TRANSFER OF RISK FROM

CONSTRUCTION PHASE TO
OPERATIONAL PHASE

A London Engineering Group Study

R Knight

A Chapman

K Gormley

K Lutz

D Turner

C Clarke

D Phipps
Contents:

Introduction

Contract Conditions

Engineering Perspective

Current Market Clauses

Appendices:

Appendix 1 Extracts from Contract Conditions

Appendix 2 LEG Conference PowerPoint Slides

2
Introduction

The handover process of a construction project to the Owner, and hence the transfer of risk
from the construction insurances to the operational insurances, should be a relatively simple
affair.

All that needs to be done is for pre-agreed criteria in the Contract Conditions to be met, such
as pre-agreed performance levels between the manufacturer/supplier and the principle,
followed by a continuous test run for an agreed time, normally 72 hours ultimately resulting
in the approval of the principle and/or his representatives/consultants, and the signing of the
appropriate handover certificate.

However, the handover process is rarely simple. Disputes often arise over whether the
performance criteria have been reached, whether all equipment is operating correctly, and
many others. Too often a snag list or punch list of items to be resolved remains. The
project can often be transferred to the principle and the operational programme before the
handover criteria have been achieved. On other occasions the risk remains completely or
partially insured under the construction insurance policy, with the majority of equipment
operating while the disputed items are fixed

Obviously the handover process is vitally important to both construction and operational
insurers. The purpose of this study is not to prepare a clause or wording, but to examine the
handover process and highlight some of the issues that can occur. A team of senior
underwriters have formed to carry out this study. To this group was added Kevin Gormley,
Engineering Manager of QBE Marine and Energy Syndicate 1036, who has already prepared
and delivered a presentation to OPERA on the Engineering aspects of handover, together
with Adam Chapman, Vice President of Marsh Energy, who has extensive knowledge of
contract conditions.

This study is divided into three sections, the first being a review of contractual structures and
their bearing on the handover process; engineering perspectives of the handover process and
some examples of handover clauses in current use.

Contractual Structures

3
The purpose of this section is to provide a background as to the various contractual structures
that might be used in a construction project, and examine how they might influence handover
to an operational policy

Contract Structures

There are a number of different ways that a construction project maybe structured from a
contractual viewpoint. The list below is suggested to be the main structures typically
encountered.

Types of Contract

Engineer, Procure and Construct

The most common structuring for a small to medium size project is that of the EPC contract.
This is where a single entity (or joint venture) is contracted to engineer, procure and construct
the project. This entity therefore is responsible for taking the project from the front end
engineering and design (FEED) stage through to completion. Completion may be either
Mechanical Completion, Ready for Start Up, or issuance of a Provisional Acceptance
Certificate following a Performance Test. Dependent upon the nature of the contract and
usually the strength of the Principal the EPC contractor may commission the plant, or may
simply provide assistance to the Principals own commissioning team during this stage.

Engineer, Procure and Construction Management

This is a variant on the EPC contract, known as EPCm, where the contractor is responsible
for the engineering, procurement and manages the construction itself, rather than performing
the actual construction. As per the EPC contract the termination of the services can be at
either MC, RFSU or PAC.

Engineer, Construct and Commission

Similar to the EPC contract, however the materials are typically purchased by the Principal
and then assigned or free issued to the contractor. In this case the commissioning as the name
suggests is carried out by the Contractor, although he may use the Principals employees
under his direction to perform such.

4
Design Build and Operate
This is a variant where the contract is responsible for designing, building and then operating
the plant. This is more applicable to projects where the construction contractor takes the role
of the operations and maintenance contract after completion.

Project Management Contract

This is where the contractor is responsible solely for the management of the various
construction activities. In this instance there are typically a number of construction contracts
(which are typically EPCs) related to the project. The PMC may also be the EPC contractor
for an element of the works. Typically the PMC is involved in the commissioning of the
plant, but not responsible for the actual activities taking place during such.

Installation Contractors
This is a variant where the contractor is responsible solely for the installation of the works,
i.e. the design is carried out by another party, as is the purchase of the equipment. In this
variant the contractors responsibility typically ceases at MC.

Vendors
For specialist items of equipment, for instance gas turbines / compressors etc, the vendors
will produce onsite assistance during the commissioning activities.

Licensors
In certain cases in which the process is licensed there will be representatives of the licensor
providing advice to the commissioning team. Under the license arrangement there may also be
separate obligations in terms of performance / reliability testing and financial commitments.

Types of Reimbursement
There are various ways in which a contractor can be reimbursed for his contract, and these
are sometimes referred to when specifying the type of contract. The main arrangements are:

Lump Sum (LS) or Lump Sum Turn Key (LSTK), where an all in price is agreed for
the execution of the contract. Turn Key contracts imply that the plant is commissioned by
the contractor, and then turned over in an operating state.
Cost Reimbursable are contracts whereby there is a predetermined formula for arriving at
the contractors remuneration based on the cost expended. (Variants of this type are for
instance open book contracts, cost plus etc.)
Target Price contracts are similar to cost reimbursable but where a target price is agreed
and remuneration is based around the target price.

