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FLNG: mitigating the risks

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LNG Industry,

With the LNG industry remaining relatively stable despite the decline in the price of oil, project sponsors and contractors are looking to floating LNG (FLNG) and floating storage and regasification units (FSRU) as a means to access stranded gas reserves and monetise offshore investments (with FLNG), and import LNG by means of a quicker and more cost-effective solution (using an FSRU). Much has been written about sponsor/charterer considerations in FLNG projects. This article instead considers key vessel owner risks in such projects, with particular emphasis on the legal provisions in the contracts for FLNG/FSRU vessel construction and charter, and subsequent operation and maintenance.

Whilst there are many variations on contracting forms for a floating project, the most common form is an FLNG/FSRU vessel constructed by an owner and chartered to the project operator or joint venture (JV) parties. This approach forms the basis of the analysis set out in this article. The form of charter will typically be a time charter party (TCP), under which the owner is responsible for operation and the provision of services to facilitate production, processing, storage and offloading of LNG (for FLNG) or the loading, regasification, storage and offloading of gas (for FSRUs). The post-construction contractual arrangements may be contained in a single agreement or in two separate agreements: one agreement for charter of the vessel; the other for operation and maintenance services.

Risk allocation

The overriding rule when allocating risk in FLNG contracts is that risks should be allocated to the party best able to manage them, and that such risks should be covered by the appropriate insurances. If risks are not allocated to the parties in this manner, then the parties will not be appropriately empowered or incentivised to manage or avoid circumstances that could lead to cost escalation or failure of the project. Often, risks must be shared in order for the parties to adequately manage the risk. A key risk best shared by owner and charterer is availability – both in terms of operating a vessel for 20 years or more and in terms of daily availability of the vessel to meet the scheduled processing, liquefaction/regasification and transfer obligations. From the outset, the parties must consider project specific motion criteria based on metocean data. The hull and topsides process equipment must then be designed to realistic project specific parameters. A key design aspect for FLNG/FSRU projects will be the functionality of loading arms, taking into account reliable ship-to-ship (STS) connectivity with varying wave conditions. Even if the topsides equipment functions with 100% availability and reliability, the reliable transfer of cryogenic liquid products is crucial to maintain the overall availability of the vessel. From a contractual point of view, risk will be shared in the contracts by specifying appropriate scheduling of vessel and equipment maintenance (both planned and unplanned), the delivery and storage of spare parts, and suitable procedures for scheduling of cargo transfers.

Another provision that requires a consideration of risk sharing is the indemnity clauses. Knock-for-knock indemnities form part of the liability allocation model frequently found in contracts in the oil and gas industry, and they appear in FLNG contracts. Under a typical knock-for-knock regime, parties agree that the loss lies with the party best placed to bear it. Damage and loss to people and property suffered by a member of the owner group is borne by the owner, and vice versa for the charterer group or other contractor groups, irrespective of fault and without recourse to the other party. The knock-for-knock regime is useful in the FLNG context, in part due to the recognition that an owner’s balance sheet cannot cope with potential liability for the destruction of the entire LNG value chain and also because these indemnities assist with risk allocation at a practical level (i.e. the responsibilities of different contractors will overlap, making it difficult to determine fault if an issue occurs).

Risk sharing is also a factor in any limitation of liability clause. When drafting such a clause, the parties should address whether they wish to exclude liability for consequential loss (a term that, as English case law has established, should be expressly defined in the contracts). In drafting this exclusion, owners should take note of the recent decision of Scottish Power UK plc vs BP Exploration Operating Co. Ltd1 (Scottish Power), which emphasised that the English courts will interpret exclusion clauses narrowly. The Scottish Power decision confirmed that, unless the exclusion has been expressly and clearly agreed and captured in the contract, the courts will generally seek to ensure that a wronged party is not denied a contractual remedy in the event that the counterparty fails to perform. It may be prudent, and more reliable, to limit liability by excluding specific identified types of loss, avoiding the consequential loss classification, or adopting an inclusive approach whereby specific losses that a party would expect to recover under the contract are stated to be recoverable, to the express exclusion of all other remedies.

