Most drilling and flotel contracts have a commencement window that allows the contractor to deliver the unit within a range of dates. The contractor nominates the time of delivery according to a notification scheme in the contract. When the delivery date arrives the company is obliged to accept delivery and the operating rate commences. Despite the standardisation of these provisions in the industry, the commencement of the operating rate is a frequently debated issue between oil companies and contractors.
The commencement date for the operating rate causes disputes primarily because of the substantial sums involved and the uncertainties in relation to whether the company is obliged to take delivery of the unit. From the time of delivery, time and costs relating to the unit will no longer to be covered by the lump sum mobilisation fee payable to the contractor but will be payable in addition by way of the operating rate.
CONFLICTING INTERESTS
Whilst the contractor obviously wishes to ensure that the operating rate commences as soon as possible, it is in the oil company’s interest to schedule the commencement of the operating rate so that it corresponds to the time from when the company is ready to use the unit. A late delivery can often be desirable for the company because of arrangements it has made with other
contractors or because the company is not ready to provide its own deliveries under the contract, such as company provided items or operating approvals from public authorities. The conflicting interests of the company and the contractor may result in a battle over contractual compliance.
ACCEPTANCE OF THE UNIT
Commencement of the operating rate will usually require the company’s acceptance of the unit. The contractor may, in order to trigger the operating rate, be tempted to deliver the unit before all outstanding works are completed. In most cases this will be minor outstanding works, but in particular for newbuilds, the outstanding works may be more extensive. In order to postpone
the commencement of the operating rate the company may refuse to accept the unit arguing that it is not ready for delivery as outstanding works remain. Whilst the company’s argument may in principle be correct a number of valid objections to it can be made.
First, it is unfortunate to leave such an important issue as the commencement of the operating rate to the sole discretion of one of the parties. If the company refuses to accept the unit the contractor’s only option may be to initiate legal proceedings claiming payment of the operating rate. Not only will most contractors be reluctant to file proceedings against their customer, but the contractor will also have the burden of proving that the unit complied with the contractual requirements at the time of delivery. Such a process is both time consuming and costly. The contractor will, more often than not, decide not to pursue legal proceedings or accept a settlement less favourable than it might otherwise be entitled to.
Second, it may be questioned why minor outstanding issues should entitle the company to refuse acceptance of the unit. Most minor issues may be cleared during the work without affecting the company’s use of the unit and/or the services to be provided. It is well known within the industry that it is always possible to find non-compliance issues on both new builds and used units if a
hard enough search is made. Most of these minor non-compliance issues are being repaired on a continuous basis without affecting the work or even the operating rate. However, at the time of delivery such minor non-compliance issues may be used by the company to refuse acceptance.
ALTERNATIVE SOLUTIONS
Where the commencement of the operating rate rests as a matter of practice within the company’s discretion this leaves the contractor exposed to an unacceptable risk. In principle, there are two ways of mitigating this risk for the contractor. The contractor can either include a risk element in the level of the operating rate to cater for the occasions where the commencement of the operating rate in reality is postponed as a consequence of the company’s
convenience or the conditions of the contract need to be changed.
The first alternative as a solution is in our view not an easy one to achieve. This is because the risk element is difficult to calculate. The occasions where the company argues that the unit is not ready according to the contractual specifications, whilst the actual motivation is to schedule the
delivery according to company’s convenience, are often unpredictable. Such a risk element will increase the company’s costs without guaranteeing that the contractor will receive payment if the risk materialises.
The second alternative allows for a more balanced solution. If the company wishes to postpone delivery, then they should pay the actual costs incurred as a consequence of that decision. The costs will then be covered by the beneficiary of the postponement and the contractor will get its additional costs covered. Ideally, such terms should be included as industry standard
conditions but that is not currently the case and until the issue is addressed, the changes must be made in contracts on an individual basis.
The company’s right to refuse acceptance of the unit should, in our view, be proportionate to the non-compliance and the consequences of the non-compliance. If the non-compliance can be remedied post-commencement without affecting the work to be undertaken or have only a minor impact on the work, the company should not be entitled to refuse acceptance. Under these circumstances, the contractor may be given a deadline for rectification of the non-compliance
and such non-compliance may also be linked to proportionate liquidated damages.
If the non-compliance is not rectified within the deadline, other sanctions such as increased liquidated damages and/or a right for the company to sus-pend the rate in whole or in part could be imposed. This is possible under Norwegian law, as penalty clauses in principle are enforceable. Such sanctions would reflect the consequence of a non-compliance with the unit in a far more balanced way than a discretionary right for the company to refuse acceptance. The challenge is obviously to motivate the company to change the existing setup. In times where the demand for the units is high there might be a fair chance to succeed. Whilst in times with less demand other contractors may be more likely to be willing to accept the existing regime hoping that no issue on delivery will arise.