This Deep Dive on Risk Management comes from Breakbulk Magazine Issue 3/2019's story, Contracting Complexity by Paul Scott Abbott
In a business full of the unexpected, contracts that tend to be both rigid and complex are challenging project cargo forwarders in their efforts to serve engineering, procurement and construction firms, or EPCs.
Project freight forwarding experts from UTC Overseas’ Mirko Knezevic to BATI Group’s Kaan Aydin concur with international shipping attorney Michael Wray in telling Breakbulk that flexibility and coordination may be keys to effectively putting together what Wray sees as a jigsaw-like puzzle.
“This is really, really tough,” said Knezevic, chief operating officer for global projects at Houston-headquartered UTC Overseas, for which he has worked for nearly 20 years. “It’s totally getting out of hand.”
Knezevic, who has more than 35 years of project forwarding experience, said today’s contracts may well be hundreds of pages in length, including extensive legal verbiage.
“It’s a whole lot of work to go through that, and sometimes they are very rigid and not negotiable, with absolutely no wiggle room,” said Knezevic, who is based in the Rochelle Park,
New Jersey, office of UTC Overseas. “You have to be almost a legal wizard to understand all this. It can distract us from doing the work, from doing what we’re good at.”
LEGAL EXPERTISE NEEDED
UTC Overseas, like other project forwarders, found itself turning to costly outside trade attorneys and consultants before a decision was made to hire an in-house legal expert dedicated to addressing contracts. Knezevic said lump-sum contracts from EPCs may require the forwarder to take responsibility for functions such as vessel hull insurance – which, he said, is not technically feasible, as the forwarder does not own the ship.
“It’s an impossible situation for us to cover that,” he said. “Legal departments of the clients want to shift the complete responsibility not only for the cargo value but [for] everything else, like accidents or any delays, to the forwarders – but the fees are the same. It’s very much an issue of compensation.”
Because, as Knezevic pointed out, “shipping is not an exact science,” it may prove beneficial to the client to adjust strict specifications of a given contract.
For example, UTC Overseas used contract flexibility to shift a kiln shipment from a scheduled ocean transit to transport on an Antonov An-124 aircraft, when the original unit at a cement plant in Guayaquil, Ecuador, suddenly failed irreparably. The shipment, from point of manufacture in China, required modification of packing and footprint to be able to fly on the heavy-lift cargo aircraft, but the replacement unit arrived at the plant much faster than if it had gone by sea, as intended prior to the existing kiln’s fatal breakdown. Thus, plant downtime was significantly minimized.
To account for the unexpected while keeping costs under control, having an in-house group overseeing the project at the forwarder is advisable, according to Aydin, who is business development manager at Istanbul-based BATI Group – which counts turnkey logistics management for projects among its areas of expertise.
“It is impossible to draw up a contract which will cover each and every cost and aspect in regard to a project, since one unforeseeable aspect will easily lead to another,” Aydin said from his office in Turkey. “The costs stipulated in the contract may be the lowest, yet once the contract is signed, all other unspecified costs which are accrued during the course of the project will lead to overspending on behalf of the EPC.
“The most reliable way to prevent this situation is the appointment of an in-house team, which will control the project, decrease the costs and minimize the risk,” Aydin said. “This method is much more reliable when the service fee for every service area is discussed and determined before the beginning of the project. The service fee may differ from one service to another, yet this difference can be determined by service clusters in advance.”
Aydin also urged greater coordination between EPCs and contractors.
“The biggest challenge is to appoint the same contractor for every aspect of the project and to collaborate with them for mutual performance,” Aydin said. “A single contractor is appointed for a project for the purpose of risk minimization. However, this brings along consequences such as overbidding. By overbidding, the contractors aim to prevent the occurrence of any hidden costs which may put the EPC in a challenging position.”
BATI Group seeks to make the process easier and more controllable by appointing a team to work with the EPC in exchange for a fixed service cost, allowing the EPC to be in control of every decision-making process while knowing the contractor has offered rock-bottom rates, Aydin said.
FLEXIBILITY HOLDS KEY
Wray, a Houston-based partner in the shipping sector practice of HFW, a 135-year-old, London-headquartered global law firm, said thoroughness must be balanced with flexibility in a collaborative approach in order to achieve mutually beneficial success in project logistics contracting.
