A Non-Lawyer’s Guide to Project Contracts – Part 2
A Breakdown of Project Contracts and why they matter to investors
In the world of ambitious projects, contracts serve as the blueprint, guide, and rulebook for all parties involved.
For those of us who aren't lawyers, the sheer volume and complexity of these agreements can seem daunting, but understanding the important clauses is essential for anyone responsible for developing, financing, and executing such projects.
From general to specific clauses within Concession, EPC, O&M, Off-take, Supplier contracts, and Host community agreements, understanding them is indispensable for success because they enable effective collaboration, prudent risk management, and ultimately, the successful delivery of complex projects that drive economic development.
The following are necessary to know as you secure legal advisors and work with them to produce project contracts that attract financing and protect against future loss.
A: Contents of a Project Contract:
Regardless of the project type or contract, these clauses that define the framework of the relationship between the parties will be found in contracts:
Naming of Parties: Identifying who is entering into the contract, legal names of the parties, official addresses, registration numbers.
Preamble: Providing background, context for the contract.
Definitions: Defining the meanings intended when certain words are used within the contract.
Scope: Clauses detailing what exactly is to be delivered by each party as it specifically relates to the scope of the project and what is to be expected from each party during the contract period.
Consideration: Clauses detailing the types of fees, quantity, structure of fees, pricing calculations, and tariff/fee adjustment mechanisms for meeting the expectations in scope.
Penalties: Clauses detailing what happens when defaults in performance or agreed expectations happen, the opportunities for redress, the type, quantity, the amount to be paid, or the mechanism for calculating and then paying damages to the aggrieved party.
Duration & Expiration: Clauses about the start and completion dates of the Contract, as well as the terms of expiration of some general or specific clauses, for instance, clauses on confidentiality, intellectual property, may still hold for a period even after the contract ends.
Confidentiality/Non-Disclosure: Clauses ensuring that sensitive information shared between parties remains private and is used solely for the agreed purpose. It often specifies limits on disclosure and requires a "need to know" basis for internal access, permissions required for making aspects of the project public. These clauses are often subject to what is later made public or what is requested under civil or criminal investigations
Liability & Indemnification: Clauses covering limitations to liability for consequential damages and providing caps on aggregate damages.
Force Majeure: Clauses covering what happens when unforeseeable and unavoidable circumstances (e.g., natural disasters, pandemics, war) that prevent contract performance, allowing for suspension or termination without penalty.
Termination: Clauses outlining the conditions under which either party can end the contract early, including reasons like breach of obligations, non-payment, or mutual agreement, and the financial consequences of such termination.
Dispute Resolution & Arbitration: Specifies the process for handling disagreements, typically starting with good faith negotiations and escalating to arbitration or litigation if unresolved. The place and language of arbitration are usually stipulated.
Applicable Law & Jurisdiction: Determines which country's laws will govern the contract and where any legal proceedings will take place. This location varies subject to the location of the project, the country of origin of one of the parties, source of capital etc.
Signatures: The signature of the exact people legally able to bind the parties to the contract.
B: Common Infrastructure Project Contracts
Let's break down the key parts of most common types of contracts you'll encounter in infrastructure project development and as usual, try to link them to
1. Concession Agreement / PPP Contract: The Project's Mandate for a public asset
Often the foundational document in public infrastructure projects, a Concession Agreement (or Public-Private Partnership (PPP) Contract) is a long-term agreement between a Project Company (the private entity) and a Contracting Authority (typically a government body). Its purpose is to grant the Project Company the right to design, build, finance, or operate public infrastructure.
Important Clauses:
Granting terms: This clause defines the actual granting of the rights to the concession area, easements, benefits accruing and liabilities as it relates to the projects terms.
Asset Ownership & Reversion: Ownership of the assets and what happens at the end of the concession period. In a "Reverting Asset" contract, the facility reverts to the Contracting Authority's control.
Concession Period: This clause defines the duration of the concession. How long the rights are granted to operate the facility and collect revenues. It's crucial as it impacts the project's financial viability and long-term planning.
Scope of Work & Specifications: Defines what is to be built or upgraded, then operated. These clauses details the technical and performance criteria for the project. The output specification is key here: it specifies what needs to be achieved, not how.
Payment Mechanism: Defines how does the project SPV (also known as the concessionaire) gets paid. Either:
User Charges: In projects like toll roads, the Project Company collects tolls or fares directly from the end-users. This means the Project SPV takes the revenue risk with the contracting authority, typical and practical with commercially driven projects
Or
Service Fee / Availability-based Payments: In more socially driven projects like hospitals or schools, the Contracting Authority may commit to a fixed regular fee to the project SPV based on the facility's availability and performance, rather than direct user payments.
