Richard Booth,* senior associate at HFW, considers what constitutes a defect, a contractor’s liability and the owner’s typical remedies, as well as practical approaches to managing defects
Unsurprisingly, defects are one of the major causes of dispute and construction litigation in the offshore industry, but there is often disagreement when it comes to identifying what constitutes a defect. In short, a defect is work that fails to comply with the requirements of the contract such that the non-compliant work is a breach of contract., for example, a failure to comply with the contract terms, the specification or drawings, as well as any implied terms as to quality, workmanship, performance or design.
It may be difficult to identify whether the completed work is defective or not. While some standard form contracts, such as FIDIC, do not define what a defect is, it is common practice to define a defect in the offshore sector. At its simplest, a defect is defined as any damage or defect arising from a failure of the works to comply with the contract. If a definition is not included, then whether or not the work is defective can be influenced by local law and practice.
An owner will normally wish to have express rights to take action upon discovery of any defective work. Such an express right also helps to avoid the argument that the contractor does not need to correct the defect until completion. Typical rights include the right to inspect, monitor and open up the works. If a contractor refuses to correct a defect, the owner will typically have a number of remedies available to it prior to take-over', for example, to do the work itself (or through others), require a reduction in the contract price or terminate the contract if the effect of the defect is to deprive the owner of ‘substantially the whole benefit of the works or any major part of the works’. If the contract does not include an express termination right and if the defect is such that it goes to the root of the contract, the owner may be able to claim that the contract is repudiated for fundamental breach.
At take-over, works are generally accepted when they are practically complete. It is invariably the subject of some form of certification. Defects in work that are significant will prevent certificates of practical completion from being issued. However, a certificate does not usually mean that the works are defect free (as defects may not have become apparent). In addition, for example, clause 10.1(a) of FIDIC, minor defects are often allowed to pass over into the defects notification/defects correction period (DLP).
The contractor will be subject to an express contractual obligation to repair, rectify or make good defects within the DLP (with an entitlement to be paid for repairing defects that are not due to its own fault). The length of the DLP will be subject to negotiation but is typically five years for offshore cabling contracts, with shorter periods seen in turbine supply agreements (TSAs). Whether the same DLP applies to all inter-array cables or turbines (for a TSA) will depend on how the contract is structured. It is generally more practicable to have a DLP covering all a particular contractor’s scope ending on a common date (rather than a number of DLPs expiring on different dates).
The DLP is typically extended if a defect arises (known as an evergreen warranty), subject to a long-stop date. We typically see long-stop dates of around seven years following take-over (with shorter periods for TSAs). Evergreen warranties are intended to prevent a contractor from just doing the minimum work necessary for the repair to last until the end of the original DLP. A DLP ought to be clearly worded to oust any parallel claim the owner may have for damages for breach of contract. This is because the obligation on the contractor to return to remedy a defect is generally expressed as the owner’s exclusive remedy. The owner also retains a cash retention for the duration of the DLP as security for the contractor’s performance.
Owners increasingly seek ‘serial’ defect provisions (particularly under TSAs). This is if an agreed number of or more identical parts or components are discovered to be defective due to the same root cause. If this occurs prior to take-over, the contractor will be obliged to stop all work on the affected parts or components, identify other potentially affected parts and the root cause of the defect and submit a root cause analysis report including a methodology for how the contractor proposes to eliminate the root cause. The owner will be entitled to approve the analysis and methodology before any works are recommenced. Serial defect provisions can also be imposed following take-over.
If the owner does not agree with the approach being proposed, it may commission its own independent expert, with the contractor bound by the recommendations. Given the risk of being bound by an owner’s expert, a contractor will often seek to incorporate an interim dispute resolution process into the contract (such as contract adjudication) as a pre-condition to the owner’s expert’s view being binding.
A contractor often warrants that the works will be ‘free from defects’ at completion.
What is often little appreciated is that a contractor is regularly obliged to build in accordance with a design or a standard, even though it has been proposed, or even drafted, by the owner. If the contract incorporates such a requirement and the contractor promises to design or build in accordance with it, it is binding, irrespective of who initially produced or proposed it.
If the works do not achieve the stipulated performance guarantees due to the owner-specified design or standard, the contractor cannot avoid liability by contending that the extent of its obligation was tempered by the fact the offending design or standard was proposed by the owner.
Irrespective of the length of the DLP, a contractor will be liable for defects that may arise after the end of the DLP. In England, this liability arises under the Limitation Act 1980, with contracts executed as a deed attracting a 12-year liability period.
An owner is not obliged to give the contractor an opportunity to rectify a latent defect; it can instead rectify a latent defect itself. If an owner chooses not to use the original contractor, it is likely the amount it may recover from the contractor will be limited to the amount it would have cost the contractor to rectify the defect itself. That said, if an owner demonstrates that it lost faith with the original contractor, it may be able to recover the full cost of appointing a different contractor (as this will not be considered a failure to mitigate).
Parties often focus on agreeing where risk lies for unforeseeable ground conditions, perhaps also limiting a cable installation contractor’s liability for its cable burying performance to ‘reasonable burial endeavours’, and give careful consideration to interface risk between packages. Why, however, do parties also not expressly clarify what is not to be considered a defect? For example, a cable installation contractor ought to exclude liability for seabed movement from what is a defect.
As well as agreeing the duration of the DLP, it is possible to reduce the 12-year statutory limitation period for latent defects. This can be reduced to a shorter period, or a financial sub-cap could be agreed. At its most extreme, a contractor may seek to limit its liability to the DLP by ousting liability for latent defects. This can be done by agreeing that the certificate issued at the end of the defects period has ‘conclusive’ effect as to the contractor’s liability under the contract. It is often supported by an exclusive remedies clause making clear that the employer’s remedies are limited to those contained in the contract.
During negotiations, it is important for a contractor to seek to secure a back-to-back position with its own supply chain to avoid being left with liability for a defect that is the responsibility of its own subcontractor. If a defect materialises in the cables or a turbine, it often costs upwards of a million pounds to rectify the defect (principally due to the cost of mobilising a vessel spread to the windfarm). On this basis, it is sensible for parties to pay close attention to how the contract requires a defect to be notified. The contractor will want prompt notice of any suspected defects, together with adequate particulars as to what the defect is. This will allow it to react and mitigate the extent of the defect or associated damage. The contract should permit the contractor to attend any inspections of the suspected defect, whether at the windfarm or, if the offending component or part has been removed, at another location.
Parties should maintain their records of the installation works (and impose similar retention policies on its supply chain). A contractor may have liability for up to 12 years following take-over, and its own records may be essential for determining liability for a defect that arises a decade or more after take-over. The owner should maintain a comprehensive register of defects, including a log of any incidents that could have impacted on the parts of the windfarm (such as anchor drags). A party notified of a disputed defect should consider retaining an external expert to advise about issues of liability from an early stage. The expert will be able to help direct the focus of the contractor’s own investigations to assist with the identification of the root cause of the defect.
* Richard Booth specialises in construction and engineering matters and has wide experience of acting on both in the UK and internationally, with a particular focus on renewables such as offshore wind and solar.