Turnkey Contracts and Substituted Performance
Summary: This article highlights the challenges of invoking the remedy of ‘substituted performance’ in case of breach of turnkey contracts, and suggests potential solutions for the same.
The Author Niharika Mukherjee is an undergraduate law student at National Law School of India University (NLSIU) Bangalore.
The recent inclusion of substituted performance as a statutory relief in the Specific Relief Act, 1963 has been considered to be of significance to construction contracts, for the reason that it will help to reduce delays and costs. However, given the variety of types of contracts used in the construction sector, it is believed that this relief must be analyzed in context of each of these types, order to gain more accurate insights about its efficacy in different contractual settings.
In this light, it is pertinent to evaluate the relief in context of one of the most-used contracts in the construction sector- ‘turnkey’ or ‘design and build’ contracts. This type of contract, which, for clients, involves a ‘hands off’ approach and a focus on the ‘what, rather than how’ of the construction project, and is often aimed at facilitating innovative and technically complex work, presents unique challenges in availing the remedy of substituted performance.
To this end, this article shall analyze the challenges of availing substituted performance in turnkey contracts. First, it shall examine the distinctive features of turnkey contracts. Secondly, it shall briefly explain the contractual relief of substituted performance. Thirdly, it shall discuss four major challenges in availing the remedy in these contracts, and present recommendations for optimizing contract terms to overcome these difficulties.
For this purpose, this article shall rely on model turnkey contracts drafted by Indian and international institutions, apart from relevant case law and statutory provisions.
Turnkey contracts place responsibility for designing, engineering, procurement, and construction of an entire project on a single contractor, such that following completion, the client receives a ready-to-use facility. Deriving from this structure, legal liability for all aspects of the suitability and performance of the project is placed on the contractor. Often used in the construction sector, these contracts are usually ‘fixed price’ contracts, meaning that most risks associated with the project are allocated to the contractor.
Besides enhanced certainty as to time, cost and liability,as also the low need for supervision associated with these contracts, which make them an attractive option for clients, turnkey contracts also have the advantage of according significant flexibility to contractors. This gives the latter freedom in designing the project and planning the work for optimum efficiency, given their capacities. This feature distinguishes these contracts from conventional ‘item rate’ or ‘design-bid-build’ contracts, which necessitate contractors to follow a rigid design prepared in advance by the client themselves.
One of the prominent types of turnkey contracts are Engineering Procurement Construction (EPC) Contracts, which are typically used for large infrastructure projects in sectors including transport, energy, and healthcare. While many such projects in the public sector are relatively simple in terms of design, those in frontier areas of technology, such as hydrogen recovery or marine engineering, require specialized and complex skills in design and execution.
Despite their numerous advantages, however, these projects also present several challenges. These include high dependence on a single contractor, severe information asymmetry between client and contractor, and low client control over the project. This article argues that these challenges are of significance in analyzing the efficacy of substituted performance in turnkey contracts, which shall be discussed in later sections.
The remedy of substituted performance was codified in India through the Specific Relief (Amendment) Act, 2018. This allows a victim of contractual breach to avail performance of the promise by a third party or their own agency, and recover the costs actually suffered in doing this, from the breaching party. This remedy, it may be inferred, seeks to further the legislative intent to make the fulfilment of the actual ‘expectation interests’ of the victim the norm in cases of contractual breach.
Earlier, such a remedy was commonly availed through ‘risk purchase’ or ‘risk and cost’ clauses in contracts, as also under Section 73 of the Indian Contract Act, 1872.
Nevertheless, three aspects of the statutory provision merit attention. First, it provides a definite procedure for availing the remedy, albeit one that does not override contractual terms, for preventing its unfair use. Secondly, it clarifies that the remedy can be availed by a party only after it has got the work completed, arguably to ensure that the recovered damages are not used for unjust enrichment and are not disproportionate to the expenses actually incurred.
Thirdly, it does not provide that the remedy of specific performance can only be availed in the absence of reasonable possibility of substituted performance. This marks a clear deviation from a wide range of legal systems ranging across the United States of America, Europe, Singapore, and Japan, in addition to common law in the UK. This has been seen as a pro-client step, which at least in theory, allows the client to demand specific performance even though a reasonable possibility for availing substituted performance may exist, and refrains from burdening them with the duty to disprove that such a possibility exists.