Force Majeure & Compensation Events: These clauses define extraordinary events (e.g., natural disasters, changes in law) that might disrupt the project, and determine whether the Project SPV is compensated or excused from its obligations.
Dispute Resolution: This outlines the process for resolving disagreements, often through arbitration rather than litigation.
Termination Clauses: Specifies conditions under which the concession can be terminated early (e.g., default by either party) and the consequences of doing this, including compensation payments. Lenders have strong views on termination sums as this impacts their ability to recover outstanding debt.
Reverting/Hand over Clauses: Who the asset goes back to at the end of the concession period. Terms for handing it over to the government authority, the state or the status of the asset when it is handed back after the concession ends.
2. Offtake Agreement: Guaranteeing Revenues from specific end users
The Offtake Agreement is a contract under which the Project Company (producer) sells its product or service to specific "off-takers" (buyers). These agreements are particularly crucial for process-plant projects (e.g., power plants, chemical plants) as they guarantee a secure revenue stream for the Project Company, which is essential for bankability.
Important Clauses:
Product/Service Specification: What exactly is being sold (e.g., electricity, processed chemicals), its quality standards, and volume.
Pricing Mechanism: The agreed price, often adjusted for inflation, and how it's calculated.
Volume Commitment: This is where the risk allocation truly shines. The terms here could be either
"Take-or-Pay" : The off-taker commits to pay for a specified quantity of product, even if they don't actually take it. This provides strong revenue certainty to the Project Company and is highly favoured by lenders.
or
"Take-and-Pay": The off-taker only pays for the product when they actually take it. This offers less certainty for the Project Company and thus more market risk.
or
Input Processing: where the off-taker commits to providing a certain level of inputs for processing in exchange for defined services or products (in kind transactions)
Duration: Clauses relating to the length of the off-take commitment. Investors like to see the length of this offtake contracts aligned with the full project life ( life of the asset being funded, or the duration of the concession) or at least loan tenor.
Penalties: Provisions for what happens if either party fails to meet their obligations (e.g., penalties for the Project Company if it doesn't deliver the agreed output, or for the off taker if it doesn't make payments).
3. Supplier Agreement: Securing the Inputs
Just as an off-take agreement secures output revenue, a Strategic resource supply (or Supplier) Agreement ensures the Project Company has a reliable and continuous supply of crucial raw materials or inputs (e.g., fuel for a power plant, water for a treatment facility). Uninterrupted supply at predictable prices is essential for project operations and financial stability.
Important Clauses:
Input Specification: The quantity, quality, and type of raw materials or fuel to be supplied.
Pricing & Price Adjustment: How the price is determined and adjusted over time (e.g., fixed, indexed to market prices, or with caps/floors).
Supply Commitment: Similar to off-take agreements, these can be:
"Supply-or-Pay" / "Put-or-Pay" Contracts: The supplier commits to making the supply available, and if they fail, they compensate the Project Company for procuring alternative supply.
Delivery Schedule & Logistics: Details on how and when the inputs will be delivered to the project site.
Force Majeure: Clauses addressing unforeseen events impacting supply.
Performance Guarantees: Assurances from the supplier regarding the reliability and consistency of supply.
4. Engineering, Procurement & Construction Contract (EPC): Bringing the Project to Life
This contract governs the detailed design and construction of the project facility. Lenders, especially those advancing project-finance, typically insist on a "turnkey" responsibility model, usually in the form of an Engineering, Procurement, and Construction (EPC) Contract or a Design & Build (D&B) Contract. This means a single contractor is responsible for delivering a complete, fully equipped, and operational project at a fixed price by a certain date. This "one-stop" responsibility minimises the risk of the Project Company being caught in disputes between multiple contractors.
Important clauses:
Scope of Works: A detailed description of the design, technical specifications, and performance criteria for the project. The scope here can include completing the detailed design as well as the procurement of parts, materials sub subcontracted services, and then the actual construction. Typically, a detailed appendix/annex covering these scopes is provided in the document or as attachments that clearly explains the scope and quality to be delivered under the contract.
Fixed Price & Payment Milestones: The total cost for the construction work is fixed, and payments are typically made in stages upon the completion of pre-agreed milestones (e.g., foundation laid, major equipment delivered, mechanical completion). This provides cost certainty, which is crucial for lenders.
Completion Date & Liquidated Damages (LDs): A firm deadline for project completion is set. If the contractor fails to meet this, they are liable to pay Liquidated Damages (LDs)—a pre-agreed penalty sum for each day/week of delay. These LDs are critical for investors as they help cover potential loss of income or penalties under the Project Agreement due to delays.
Performance Guarantees & Tests: The contractor guarantees that the constructed facility will meet specific performance standards (e.g., electricity output for a power plant). Performance tests are conducted at completion, and failure can trigger further LDs.