The environment of the project plays a large role in determining the risks that are important to the entities involved, as well as the appurtenant costs, he said. For example, an offshore energy project by nature presents more challenges than a landside endeavor, as everything from hurricane seasons to tides may pose limitations while the number of available contractors is likely smaller as well.
“There are a lot more moving parts when you’re conducting an offshore project,” Wray said, noting that basic considerations include when work can be done, who will undertake it, who is qualified to do so and when they are available – as well as overall shipping market conditions, all of which may impact the price, risk and timing.
Regardless of specific circumstances, a typical contract addresses such common issues as indemnification, insurance, warranties and regulatory requirements, Wray said. Also, considerations include market conditions and, more recently, cybersecurity concerns.
“You certainly see cyber risk clauses getting inserted into some of these contracts,” Wray said, pointing out this adds to complexity. “What you try to do in these contracts when you’re drafting them is allocate, ahead of time, basically all of the foreseeable risks and costs so, if there’s a problem, you just look to your agreement. You don’t want to have to go to court. You don’t want to have to go to arbitration, depending upon whatever dispute resolution mechanism you choose.”
Importance of appropriately thorough risk identification and allocation – balanced with flexibility – is especially paramount in a world in which the unexpected seems to be inevitable.
“You’re there to try to get a project done,” Wray said. “You’re there to try to make money. You’re there to try to safeguard life, property and environment and do things in a reasonable and safe manner, but there’s always the unforeseen, and – much like life – you look at what has happened in the past as sort of a benchmark for the future.”
That can mean parties may be tied to the “that’s how we’ve always done it” mentality.
“When you’re trying to account for the unknown, you have to be a little bit flexible, but sometimes, particularly in large organizations, there is inherent inflexibility,” Wray said. “They may say: ‘This is the contract we’ve used, and it has worked for umpteen projects in the past. Why would we change it now?’
“Well, maybe you should change it, or think about changing portions of it, because the world has changed. As the lawyer, you try to think of creative solutions to protect your client from various risks and you also want to try to make sure it’s not so onerous that you can’t get the deal done.”
Wray noted that certain aspects may be deal-breakers for a specific client but not so important for others, or vital to a contractor but not to an operating company.
“There has to be a degree of flexibility when you’re preparing these contracts, but it all ties back to leverage,” he said. “If it’s a down market and contractors are hungry for work, the operating companies have more leverage. But if it’s a hot market and you can’t get a contract lined up, then the contractors have more leverage.”
Flexibility relates most directly to commercial terms, according to Wray, while parties tend to be less flexible when it comes to standard insuring and indemnification clauses. Some oil and gas-producing states, for example, have anti-indemnification statutes that modify or even prohibit indemnity in certain circumstances, so the choice of state and/or country for a contract may modify obligations as well as regulatory compliance remedies.
‘COMPLEX JIGSAW PUZZLE’
“It’s really a bit of a sort of complex jigsaw puzzle,” Wray said. “It involves understanding your environment, where you’re working, who your regulators are, what law will apply, what law the parties choose and understanding the market conditions. From a technical side, we rely on our clients and what they need to get this job done. There’s definitely a balancing act. It’s kind of like a conductor managing a symphony.”
The sheer size of today’s contracts and the potential need to harmonize more than one such legal agreement are likely to be factors too.
“When you have documents with multiple schedules and parts, and you’re building large, complex structures, they can be very unwieldy,” Wray said of contracts. “These contracts tend to have long lead times. It takes time, and it takes people to talk about this stuff, to understand it, to review it and to make sure all the moving parts are in order.”
Furthermore, the multiple contracts that may be required for an offshore wind energy farm project, for example, must be coordinated with each other. Wray said separate contracts are likely to cover project financing, regulatory compliance, shipping and construction.
“To have not just one contract work, but all of your contracts required for this project to be in sync, does create a lot of work and takes a very long lead time to make sure everything
is in harmony,” he said. “It generally impacts the cost of the project when you have multiple contracts with multiple lawyers reviewing them and multiple vendors. It definitely creates cost and affects your risk allocation model.”
With all that said, UTC Overseas’ Knezevic said project forwarders may wind up coming to a question-based conclusion when it comes to undertaking work under a highly restrictive contract: “Is it worth the effort?”