator. Payments should be limited to the output of the project as payments are generally made through offtake agreements.[15] Additional continuing obligations may be implicated as well, these may include the supply of fuels, raw materials, food, and other consumables. Additionally, spare parts inventory may be contracted for, which generally aligns the spares inventory provided under the EPC contract. Compliances may include maintenance of the records of functions performed by the operator to make necessary adjustments to the payment provisions. Another crucial obligation of the owner is to provide for payment mechanisms for payment of owner supplied spares, overhaul expenses and payments for the work performed by the operator beyond the scope of the agreement, legal changes and other reasons which may result in rising of necessary obligations to payments.[16]
The World Bank and scholars like Vinter[17] and Finnerty[18] have provided for various other features which are crucial to the functioning of the agreement.
Clear scope of work
The scope of work of the operator must be clearly delineated in the agreement. In projects which seek to list down the standard of performance in a clear contractual manner, it is critical for the operator to take on the compliances as the agreement may provide. Additionally, in situations where the project company has retained certain obligations to itself, to the extent that it has been done, the investors shall price the said liabilities appropriately and the risks involved may be understood by the lenders.[19]
Exclusivity[20]
Some agreements may also include provisions of securing exclusivity, i.e. the restriction on the ability of the owner to appoint another operator for provision of services. However, the exclusivity may be limited to certain services and may be excused for others which must be borne in mind while drafting the contract. As a customer, the owner should consider when the company would need to source services from a third party, for example, when the contractor has not performed or is unable to perform, as well as in the situation of additional services.
Provisions for operator’s remuneration
As per Vinter, the operator’s remuneration package in an O&M is divided into three parts. First, it seeks to reimburse the operator for the sums paid to the supplier on behalf of project companies. These may include the sums which are paid for procurement of spare parts and consumables. Second, payments are made on a unit or hourly basis, for non-core or additional services which are provided by the operator. This payment may include a small profit margin and comprises of services like operator’s payroll costs. Third, the operator’s fees for the core tasks performed by them is a single fee which is the operator’s main source of profit from the job. Additionally, the duration of the O&A agreements is that of a long term, in general. Consequently, the payments may need to be adjusted through retail price or consumer price index, inflation rates, wage cost inflation rates as well as agreed to inflation rates for countries lacking developed consumer price indexes and retail price indexes.
Incentives for the operator
In order to ensure the mobility and added efficiency to the operators’ performance, appropriate provisions for incentivizing the operator should be sought. A basic system of bonuses and penalties may be linked to the remuneration package to serve for the incentivizing needs. Moreover, the penalties to be incurred in any operational year shall not exceed the operators’ remuneration for obvious reasons.
Creation of Operation and Maintenance Manual/Budget
Creation of operation and maintenance budget is crucial to avoid over expenditure and control the operator’s expenditure.[21] In absence of a long term O&A Arrangement, the budget is the means of controlling over expenditure by including provisions like ones requiring owner’s consent before incurring expenditure over a threshold limit, for example, on a replacement part which is extremely expensive.
The agency relationship between operator and owner when purchasing spares and consumables
Lack of clarity between the agency relationship between the project operator and owner can invite numerous credit risks. However, often the operator’s own networks and bargaining power can provide the project company with substantial discounts. If an arrangement is reached, the same shall result in the owner being considered a purchaser and the operator may invite liability under the Sale of Goods Act, 1930.
Limitation on the operator’s liability
An operator party to the project agreement shall seek a limitation on their liability equivalent to their fee for the concerned year. This is especially owing to the argument that their fee is highly insignificant compared to the significant losses that the projects have the potential of incurring. This argument is usually conceded to by project owner companies as well as their lenders.
Termination Clauses
Although not honoring the contracts is an obvious breach, the project companies always look into the options to secure the right to terminate the operation and maintenance agreement for the poor performance of the operator. It has since been a debate as to what constitutes the benchmark for poor performance. Assets like IP play a crucial role in this process as the project companies need to secure the flexibility of transferring to the successor all rights needed for the functioning of the project.
Force Majeure clause in O&M Agreement
In the cases where the obligations of project companies are largely limited to amounts due under the O&M agreements, force majeure clauses are a crucial element. The parties to the O&M agreement should be familiar with the fact that during the construction phase, the force majeure events can be severe for the project’s life, but usually manageable. This is owing to the fact that while such events are severe, they simply increase construction costs and delay completion.
