Battery purchase contracts: Key pitfalls
Anyone developing a battery energy storage project should be prepared to address two main issues.
The first, and the topic of an earlier article, is the general contracting structure. Developers of battery energy storage system, or BESS, projects are using a multi-contractor, split-scope contracting structure instead of the more traditional single-contractor, turnkey approach. (See "Battery Purchase Contracts" in the December 2021 NewsWire.)
The second topic, and the focus of this article, is key pitfalls to avoid when negotiating specific contracts.
There are three such pitfalls: failure to use the correct structure for agreements, failure to secure warranties to maximize protection for the project owner, and failure to negotiate a fair price adjustment mechanism that protects the project owner while minimizing contingency pricing by the equipment supplier.
How the procurement agreement is structured is important.
Suppliers will often attempt to structure agreements to pass risk to the developer. Some suppliers may separate projects into individual orders to limit liability with respect to individual projects. Many suppliers propose shipment of equipment “ex works” at the supplier’s factory, which places risk of loss during shipment and import tariff risk on the developer.
This creates a heightened potential for disputes after warranty claims, with suppliers claiming defects occurred after the developer picked up the equipment at the factory.
Other suppliers have moved away from firm pricing and ask for price adjustments, including for key material costs or shipping costs.
While suppliers generally accept liquidated damages for delivery delays, many resist liquidated damages tied to final completion of the project and commissioning of the supplied equipment. This can place the developer in a bind if the BESS arrives on site but is not able to be appropriately commissioned, either due to warranty claims or unresponsiveness of the supplier’s operations and maintenance personnel.
For developers who are developing multiple projects, whether simultaneously or sequentially, it can help to structure the procurement agreement as a “master agreement” under which individual purchase orders are issued. The master agreement has general terms that apply to all of the purchase orders. More tailored terms applying to specific projects go in the purchase orders.
This structure helps minimize the risk of having to reopen negotiations for each project and allows for a faster order process. It is not unusual to see developers negotiate master agreements with several potential battery suppliers, allowing them to decide later how many orders to place with each. Any subsequent request to suppliers for proposals will then be issued with the expectation that the master agreement will govern for the purchase orders.
This approach saves time later. The later negotiation of purchase orders focuses on price and schedule rather than legal boilerplate.
Developers using a master agreement structure should consider which entities to use for contracting.
The master agreement is usually signed by a general procurement or development company high up the ownership chain. Individual purchase orders are then executed by special-purpose project companies. These can take the form of “daughter contracts” that are considered to incorporate the general terms in the master agreement. Where shorter-form purchase agreements are used, the master agreement should state clearly that each purchase order is a “several” and separate agreement that is considered to incorporate the terms of the master agreement.
The master agreement should allow free assignment of both the master agreement and purchase orders to allow the developer to restructure, finance and sell projects later.
Anyone using a master agreement structure should consider whether a default under one purchase order should be considered a cross default of all the purchase orders.
For a developer, a material breach by a supplier under one purchase order may be a sign of execution issues and a reason to end the relationship with the supplier. While a full-scale termination may seem drastic for a developer, a cross-default provision gives the developer leverage to ensure smaller orders are not dropped or de-prioritized by the supplier after an increase in costs of raw materials, components or shipping. This helps ensure a supplier maintains a “whole of relationship” approach to project delivery.
Developers should expect suppliers to request a quid pro quo cross-default termination right in exchange for giving the developer such a right.
While some developers may be willing to accept this, given that their primary obligation is merely to pay the undisputed contract price, it is important to consider any financing of projects that might occur. Lenders are usually reluctant to accept that a developer default on a different project can cause a default on the financed project. For portfolio financings this may be acceptable where the master agreement and all projects for which purchase orders were issued are covered under a single portfolio financing.
Just because a developer has multiple projects does not mean that a master agreement structure is the right course. For example, if a developer has a number of projects supplying battery storage under a single offtake contract, then it might prefer a single battery procurement contract aggregating liability in the collective project, given that liability under the offtake contract may be connected for failure to develop the collective project.
Alternatively, if a developer plans to finance projects individually, then it would be best to avoid cross default provisions.
The supplier’s warranty is a key provision of any equipment procurement agreement.
For BESS projects, battery cell degradation is inevitable, but a proper warranty helps ensure that this can be modeled and augmentations planned.
A BESS warranty should include performance testing as part of the commissioning process.
It should include a capacity and degradation guarantee, a round-trip efficiency guarantee and an availability guarantee.
Depending on the type of project and the business model it supports, there may be other guarantees as well, such as for response time, for ramp rate and settling time and for signal-following accuracy.
Warranty testing should be performed as part of annual maintenance, but developers often also ask for the flexibility to require interim testing as necessary to troubleshoot the system. It is a negotiated point whether developer or supplier is responsible for performance of the annual warranty testing, generally dependent on whether the supplier is also providing services under a long-term services agreement or LTSA.
The supplier’s primary obligation for failure to meet any warranty guarantees should be a make-whole payment or an obligation to repair or replace the equipment so that it performs as guaranteed. Developers can negotiate a liquidated damages amount for underperformance or downtime. Some suppliers try to include a buy-down right in place of a make-whole payment. Developers should carefully consider the sizing and impact of any buy-down right on the project model. A buy down will not fully compensate a developer for lost revenue associated with the lost capacity.
Many suppliers try to put the BESS warranty terms in a separate document or fold them into the LTSA between the project company and the supplier’s operations affiliate. Neither approach is ideal. A separate warranty may include different choice of law, assignment or dispute resolution provisions from, or otherwise have conflicting terms compared to, the master procurement agreement, which can cause material issues with respect to enforcement or when trying to finance the project.