5
Common Features

Definitions
All contracts will typically contain a definitions section. Whilst this paper contains
suggestion as to the meanings of a particular term and its use within this paper, it should be
noted that all contracts vary and therefore the definitions section of a particular contract
should be referred to, to determine the meaning of a particular term in context.

Mechanical Completion
Whilst the specifics vary from contract to contract, generically this is the point at which a
system or the plant as a whole is mechanically complete, and ready for pre-commissioning.

Precommissioning
Commissioning / testing prior to the introduction of feedstock. This is typcially done on a
system or subsystem level and may involve the energisation of the system, cold dynamic
testing etc. Typically it does not involve the introduction of feedstock, although from an
insurance viewpoint it may involve the introduction of hydrocarbons for the drying out of
refractory linings, preloading of reactors etc.

Ready for Start Up

Typically the point at which the plant is ready for feedstock to be introduced, and
commissioning (as opposed to pre-commissioning) to commence.

Performance Test
A test of the plant performance, usually for a short duration such as 72 hours during which
nameplate capacity has to be achieved and maintained. However it should be noted that this
test also typically includes a number of other criteria that need to be met as well as
production:-

Quality and consistency of product

Consumption of feedstock
Consumption of utilities
Catalyst (if applicable) performance
Environmental constraints
However it should be noted that certain types of plant such as batch plants have atypical
performance tests, for instance the generation of a certain grade of polymer over a single
batch cycle.

6
Reliability Test
Some type of plants also have reliability tests. These are longer in duration than the
performance testing being typically 30 90 days, and monitor availability and consumption
typically rather than maximum output.

Provisional Acceptance Certificate

Typically issued following successful completion of a performance test. However may also
be issued due to contractual reasons. An example of such would be that the Principal has
failed to make available the resources required to execute the performance test (e.g.
insufficient feedstock etc), in which case after a certain period of time (typically 6 months
after the contractor has notified the Principal that the plant is ready for the performance test) a
PAC is deemed to have been given.

Final Acceptance Certificate

Typically issued following the completion of any defect liability / maintenance period.

Contract Forms
The vast majority of construction contracts for major projects are bespoke contract forms, and
a couple of examples of these are included in Appendix 2 to this paper. However there are
also several standard contracts such as FIDIC and IChemE that form the basis of contract for
smaller projects and are in widespread use.

Bespoke Forms
Unfortunately these tend to be tailored to the particular project and therefore it is difficult to
generalise regarding such. However most detail the transition to completion via a series of
steps of mechanical completion, pre-commissioning leading to ready for start up,
commissioning leading to the performance test and issuance of a provisional acceptance
certificate.

FIDIC
FIDIC contracts have four main types of contract:-

Conditions of Contract for Construction for Building and Engineering Works Designed
by the Employer: The Construction Contract (the new Red Book)

7
 Conditions of Contract for Plant and Design-Build for Electrical and Mechanical Plant
and for Building and Engineering Works, Designed by the Contractor The Plant and
Design/Build Contract (the new Yellow Book)
Conditions of Contract for EPC/Turnkey Projects: the EPC Turnkey Contract (the Silver
Book)
A short form of contract (the Green Book).

The forms use terms such as Tests on Completion, Performance Test and Taking Over
Certificates. Tests on Completion are divided into three categories, being:-

Pre-commissioning
Commissioning
Trial Operations

Taking Over Certificates are typically issued upon completion of the Test on Completion for
a particular element, however it may also be issued due to failure to perform either by the
contractor or by the principal the tests within a designated timeframe. The Performance
Certificate is issued upon expiry of the Defects Notification Period.

Contractual Regime applied to Operational Transfer

The first and most obvious point to make is that typically a construction contract is written in
ignorance of any insurance arrangements. Whilst certain Principals have modified their
construction contracts to reflect the insurance arrangements within the current market place,
it is unlikely that the majority of construction contract will have specifically imposed a test
that will address the requirements of the operational market testing and commissioning
clause. This having been said operational insurers typically rely upon the Performance Test
as evidence that they can accept a plant under operational coverage. Whilst this tends to be
acceptable for single plant single train projects, as the plant becomes more complex so do the
challenges. This section aims to highlight some of the issues associated around contracts that
might complicate an operational transfer. It has been divided into section to parallel a typical
operational testing and commissioning clause.

