I’ve been finding myself doing a few technical due diligence reviews recently, and I thought it was time to do a write up about contracts again. It’s been a while. Today I thought I’d write about Delay Liquidated Damages.
Liquidated damages are a mechanism available to the Principal* when it is not possible to accurately predict what the financial impact would be from a failure on the part of the Contractor. The method for determining damages payable is then set out in the Contract with the idea being that the amount payable is commensurate with the loss the Principal would experience, as a result of that failure. It’s a best estimate, understood to be inexact and subject to negotiation.
Delay Liquidated Damages (DLDs) are payable if the project is not completed on time. They are becoming increasingly complicated. This is a small frustration for a technical advisor (or at least this technical advisor), as it becomes a bit trickier to assess the appropriateness of the rates set out and the methodology proposed.
In simpler days, the DLDs were typically a daily rate for any delay to achieving Commercial Operation/Provisional Acceptance (or whatever your final revenue generating milestone is called.) As an advisor I would then look at the rate and at how much energy was expected to be generated that day. I’d calculate the equivalent price/MWh and compare that against the assumptions in the financial model and by assessing the rate set out in the power purchase agreement, or looking at current market rates.
Things are becoming a bit more complex now. As facilities get bigger there are more completion stages – so damages may apply if each stage is delayed, but also if the facility is delayed as a whole. The energy yield assessment may not have been done on a staged approach. Typically we’d see some sort of output value per month based on the completed facility design. Maybe this will start to change.
Also, sometimes facilities can export power even if they’re not really finished according to the contract. So maybe they have approval to export 30% of their final capacity because they’re constrained for not successfully completing all their grid connection tests. And that 30% electricity that is exported results in some sort of revenue to the Principal. DLDs are then still payable because they haven’t completely finished, but the Principal would be double dipping if they claim the revenue and the full DLDs. After all, the DLDs are there to compensate the Principal for losses. If they’re getting some revenue then the losses aren’t all realised. So DLDs may be netted off against revenue realised.
Finally, DLDs can also be different for different months of the year. Say now a facility is meant to be finished in March (assuming one completion milestone…) March will have a different energy yield profile to August. So the daily compensation should be different. Imagine if Completion was scheduled for March, but through no fault of the Contractor (like grid connection delays), the Completion Date was extended to July. Then the Principal may be better or worse off if the DLDs remained the same if the Contractor was then further delayed. So linking DLDs to the month allows for a better alignment between DLDs and lost revenues.
There’s a lot to digest there.
*I use Principal in this post but different contracts may refer to the party as the Employer or Owner. Or Handsome Devil. The options are endless.
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