Beware the Fine Print in Performance Contracts

You think you’re about to be a hero by entering into an Energy Savings Agreement to fund improvements based on future savings. Your law firm has reviewed the contracts and your engineers have signed off. What can go wrong?

Actually, quite a bit. Unless you have spent years in performance contracting, you are not prepared. In fact, very few law firms or engineering firms have handled enough performance contracts to avoid pitfalls. If you are a building owner/manager, it’s unlikely you have made it a priority to study performance contracting legal language. Moreover, you are at a disadvantage compared to the folks on the other side of the table, who develop and execute contracts year-round.

I have served as an expert witness when performance contracts have gone wrong. I have seen the multi-million dollar consequences when contracts are not developed correctly. Besides not achieving the savings claims, paying lawyers is expensive and courtroom outcomes uncertain.

There are state laws, international standards, best practices and certification courses for developing performance contracts. There are also important things to know about how to interpret the protocols, savings calculations and statistics. However, many municipal and institutional facility managers don’t have the time to master guidelines such as the International Performance Measurement and Verification Protocol (IPMVP).

This article was inspired by a performance contract that I was asked to review. After reading it, I could not believe the amount of unclear boilerplate language that would likely lead to confusion and possible lawsuits in the future. Few people are experts and unfair contract templates are used every day.

To help you avoid painful litigation, I will point out five specific clauses that may harbor hazards.

1) Politics and Attention Spans

Like achieving physical fitness, achieving energy savings requires a long-term focus. This is a widespread problem for municipalities, military bases and even college campuses, where leaders may change every few years. Mistakes become a problem for the next manager. Many elected officials may not be in office seven years into a contract, and they pay little attention to long-term details.

For example, in a recent contract, an ESCO proposed to install LED lighting that would last about seven years before relamping. However, when the LEDs do fail, the fixtures will need to be replaced at a cost of about $350,000. To maintain the energy savings over the 20-year contract, the fixtures will need at least two replacements. The ESCO had zero dollars budgeted for this eventuality, but it claimed all of the energy and maintenance savings. This was unfair, and these types of misleading savings estimates hurt the reputation of the ESCO industry. Nevertheless, an ESCO may do this to stay competitive with another ESCO’s claims. Facility managers may never recognize the problem until it is too late.  

2) Equipment and Installation

To my dismay, I have recently seen a few performance contracts that were signed before a detailed cost breakdown was provided. In one case, the facility was going to receive a new chiller but no additional details were provided about the size, operating efficiency, warranty, etc. The ESCO was pressuring the facility manager for a commitment and no one was reviewing the details.

I can understand that everyone appreciates a fast-track process for performance contracting. However, your organization can show commitment by signing a project development agreement that would protect the ESCO’s intellectual property as well as the organization’s need to know details. A sample project development agreement template is available at Profitable Green Solutions.

3) Estimated Savings

“Stipulated Savings” and “Avoided Capital Expenditures” are contract terms worth understanding. In a recent contract review, I found that about 50% of the savings were “stipulated avoided capital expenditures” and would not be measured. While I agree that it may not be worthwhile to measure every single piece of equipment, the facility manager should review all stipulated savings because some assumed savings may never materialize.

In addition, the language and calculations should be clear enough so that 10 years into a contract, a new employee or ESCO representative can read and understand the calculations. Also, make sure you understand the escalation rates that ESCOs typically assign to utility, maintenance and labor costs.

4) Additional Maintenance/Training Required to Maintain Savings

I have seen contracts implying that once the initial savings are achieved, the savings will continue for the next 20 years. However, much like a diet to lose weight, savings will continue only if the facility puts some effort into maintaining the equipment. Annual training as well as a budget to replace parts is critical to achieving the long-term savings.

If you are installing more sophisticated systems (VSDs, controls, etc.), you will need to spend more on maintenance. You should plan on investing 10-20% of savings toward a budget line item to maintain those savings. Also, a distinction needs to be made between Maintenance and M&V. An ESCO is usually happy to provide M&V, but a prerequisite for the guaranteed savings is that the owner is responsible for maintaining the equipment “properly” – a description that lawyers find vague.

5) Measurement and Verification Plan and Procedures

Several protocols exist to help the facility manager and ESCO navigate deviations from estimated savings due to variances in weather, facility uses, or other changes that inevitably occur. However, because the protocols are constantly improving (for example, IPMVP just launched a 2016 version), it is important to be up to date. Having clear instructions and step-by-step methods to calculate savings is critical to success. Several organizations offer training in M&V.

I recently reviewed a contract in which the ESCO required the owner to pay for M&V as well as preventive maintenance services for the duration of the 20-year contract as a prerequisite for the guaranteed savings. However, the ESCO’s financial model only accounted for five years of such services, and what was missing was about $500,000 in unbudgeted costs to the owner. Fortunately, we got that corrected, but what a mess it would have been.

Entering performance contracts can be risky. It makes sense to have someone with experience on your team or to hire an expert consultant. If you want to do it yourself, take a class on contracts. I also encourage you to review the contracts that you have in place and look for areas to improve. You might save millions!

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