Historically, most alliances have tended to automatically include a limit (or 'cap') on the amount of painshare that is payable by the NOPs. The cap is typically equal to the NOPs' Fee.
| Is a cap on the NOPs' Fee appropriate? A rationale which is usually provided to support a cap on the NOPs' Fee is that under an alliance, the NOPs are exposed to a share of the Owner's risk beyond their normal design and construction environment, and that a limit (or cap) on the NOPs' exposure is therefore appropriate. However, under an alliance, the Owner is also exposed to a share of the NOPs' design and construction risk beyond their normal risk profile under a traditional contract (where these risks are transferred entirely to the D&C contractor). Logically, according to the rationale offered by designers/contractors, this means that the Owner's risk should also be capped. In addition, if the NOPs' painshare is capped, this means that the Owner will bear all project risk once the cap has been exceeded. Traditionally, one of the key aspirations of alliance contracting has been the principle of 'win:win, lose:lose' for all Participants. However, in circumstances where the NOPs' risk is capped and the cap is exceeded, this principle will no longer apply. |
As alliancing has matured as a method of project delivery, it is no longer considered essential to automatically apply a cap to the NOPs' painshare. Instead, the application of a cap should be assessed on a project by project basis. In particular, account should be taken of the following issues when considering whether a cap on painshare should apply, and the appropriate amount for that cap:
Risk and reward are intrinsically linked. The NOPs' fee will reflect, amongst other things, the potential amount of painshare that may be payable by the NOPs, and the desired reward for taking that risk. The level of any cap on the NOPs' painshare will vary according to the NOPs' risk appetite, the agreed fee and the project specific risks. Therefore, the level and appropriateness of any cap on painshare should reflect the project, the wider market and the specific NOP. Similarly, the Owner will have its own views about the appropriate fee.
The cap is most likely to be exceeded if the project is in distress. The Owner will bear all design and construction risk once the NOPs' cap on painshare has been exceeded. This is because the NOPs will be insulated from any further pain if the cost overrun continues beyond their cap. At the time of greatest need, a cap therefore has the potential to place stress on the key alliance features of 'risk and opportunity sharing' and best-for-project 'unanimous decision making'. Also, an alliance contract is underpinned by the principle that the NOPs' commercial objectives and the Owner's project objectives should be aligned. This approach is directed at avoiding the adversarial behaviours that may emerge under traditional contracts. However, in circumstances where the NOPs' painshare is capped and this cap is exceeded, the cap can create significant commercial misalignment given that, practically, the Owner is bearing all project risk.
If a cap on painshare is applied it may be appropriate to consider a reciprocal cap on gainshare (Risk or Reward Regimes 2 and 3 in Appendix D). This should be considered in the context of the particular project.
If a cap on painshare is in place, this may reduce risk contingencies built into the TOC.
If the painshare cap is set at the NOPs' fee (as has often been the case historically) it would require an overrun to the TOC of twice the NOPs' fee before the cap is reached.
Above all else, the NOPs will be motivated by the financial impact of any arrangement, whether it be negative or positive.
| Tips for structuring the Commercial Framework The principles of the Commercial Framework are relatively simple and straightforward. However, applying the Commercial Framework in practice will not achieve optimal outcomes for the Owner if sufficient attention isn't given to: • definitional problems (e.g. are the NOPs' Corporate IT fees a Reimbursable Cost or part of the Corporate Overhead?); • measuring costs (e.g. the NOPs' plant and equipment should be reimbursed 'at cost' but some NOPs do not have plant management systems that record cost); • aspects of the Commercial Framework that may fail to align the Owner's and NOPs' objectives; and • designing a Commercial Framework that fairly and satisfactorily deals with the possibility of a 'soft' TOC. A common approach is to include a 'flat spot' on the gainshare so that (for example) the first 10% of any cost underruns accrues 100% to the Owner before reverting to a 50:50 split between the Owner and the NOPs. However, in practice, this fails to align the NOPs and Owner to achieve that first 10% and is unlikely to drive desired behaviours. |