Force Majeure risks can be therefore allocated between the project participants prior to the commencement of the project. Contrary to this, force majeure events during the operations phase can result in the insolvency of the operator. In this event, the operator may not be able to abide by the terms of the agreement. The agreement should obligate the affected parties to take all steps possible for overcoming the event, including fund expenditure while failure to perform contractual obligations in this scenario generally prevent the affected party from being in default.
Conclusion
The transition of the O&M agreements from that of an ancillary document in the project development to one of the crucial value has been substantial. This development is a much-anticipated one as the focus of project development has with time, shifted to the operations phase with more and more service based projects appearing in the economies. Moreover, this transition has been extremely crucial as the intended output of a project solely depends on the standards of operations and maintenance undertook for its development. A four-part structure composed of title clause, background, agreement, and closing clauses is a model O&M agreement. Additionally, numerous key provisions like agency relationship, force majeure, and incentives/payments need to be taken care of to ensure that the O&M agreements are well crafted and intact. Further, the same cannot be ensured without elaborate analysis of all the relevant provisions of the agreement, considering how crucial it happens to be for the life of an operating project. Moreover, unless a project is a small scale one and is planned to be catered to by the owner during the operations phase, outsourcing of its operations is crucial for the longevity of the project operations. The author’s hypothesis thereby stands correct.
[1] Graham D. Vinter, Project Finance: a legal guide (2006, 3rd Ed.).
[2] Id.
[3] Global Trade Funding, Operation and Maintenance Agreements, available at https://globaltradefunding.com/project-finance/project-finance-documents/o-m-agreement/ (Last accessed: February 28th, 2019)
[4] Graham D. Vinter, Project Finance: a legal guide (2006, 3rd Ed.).
[5] Attica Tollway, Credits of the project, available at https://en.aodos.gr/credits_of_the_project/ (Last accessed: February 28th, 2019).
[6] See Engineer Live, Why third party operation and maintenance makes sense, available at https://www.engineerlive.com/content/why-third-party-operations-and-maintenance-makes-sense (Last accessed: February 28, 2019).
[7] See Delhi Metro Rail Corporation, Tenders, available at http://www.delhimetrorail.com/tender/Default.aspx?cid=N6bP2JEr4WMlld (Last accessed: February 28th, 2019).
[8] Conservation Tools, Model Maintenance and Operation Agreement with Commentary, available at https://conservationtools-production.s3.amazonaws.com/library_item_files/1452/1620/MaintainAndOpAgreement170829.pdf?AWSAccessKeyId=AKIAIQFJLILYGVDR4AMQ&Expires=1551183696&Signature=p27N0OP8duR1liQFUqsKyio1bVs%3D (Last accessed: February 28th, 2019).
[9] World Bank, Operation and Maintenance Agreement Template, available at https://ppp.worldbank.org/public-private-partnership/sites/ppp.worldbank.org/files/documents/o_m_agreement_template_EN.doc (Last accessed: February 28th, 2019).
[10] Graham D. Vinter, Project Finance: a legal guide (2006, 3rd Ed.).
[11] Cleverism, Management Contract: Definition, Pros and Cons, and More, available at https://www.cleverism.com/management-contract-definition/ (Last accessed: February 28th, 2019).
[12] John D. Finnerty, Project Financing: asset based financial engineering (2014, 2nd Ed.).
[13] Global Trade Funding, Operation and Maintenance Agreements, available at https://globaltradefunding.com/project-finance/project-finance-documents/o-m-agreement/ (Last accessed: February 28th, 2019)
[14] Id.
[15] World Bank Group, Management/Operation and Maintenance Contracts, available at https://ppp.worldbank.org/public-private-partnership/agreements/management-and-operating-contracts (Last accessed: February 28th, 2019).
[16] Global Trade Funding, Operation and Maintenance Agreements, available at https://globaltradefunding.com/project-finance/project-finance-documents/o-m-agreement/ (Last accessed: February 28th, 2019)
[17] Graham D. Vinter, Project Finance: a legal guide (2006, 3rd Ed.).
[18] John D. Finnerty, Project Financing: asset based financial engineering (2014, 2nd Ed.).
[19] Graham D. Vinter, Project Finance: a legal guide (2006, 3rd Ed.).
[20] Stephens Scown, 10 Things to consider before entering into an operations and maintenance agreement, available at https://www.stephens-scown.co.uk/specialist-sectors/renewable-energy/10-things-consider-entering-operation-maintenance-agreement/ (Last accessed: February 28th, 2019).
[21] John D. Finnerty, Project Financing: asset-based financial engineering (2014, 2nd Ed.).