Security & Bonds: The contractor typically provides performance bonds or guarantees to ensure their obligations are met.
Owner's Risks: Specific risks that remain with the Project SPV (and not the contractor), such as providing site access or utility connections.
Defects Liability Period: A period after completion (usually 12-24 months) during which the contractor remains responsible for rectifying any defects in the works.
5. Operation & Maintenance (O&M) Contract: Keeping the Project Running
Once construction is complete, the Operation & Maintenance (O&M) Contract comes into play, covering the long-term management, operation, and upkeep of the project facility. This can be a single contract or split into separate agreements (e.g., for toll operations and road maintenance).
Important clauses:
Scope of Services: Clearly defines the responsibilities of the O&M contractor, which can range from core (maintenance of core infrastructure) to general (cleaning, catering, security). It's crucial that corporate functions (e.g., general administration, finance, insurance) remain with the Project SPV.
Performance Requirements & Key Performance Indicators (KPIs): Specifies the expected operational performance, service levels (e.g., plant availability, quality of service) and uses KPIs to measure adherence. Penalties or bonuses may be linked to performance.
Maintenance & Lifecycle Costs: Defines responsibilities for routine maintenance and major periodic overhauls (lifecycle renewals). This is a critical area for lenders as these costs can be substantial over the project's long life. Often, a Maintenance Reserve Account (MRA) is set up where cash builds up to cover these future costs. Contributions of revenue or profits to the MRA account by the O&M partner are subject to if they share revenue risks with the project SPV or not. If the O&M terms do not cover this risk, then only the Project SPV contributes to the MRA.
Fee Structure: How the O&M contractor is paid (e.g., fixed fee, variable fee based on output, or a combination, profit sharing with project SPV).
Staffing & Expertise: Ensures that the O&M contractor has the necessary personnel with the requisite experience.
Reporting Requirements: The O&M contractor typically provides regular reports on operational performance, allowing the Project Company and lenders to monitor compliance.
Even if an equity investor in the Project SPV is the O&M partner. They are considered a separate legal entity from the SPV, and a separate O&M contract which defines the scope of their involvement, is necessary.
Reiterating the need for suitable legal advice
As I typically do in these notes, I provide examples or considerations relevant to toll roads, energy projects, and logistics parks.
Energy projects:
If for a Commercial & Industrial user or large-scale utility, a Power Purchase Agreement (PPA) - a form of off-take contract is needed. Also needed are an EPC contract and an O&M contract.
If Solar-powered, no need for a supply contract, but if Diesel or Gas-powered, then a supply contract is needed.
For smaller-scale mini grids within communities, PPAs demanding volume commitments may not be practical. But PPAs with the community are still needed and should include tariff calculations and adjustments, as well as exclusivity rights for the project company. An EPC contract is needed if the contractor is building many sites at once, and an O&M contract is needed if the oversight of many sites is given to another company. - including a sponsor of the project company.
Toll roads
If a concession of a public asset, then a concession agreement that grants the rights to the project company is needed.
If fully private or a PPP, then an EPC contract and an O&M contract are needed.
No need for a Supply contract.
Logistics parks
If a concession of a public asset, then a concession agreement is needed.
If also including processing, then supply contracts are needed to feed the processing facilities.
Whether private or PPP, an EPC contract is needed.
The above are suggested because of the characteristics of these projects. I will have to reiterate that the exact type and content of the project contracts depend on the project specifics, and having legal advisors clearly define what is needed for each particular project is necessary.
It cannot be overemphasized that you need to get the right legal advisors to support you with identifying the necessary types and content of project contracts, then drafting and negotiating them accordingly.
If your end game is one or both of preventing loss and securing external return-seeking capital, do not skimp on quality legal advisory.
Bringing it all home
Contracts are not just paperwork; they define relationships, responsibilities, risks, and rewards of the project.
While you need suitable legal advice, understanding project contracts is not just for lawyers; it is important for anyone who wants to successfully lead project development, and even more important for those seeking to attract finance to their projects.
It is also important to watch out for and maintain consistency across all contracts, ensuring that what is in one contract doesn't negatively impact other contracts. For instance, force majeure clauses across contracts must be coordinated to avoid inconsistencies that could expose the project SPV or the company responsible for the project.
These meticulously crafted documents provide the essential framework that transforms a project idea into a successful, revenue-generating reality. Without this robust contractual foundation, securing the necessary funding for infrastructure projects at scale would be impossible.
Reviewed to complete this edition
Principles of Project Finance - E.R. Yescombe
Project Finance for Business Development - John Triantis
International Project Finance Law and Practice - John Dewar
Innovative Funding and Financing for Infrastructure: Addressing Scarcity of Public Resources – Jeffrey Delmon