A warranty under an LTSA may be subject to a lower liability cap equal to the annual fee, rather than the actual purchase price of the BESS equipment. The liability cap can be eroded by mixing liabilities for equipment defects with liabilities for a services warranty. Putting the warranty in the LTSA also ties the existence of the warranty to the use of a single O&M provider. In the event the supplier fails to provide an appropriate level of service under the LTSA, a developer may be forced to choose between continuing its warranty and continuing to accept substandard LTSA performance.
Many suppliers attempt to structure procurement agreements so that, following delivery and a short inspection period, any defects in the BESS equipment will be considered automatically to have triggered a warranty claim.
If batteries are shipping on a rolling basis, rather than in one single shipment, this may leave a developer paying additional milestone payments for equipment that it is unable to install due to defects discovered after delivery. Developers should consider tying a sizable milestone payment to commissioning completion and requiring that any defects found before or during commissioning are remedied expediently. This formulation motivates suppliers to test BESS equipment at the factory prior to shipment and to address any issues before shipping.
Liquidated damages may be tied to the commissioning completion milestone to help offset costs incurred by the developer under its construction or offtake agreements due to a delay in completing the project.
Another item to consider is the use case for the BESS equipment. Each developer has a different intended use for the batteries, including charging and discharging frequency and whether batteries will be part of a standalone storage project or a larger renewable energy facility. Many suppliers offer a “one-size-fits-all” warranty and testing regime that will not take a developer’s use case into account.
In order to ensure a developer is purchasing equipment that will function as modeled, the use case should be included in the technical specifications in the procurement agreement. Developers should carefully review the supplier’s testing and commissioning regime to ensure it aligns with the use case. Long rest periods between charges or reduced charging and discharging rates are commonly included in a testing regime, which leaves the developer with a BESS that passes commissioning and warranty testing, but subsequently fails to perform in the field.
A commonly-included, but under-negotiated, provision of any warranty is the exclusion events where the warranty does not apply.
Exclusion events include failure to comply with supplier recommendations or documentation, including any updates issued after the date of purchase. Developers must be able to plan for the long-term operation of projects. Any parameters for storage, installation, operation and maintenance of the equipment should be attached to the procurement agreement. Later updates to the operating parameters could allow a supplier to fix a defect by limiting the operating parameters of the equipment and destroying the developer’s use case and the project model.
Suppliers commonly attempt to limit the warranty to performance of operations and maintenance services by a supplier affiliate.
This can handcuff the warranty to continued use of a specific O&M provider. It is better to have the warranty continue after a change in operator as long as developer complies with the operations and maintenance manuals provided by supplier.
It is fair for suppliers to exclude any damage caused by a developer’s improper installation or operation of the equipment. However, a developer should ensure that these provisions do not overly limit the developer’s ability to upgrade, assign or move the equipment without permission from the supplier. The developer should negotiate to ensure the agreement works for its use case and allows flexibility to operate, maintain and finance the project.
Developers should negotiate a fair price adjustment mechanism that protects the owner while minimizing contingency pricing by the equipment supplier.
Hard-nosed negotiation rejecting price change for low-risk or reasonable requests by the supplier may offer limited protection for developers while drastically increasing the initial price and delivery schedule offered by suppliers.
The following mechanisms are key negotiation points for a developer procuring a BESS.
The developer should retain flexibility to adjust the delivery schedule for the procured equipment. Many procurement agreements are signed more than a year in advance of anticipated delivery. In the interim period, construction, interconnection or other development issues may arise that require a developer to push back the delivery date or to reallocate equipment to other projects. It is best to negotiate an adjustment mechanism up front. This may include a grace period for storage at the supplier’s factory prior to shipment or storage at the port of entry without a price adjustment.
Some developers offer to cover cost and expenses to use the supplier’s third party storage after the grace period has run. Developers should ensure that risk of loss and the warranty start date are not affected by this storage, but should be prepared to negotiate degradation for extended storage.
Over the past two years, force majeure definitions have continued to evolve to account for both COVID and shipping risks.
The arguments for not excusing COVID delays are that two years into the pandemic, suppliers should have contingencies in place to limit the impact of COVID that are priced into the initial order. However, many suppliers are quick to point out that COVID continues to evolve and the risks are ongoing. We also see suppliers have begun to insert clauses into force majeure definitions allowing for relief for delays in shipping, including port congestion or closure.
A developer may placate suppliers by offering limited force majeure relief for unforeseeable, direct impacts of COVID that occur after signing the individual purchase order, subject always to a supplier obligation to mitigate such impacts. This might include relief in certain limited circumstances for port closures or other shipment delays that meet the broad definition of force majeure (events outside the control of both parties that occur after the purchase order is placed).
Offering more limited COVID relief in an initial draft may be the best way for a developer to streamline negotiation and avoid overreaching by the supplier.
A key final category of cost relief is for developer-caused delays.
Suppliers ask for price and schedule relief in the event a developer acts in a manner that directly interferes with performance of the supplier’s obligations under the contract. However, developers should insist on certain carveouts.
A developer should always be able to exercise its rights under the procurement agreement, including reviewing and commenting on drawings and documents to ensure compliance with technical specifications.
A supplier should not be granted relief for common-course coordination with the developer’s other contractors, including construction contractors and engineering specialists. Interfacing during the design, delivery and commissioning of the project should be priced into the purchase price for the BESS equipment, and developers should avoid language allowing change for “any impact by owner or its subcontractors” or similar formulations. Even in the event a change is otherwise permitted, a supplier should not be entitled to price or schedule relief if the supplier’s actions contribute concurrently to the delay.