In relation to turnkey contracts, the remedy is advantageous primarily because it allows for timely relief where the contractor fails to perform their obligations under the contract. This is particularly relevant where ‘time is of essence’, a common feature of turnkey contracts in, for instance, the oil and natural gas sector.
Model turnkey contracts, therefore, frequently provide for this remedy. For instance, it becomes available under one model contract when specified conditions arise and the client acquires the right to terminate the contract. These include situations where a contractor abandons the work, fails to comply with a notice to correct faults, or declares bankruptcy.
Substituted Performance in Turnkey Contracts
Where situations similar to those listed above arise, the remedy of substituted performance has considerable utility in contracts where substituting parties are easily found and the transition does not require transfer of significant amounts of information and resources. It is therefore an effective remedy in simple construction contracts, such as in Karnataka Electricity Board v MS Angadi, where a contract for building hume pipes was easily completed through a new contractor.
In case of turnkey contracts, however, the availing of the remedy presents certain complexities. The foremost disadvantage encountered by the client is that it alters the basic framework of the contract itself- for the contract, when substituted for completion or rectification of the project, is in practical terms replaced by a design-bid-build or item rate contract. This is because, assuming that the substitution occurs after the design has been prepared by the original contractor, the new contractor is not required to submit their own design, and hence does not acquire back-to-back liability for the entire project as a turnkey contractor does.
Several practical problems arise from this alteration, which, this article argues, can be examined in four categories. These shall be discussed below, and contract-based solutions shall be proposed to mitigate each of them.
Challenge of Information Asymmetry and Disclosure
Turnkey contracts typically involve minimal supervision and involvement from the client. This may cause a client to lack access to vital information regarding the on-ground realities of the project, including those which affect its safety and overall efficacy. As a result, for one, at the time of substitution, the client may not be able to immediately provide adequate information regarding these aspects to new bidders or potential contractors. Where time is of the essence, this can become a significant obstacle in efficient availing of the remedy. Secondly, this may later lead to allegations of misrepresentation by the new contractor, which can complicate execution further.
To tackle this problem, this article suggests that contractual terms may envisage a greater inspection role for the client’s engineer, typically an engineering firm employed by a client to review the performance of the contractor in large-scale turnkey contracts. Although it imposes higher costs on clients to employ such a professional, several model contracts, in practice, provide for such a professional, as also detailed descriptions of their duties, including submitting monthly inspection reports and conducting tests on a random sample basis. A well-informed engineer may be relied upon by the new contractor to provide adequate disclosures and guidance in work completion.
Challenge of Skills and Resources Transfer
A related problem is that of making a smooth transition from a contractor that designed a project according to its own supplies and technical knowledge, to one that must complete it according to a pre-existing plan with its own resources. This gains significance where contractors occupy a niche position in the market.
To mitigate this, first, several model contracts contain clauses requiring the contractor to transfer selected subcontracts, relevant Intellectual Property and ‘designs, drawing, other documents’ to the client in case of termination with incomplete work remaining. Yet, in cases where technically insightful human resources may be the core competency relevant to the project, these measures may fall short. To reduce this difficulty, this article suggests that contracts for such complex work may include a provision requiring the original contractor to provide ‘assistance and cooperation’ to the new contractor, as provided by one model turnkey contract for some incomplete projects.
Secondly, and relatedly, the possibility of defects in the partially completed work presents additional risks for clients or new contractors in the transition. This risk is exacerbated by the fact that typically, ‘defect liability periods’ in turnkey contracts begin from the time that a contractor has completed a certain portion of the work, such as from when they attain a Provisional Certificate from the client. This article suggests that in case of termination with incomplete work, such time frames are expressly provided to have begun regardless of the extent of work remaining, to avoid any disputes about the original contractor’s liability to later remedy defects arising from their own performance.