Typical Components of Testing and Commissioning Clause

Requirements satisfactory completion of:
Mechanical completion, including Testing and Commissioning
Performance Testing
100% design criteria
72 hours
Stable and controlled operation
Continuous ongoing period

8
 Also requires
Official acceptance by Insured.
Plant handed over without reservation or waiver of guarantee
No equipment faults or punchlist items affecting operational integrity
No temporary structures or start-up modifications

72 hours run

Non compliant Performance Test

By this it is meant that the performance test does not actually satisfy the requirements of the
testing and commissioning clause. This may be because the plant is a batch plant (and
therefore only operates continuously for a shorter period), or because the performance test
requires a lesser throughput (for example where the plant is down rated during summer
conditions), or because the performance test has been modified due to a known problem (e.g.
undersizing of unit, late delivery of ancillary vessel etc).

Lack of a Performance Test

Whilst it is unlikely that the construction contract will not contain some form of performance
test, this obligation can fall away during a construction contract for a number of reasons. The
most typical is that due to reasons beyond the Principals control the Principal has been unable
to carry out a performance test within the contractual timeframe. Under the majority of
contracts, this means that the contractor receives an implied Provisional Acceptance
Certificate, and therefore is relieved of his contractual obligations to carry out a performance
test. The Principal may continue to be unable to perform such due to outside causes, or may
be unable to perform the test without contractor / vendor assistance, or may merely be
unwilling to do so due to the administration and cost involved in such.

Failure of a Performance Test

A plant may fail its performance test for a number of reasons, such as poor product quality,
higher than anticipated utilities consumption etc. Not all of the reasons for failure necessarily
prohibit the attachment of an operational policy.

Official Acceptance
Most operational insurers determine official acceptance as the issuance of the provisional
acceptance certificate. However as mentioned above this can happen for reasons other than
those intended by the operational insurers. Furthermore it should be noted that typically it is
only a provisional acceptance certificate that it is used following the performance test, the
final acceptance certificate only being issued after the defect liability period.

9
Without reservation
From a contractual compliance viewpoint this is very difficult to comply with, since in the
vast majority of cases the Principal will retain certain rights against the contractor following
acceptance, even if it is only that of the remedying of defects during the defects liability
period, and completion of the outstanding punchlist items (see below).

Punchlists
In the vast majority of cases in order to move from mechanical completion to ready for start
up the more serious of the punchlist items (typically called Category A and B items) will
need to be resolved. Category C items (i.e. those that remain whilst the plant moves into a
commissioning phase) are typically items such as painting, making good, and removal of
items from site. Therefore from a contractual viewpoint this can generally be complied with.

Temporary structures or start-up modifications

From a contractual viewpoint, this too can be problematic, as for instance the FIDIC contracts
typically allow upto 28 days for the contractor to clear the site following the performance
test. Furthermore, in order to execute the actual performance test itself with the majority of
plants additional monitoring equipment is utilised that then needs removal. Lastly there is the
completion of Category C punchlist items such as typically painting which would require
scaffolding etc to be in place in order to execute.

Engineering Perspective

The handover process involves two teams of engineers, both working towards the same goal,
but from different perspectives. On the one hand, there are the engineering designers,
manufacturers and contractors who are trying to ensure that the plant perfumes adequately to
match the handover criteria; and then there are those of the owner, who are monotoiring
performance to ensure that the plant performs to the required criteria.

10
From the engineering perspective (and insurers and reinsurers too) the testing and
commissioning period is the most difficult and potentially hazardous part f the construction
phase. It comes at the end of a hectic construction programme with intense pressure to bring
plant and equipment to operation as quickly as possible. It brings a disparate mix of
equipment from their as-built state into operation as a dynamic process, operated by human
beings and producing saleable products. The presence of feedstock also increase risk
exposure levels.

The First Rule of Testing and Commissioning

You get what you inspect, not what you expect!

Testing and Commissioning Some Definitions

Precommissioning/Cold Testing encompasses all static and non-energised checking and test
work, necessary to ensure that a given system is built according to project specifications and
documents

Commissioning/Hot Testing encompasses all dynamic and energised tests necessary to

ensure that a given system is ready for its safe start-up

Testing and Commissioning Pre-Commissioning/Cold Testing

Diagram to be inserted

Testing and Commissioning Commissioning/Hot Testing

Diagram to be inserted

11
Testing and Commissioning Typical Time line

Diagram to be inserted

Testing and Commissioning Documentation

Diagram to be inserted

12
Testing and Commissioning Example of Workload

The statistics from a recent project were:

3.5 million man-hours, 470 items of equipment

140 sub-systems

1,600 system test packs

6,500instrument loops

100 operational procedures

22,600 pre-commissioning activities

6,000 commissioning activities

5,000 to 10,000 expected punch-list items

Testing and Commissioning Typical Start-up Procedure

Pre-start-up Safety Review

Final purging and air-freeing of equipment

Introduction of hydrocarbons

Circulation and Warm-up

13
 Introduction of Feed

Ramp-up to operating conditions

Production of on-specification products

Optimization and tuning

Troubleshooting (if required)

Ramp-up to design feedrate and operating conditions

Performance / guarantee test-run

Testing and Commissioning Typical Problems

Most construction projects are commissioned and start operation with only minor problems,
resolved in the normal course of operation.