Commissioning and liquidated damages

The vessel engineering, procurement and construction (EPC) contract and TCP will both provide for set delivery dates, which may be extended by permissible delays, such as variation orders and force majeure events. If the vessel is not delivered by the yard, or does not arrive at its destination by the contractual delivery date, or does not pass performance testing within a certain timeframe, then the yard/contractor (in the case of the vessel EPC contract) or the owner (in the case of the TCP) will generally become liable for liquidated damages for delay/failure to start-up. It is crucial, therefore, that the contractual arrangements are back-to-back regarding permitted extensions of time, such as force majeure events. Owners will also want to ensure that there is some parity in the quantum of liquidated damages for delay under each of their contracts. Back-to-back delay arrangements should be familiar to participants in an LNG project, potentially with a negotiated long-stop cancellation right, but the key will be ensuring that all circumstances (most of which are purely hypothetical at the time of contracting) are adequately dealt with. The commissioning period is one of the most heavily negotiated clauses in the TCP, as the owner will want to pass and start to get paid as quickly and painlessly as possible, and the charterer will want to carry out as many tests as possible to ensure that the vessel functions as required.

Similarly, the owner of the vessel will need to carefully manage completion obligations and interface risk between the hull contractor and the topsides engineer to ensure that there is no gap in liability for delay or performance. A single engineering, procurement, construction and installation (EPCI) arrangement, where one contract covers both hull and topsides construction, may be preferable and may help to avoid any gap in liability for performance related damages.

Parties should also pay careful attention to the wording of the liquidated damages clause. The recent decisions of Cavendish Square Holding BV vs Talal El Makdessi (Cavendish) and ParkingEye Limited vs Beavis (ParkingEye)2 suggest a shift in focus from the English courts regarding liquidated damages. The principle established in the Cavendish and ParkingEye judgments is that liquidated damages must be proportional to the innocent party’s legitimate interest in enforcing the counterparty’s obligations under the contract. The court’s decision introduces a more flexible test for whether a clause will be found to be penal. Prior to Cavenish/ParkingEye, the courts would focus on whether a clause was aimed at deterrence rather than compensation. Deterrence was, in most cases, seen as penal and, therefore, unenforceable. The English courts now recognise that a party can sometimes have a legitimate interest in enforcing performance that goes beyond simply being compensated for its losses.

Getting paid

Under a typical TCP, a charterer will pay a daily hire to the owner for use of the vessel, usually divided into a capital element (including an amount to cover the owner’s capital costs and equity return), which is ordinarily fixed over the term of the charter; and an operating element (covering operating costs for which charterer is responsible), which may simply allow for inflation (or an automatic escalator), or may be passed through to charterer on an open-book basis. The TCP may also incorporate a cost element to account for any modification (at cost to the charterer) to the vessel during the term of the charter. In relation to hire, it is in the owner’s best interest to reduce the circumstances in which the vessel may be placed off-hire (i.e. where charterer’s payment obligations are suspended), or where the charterer is entitled to pay hire at a reduced rate proportionate to a reduced level of performance. It will be key for the owner that at least the capital element of the hire remains due, as this represents the owner’s committed financial obligations (often for third party financing). The circumstances in which the vessel can be placed off-hire, or where hire reduces, will be a negotiated element taking into account the vessel’s performance. It will be important for owners to ensure that there is a realistic reduction in hire – not a penalty – if performance falls below guaranteed levels.

Force majeure

Another significant provision in the contracts will be force majeure relief. The type of force majeure events, and whether an inclusive or exclusive list is agreed, may largely depend on the force majeure events already negotiated under the upstream contracts. The relief granted to the charterer if a force majeure event occurs to any part of the value chain outside of the vessel must be carefully negotiated as any relief from the payment of hire during force majeure events will detrimentally impact the owner.

One of the most contentious areas for force majeure relief will be governmental interference in the project. Owners of FLNG/FSRU vessels will often be operating their vessels in politically unstable environments, where there is a real risk of operating permits being revoked or the vessel itself being expropriated. Insurance against such risks can be prohibitively expensive, and owners will, therefore, seek to cover themselves in the contract through continued hire payments and termination fees, secured with a bank letter of credit.

The issues considered in this article represent some of the issues that parties may face when negotiating contractual arrangements for an FLNG project. Given the nature of such projects, there will no doubt be a myriad of project specific concerns and complications, but this article gives a flavour of the key areas for negotiation and the parties’ approach to them.


  1. [2015] EWHC 2658 (Comm).
  2. [2015] UKSC 67.

Written by Jonathan Goldfarb, UK, and Patricia Tiller, Dubai, Ince & Co. Edited by

This article was originally published in the March 2016 issue of LNG Industry. Subscribe today to receive 12 issues and gain access to back issues online.

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