Challenges of Financing
As many turnkey contracts rely on project financing or credit, this article envisages that the requirement for having completed the unfinished work before qualifying to recover the costs of substitution under Section 20 of the Specific Relief Act, 1963, may pose difficulties for some clients. This is particularly apprehended where costs of completion far exceed those planned for under the contract, a situation that may arise where the technology available to the original contractor differs from that of the new contractor.
Given that the Section does not override terms agreed upon by parties, it is submitted that where necessary, parties may consider providing for recovering the expenses of substituted performance at the time of entering into the substituted contract, rather than upon its completion. This would prevent projects from being left incomplete on account of lack of funds available to the client.
Challenges of Finding Substitutes
The final, and arguably most intractable, challenge is that of finding substitutes where the work remaining requires skills specific to the original contractor, resembling contracts involving personal qualities. Similar considerations may arise where pre-existing goodwill or the contractors’ reputation were material to their selection for undertaking a high-value project for the client.
As noted earlier, Indian law advantages clients in such situations, in that it does not require them to disprove the possibility of substituted performance while demanding specific performance. However, as these contracts often involve the performance of a ‘continuous duty’, difficulties may arise in availing specific performance, in addition to practical difficulties where, for instance, the contractor has become insolvent.
A proposed solution to reduce the indispensability of a turnkey contractor is to contract with multiple contractors, as in consortiums, for large-scale projects- thus reducing the risk of the project being left unfinished due to inability of one contractor to complete it.
In addition to the above, general problems of substituted performance include those of variance of terms between the original and substituted contract, and the reasonableness of availing substituted performance in case of minor deficiencies. While these may be faced in turnkey contracts too, they can arguably be mitigated sufficiently through detailed construction plans, which are a typical component of these contracts.
While it has been argued that the remedy of substituted performance leaves issues that call for ‘strict implementation of the law’ to ‘managerial resolution’ in construction contracts, this article argues that the remedy, specifically as introduced in Indian law, serves several objectives. For one, it prevents the burden of supervision of complex projects from being placed on the court, while enabling a different avenue for fulfilment of the party’s expectations. For another, in leaving contracting parties free to deviate from the prescribed procedure, it allows scope for parties to place additional safeguards in ‘risk and cost’ clauses, such that the remedy may be easily modified in accordance with the requirements of each contract type, while also ensuring the statutory right where such clauses are absent.
While ultimately, the efficacy of the remedy in turnkey contracts depends on the market conditions in the construction industry, it may be hoped that carefully drafted contracts, cognizant of market risks, shall help parties to utilize the remedy to their best advantage.
 Nishith Desai Associates, Construction Disputes in India (2020) 24.
 NITI Aayog, Engineering, Procurement and Construction of Civil Works- Model Agreement (2018). Hereinafter, ‘NITI Aayog Model Contract’ xix.
 Model EPC contracts referred to in this project include those published by the Fédération Internationale des Ingénieurs-Conseils (FIDIC), the Caribbean Community and Common Market (CARICOM), and NITI Aayog.
 PC Markanda, Building and Engineering Contracts (5th edn, LexisNexis 2017) 3.107.
 Ibid 3.107.
 Delhi Jal Board v M/S Kaveri Infrastructure Pvt Ltd 2014 DLT 206 136.
 Michael Schneider, Turnkey Contracts: Concept, Liability and Claims (MCE International Company Lawyers’ Conference, Paris, 1986) 340.
 Prasanna Kulatilake, ‘Innovations in the Construction Industry: Problems and Potentials’ (2000) 1 Built Environment Sri Lanka 2 6.
 NITI Aayog Model Contract (n 2) xvi.
 Markanda (n 4) 3.107.
 Kinetics Technology, Company Brochure (2020) <https://kt-met.com/en/media/publications> accessed on 20 July 2021 5.
 James Doe, David Nitek and Noe Minamikata, ‘Construction Arbitration and Turnkey Contracts’ (Global Arbitration Review, 2019) <https://globalarbitrationreview.com/guide/the-guide-construction-arbitration/third-edition/article/construction-arbitration-and-turnkey-projects> accessed on 20 July 2021.
 Specific Relief Act 1963 Section 20.