Some construction projects suffer damage and delays that can be related to one or more of the
following:

Poor planning

Ineffective leadership and lack of Owner involvement

Rushed installation

Poor QA / QC

Poor quality workmanship

Too few experienced or too many inexperienced commissioning resources

Inadequate design

Poor industrial relations and/or sabotage

Testing and Commissioning Project Delays

75% due to equipment failures, most of which relate to rotating machinery

(centrifugal compressors, steam turbines, gear boxes, etc)

20% due to inadequate equipment

5% due to process failures

14
Testing and Commissioning Typical Incidents

Rotating machinery failures

Boiler and fired heater explosions if correct procedures not followed

Refractory failures if heat-up rates are too hang

Pressure vessel and/or piping failures due to inadequate design; manufacturing

defects; poor structural supports

Leaks due to improper gasketing or bolting

Failures due to thermal expansion

Loss of containment leading to fires and explosions

Prototypical plants and equipment or significantly scaled-up plants sustaining

unexpected failures

Construction debris damaging equipment

Testing and Commissioning Some Recent Problems

Client unaware of Testing and Commissioning requirements before transfer to

operational insurances

Testing and Commissioning deferred on some plant, but transferred to operational

insurances

15
 Insufficient feed to test at 100% capacity

Batch operation, not all plant run and tested for 72 hours before handover and transfer
to operational insurances

Phased handover, again not all plant run and tested before handover and transfer to
operational insurances

Design issues prevented 100% operation before handover and transfer to operational
insurances

Testing and Commissioning Recommended Data Requirements

When a plant cannot strictly comply with the contract criteria for handover,
underwriters should require an engineering review consisting of:

A detailed description of plant and equipment involved

Current status of commissioning activities

A copy of the Testing and Commissioning Plan

Reasons why Testing and Commissioning clause in the operational insurance policy
cannot be complied with

The Insureds plan to test and commission the rest of the plant

The extent to which plant and equipment can be individually tested

A copy of the pre-start up safety review

List of punchlist items

Handover Insurance Clauses in Current Use

These clauses are current examples and are not deemed to be approved or recommended by
LEG.

16
Property and Plant Testing and Commissioning Clause

This clause was originally drafted by IOI and CIGNA in the 1990s following a number of
incidents that followed handover from the construction phase to the operational phase without
he achievement of the handover criteria. It is still very much in general use.

It is hereby noted and agreed that this insurance does not cover destruction of or damage to
property in course of construction or erection, dismantling, revamp or undergoing testing or
commissioning including mechanical performance testing and any business interruption
resulting therefrom.

Acceptance of property hereon is subject satisfactory completion of the following procedures:

Mechanical completion including Testing

Testing and Commissioning

Performance Testing conforming to 100% Contract design Criteria maintained by the

entire plant in a stable and controlled manner for a continuous ongoing period of a
minimum of 72 hours duration.

Official acceptance by the Insured following formal handover without reservation or

waiver of guarantee conditions. It being understood that no equipment faults or punch
list items affecting operational integrity of the plant are outstanding and that no
temporary structures and no modifications remain.

Notwithstanding the above, attachment of property and plant hereon is to be agreed by

Insurers/Reinsurers. It is further noted and agreed that terms and conditions are to be
reviewed, if required, by Insurers/Reinsurers

It is further noted and agreed that the above provisions do not apply to normal routine
maintenance activities and schedule turnarounds.

Some other clauses supplied by LEG members are also currently in usage:

Handover

Notwithstanding that phases or sections of the Project will be completed and/or handed over
prior to completion of commissioning of the last phase or section of the Project the cover
provided by this Policy shall continue for the benefit of the Principal in full force and effect
with respect to all the lnsured Property until the completion of commissioning of the last
phase or section of the Project but excluding any such completed and/or handed over phase(s)

17
or section(s) in full commercial operation other than in connection with the completion or
ramp up of the Project.

Taken into use

Notwithstanding that sections of the insured contract will be completed prior to completion of
commissioning of the last section of the contract the cover provided by this Policy shall
continue in full force and effect for all of the lnsured Property until the completion of
commissioning of the last section of the contract but excluding any handed over section(s)
that have reached the contractually agreed specification and are in full commercial operation.

Conclusions
This exercise has taken a considerable time to prepare, and hopefully manages to convey the
problems and pitfalls that can be encountered in the handover process.

There is still a considerable amount of research that is left to be done, and it is hoped that this
Study Group can continue to work on this subject and take this report to a more detailed
level.

18
October 2009

19