 Mark Gergen, ‘A Theory of Self-Help Remedies in Contract’ (2009) 89 Boston University Law Review 1397 1436.
 Badrinath Srinivasan, Substituted Performance in Contract Law: An Analysis (Proceedings of the Fourth International Conference of International and Domestic Arbitration: Current Scenario and Way Ahead, 2018) 1.
 Ibid 5. Such a claim under Section 73, Indian Contract Act, 1872 is made on the basis that such expenses ‘naturally [arise] in the usual course of things from such breach’ and constitute the ‘means of remedying the inconvenience’ caused by non-performance, which, under the section, must be taken into account while estimating damages.
 Specific Relief Act 1963 Section 20(2).
 Specific Relief Act 1963 proviso to Section 20(2).
 Badrinath Srinivasan, ‘Hardship & Substituted Performance as Defences against Specific
Performance: Critique of the Recent Developments’ (2019) 31 National Law School of India University Review 53.
 Ibid 67.
 Ibid 66.
 Nishith Desai Associates (n 1) 27.
 Terje Salvesen, Contractual Incentives in EPC Contracts (University of Stavanger, 2011) 12.
 Fédération Internationale Des Ingénieurs-Conseils (FIDIC), Conditions of Contract for EPC/Turnkey Projects (1st edn, 1999). Hereinafter, ‘FIDIC Model Contract’.
 Ibid Clause 15.2.
 Karnataka Electricity Board v MS Angadi (2009) 3 RAJ 682 (Kant), quoted in Markanda (n 4) 19.33.
 Schneider (n 7) 340.
 A Merna and NJ Smith, ‘Project Managers and the Use of Turnkey Contracts’ (1990) 8 International Journal of Project Management 3 183.
 Joe, Nitek and Minamitaka (n 12).
 Ali Haider, Global Claims in Construction (Springer-Verlag London 2011) 54, 210.
 NITI Aayog Model Contract (n 2) Clause 16.1.1.
 Ibid Clause 4.7
 Haider (n 31) 54.
 World Bank Public-Private Partnership Legal Resources Centre, The Caribbean Renewable Energy Development Programme (CREDP) Toolkit: EPC Template (Updated March 2021) < https://ppp.worldbank.org/public-private-partnership/library/caribbean-renewable-energy-development-programme-credp-toolkit> accessed 18 July 2021 Clause 13.2.1. Hereinafter, ‘CARICOM Model Contract’.
 NITI Aayog Model Contract (n 2) Clause 21.4.
 CARICOM Model Contract (n 35) Clause 13.2.1.
 NITI Aayog Model Contract (n 2) Clause 13.5.1.
 Haider (n 31) 41.
 NITI Aayog Model Contract (n 2) Clause 15.1.1.
 Jonathan Hosie, Turnkey Contracting under the FIDIC Silver Book: What Do Owners Want? What Do they Get? (Mayer Brown 2007) 2.
 Specific Relief Act proviso to Section 20(2).
 Markanda (n 4) 19.6.
 Srinivasan (n 15) 5.
 Kapilaben and Ors v Ashok Kumar Jayantilal 2019 SCC ONLINE SC 1512.
 Srinivasan (n 19) 2.
 Specific Relief Act 1963 Section 14(b).
 FIDIC Model Contract (n 24) Clause 15.2.
 Sajith Sreedharan, ‘Turnkey Project Execution with Consortium Contracts’ (Eka Infra Consultants, 2019) <https://www.ekainfra.com/turnkey-project-execution-with-consortium-contracts/> accessed on 21 July 2021.
 Markanda (n 4) 19.34.
 Ruxley Electronics v Forsyth (1996) AC 344, quoted in Haider (n 31) 77.
 Sintayehu Kabede and Tiewei Zhang, ‘Enforcement of Legal Remedies Against Construction Projects Time Overrun in Ethiopia: A Critical Appraisal’ (2020) 6 Heliyon 10.
 Kanishk Thakur and Dushyant Thakur, ‘Improving Substituted Performance in India: Attending to the Loopholes’ (2020) 10 Statute Law Review 10 1.
 Specific Relief Act 1963 Section 20(1).