Turbine Manufacturer LTSA

1
Turbine Manufacturer LTSAs

• Hidden Risks

Presented By Rex Andrews Associates,
Inc. Donato, Minx Brown, P.C. M.G. Thomas
Associates, Inc.
2
What is an LTSA?

• In short, a long-term service agreement (LTSA)
  is a contractual agreement between a customer and
  a manufacturer under which the manufacturer is
  responsible for operations, maintenance and
  repairs of the product purchased by the customer
  and offered by the manufacturer, for a fee.
• An LTSA is like an insurance policy or extended
  warranty on the product purchased.

3
How Prevalent are LTSAs?

• Long-term service agreements - a.k.a.
  maintenance agreements, maintenance service
  agreements, service contracts, maintenance
  programs, and various other designations - are
  gaining favor as a risk management tool for the
  growing fleet of installed gas turbines,
  especially in the large power generation market.
• Siemens-Westinghouse, for example, expects a
  2,070 percent increase in the number of units
  covered by long-term service programs, from 10 in
  1998-99 to 217 by 2004.
• Power Engineering
• August, 2001

4
Who Gains From an LTSA?

• Benefits of LTSAs for the Turbine Owner
• The Owner knows in advance how much maintenance
  and parts will cost, eliminating uncertainty
• The cost of maintenance can be linked exclusively
  to the annual production level (kWh for power
  generation plants, cubic meters of gas handled
  for gas compression stations, etc.)
• Maximizing production is the common objective of
  both Owner and Manufacturer, and both are
  recompensed in proportion to the production
  level consequently, the plant will be maintained
  at highest efficiency and constantly updated
  technologically, eliminating the risk of
  obsolescence . . . often the Manufacturer shares
  risks and rewards with the Owner
• The Owners personnel are kept constantly
  informed of new technologies introduced into the
  plant and trained about the equipment and its
  operation and maintenance
• The Owner is not obliged to keep and manage a
  spare parts warehouse with the locking up of
  capital this implies, and the Manufacturer can
  benefit by sharing its warehouse and inventory
  with more than one Owner
• The Owner has reassurance that people and parts
  will be available on relatively short notice for
  repair and/or service of the machinery.

5
Who Gains From an LTSA?

• Benefits of LTSAs for the Manufacturer
• Guaranteed market for repair work and service.
  Maintenance and payments are scheduled at regular
  intervals
• Guaranteed prices that are determined and
  negotiated by the Manufacturer
• Limitation of Liability clauses that protect the
  Manufacturer for repair work and services they
  provide as a part of the LTSA
• Essentially eliminates the competition. The
  parts must be provided by, purchased from and
  replaced by the Manufacturer
• The parts replaced are the property of the
  Manufacturerwhich protects the design specs and
  other features of the parts making it hard for
  other companies to produce similar parts.

6
This is all good news for Insurers, right?

• Not necessarilythe bad news arrives when a claim
  occurs.

7
LTSA Problems for Insurers

• Issue 1 The Agreement is Secret!
• The disclosing Party shall indemnify and hold
  the nondisclosing Party harmless for any
  liability suffered by the nondisclosing Party as
  a result of the disclosing Party's improper
  disclosure to third parties or improper use of
  Seller's Confidential Information.
• Any unauthorized disclosure of Confidential
  Information or other violation of the provisions
  of this Contract shall be deemed a material
  breach of this Contract. The Parties agree that
  monetary damages for any breach of the provisions
  of this Contract are inadequate and that the
  non-breaching Party is entitled to appropriate
  equitable relief (including without limitation,
  injunctive relief or specific performance) for
  any breach of such provisions.
• Disclosure of LTSA details (to Insurers or
  Adjusters) can be problematic for the Assured.

8
More Problems

• Issue 2 Any Damaged Parts Are the Property of
  the Manufacturer!
• When the Program Parts and Miscellaneous
  Hardware are replaced, the parts shall be deemed
  to have a scrap value of 0 and, if Seller so
  requests, shall be returned by Buyer to Seller
  along with free and clear title thereto. These
  parts include items down to the pins, springs,
  studs, gaskets, tie wires, fasteners, screws,
  washers, nuts and bolts.
• The OEM performs a Root Cause Analysis on
  Failed Parts
• Is an Independent Root Cause analysis necessary?
  
• RCAs are essentially impossible without access
  to the broken part.

9
What if the problem is the Manufacturers Fault?

• Issue 3 Limitation of Manufacturers Liability
• The LTSA limits the Owners causes of action
  against the Manufacturer and also limits the
  amount of recoverable damages that the Owner can
  recover from the Manufacturer. The provision
  states that the Manufacturer will not be liable
  under any theory of recovery, whether based in
  contract, in tort, under warranty or otherwise.
• The LTSA also restricts recoverable damages and
  excludes any recovery for any indirect, special,
  incidental or consequential loss or damage . . .
  damage or loss to property or equipment.
• Was a Waiver of Subrogation Insurers Intent?

10
What if the problem is the Manufacturers Fault?
Part 2

• Issue 4 LTSA Insurance Requirements
• The Owner is required to maintain property
  damage insurance, commercial general liability
  insurance, umbrella excess liability coverage,
  workers compensation insurance and business
  automobile liability insurance. Further, the
  Owner is required to make its policies primary to
  any of those maintained by the seller. The Owner
  is also required to name the Manufacturer as an
  additional insured on all types of insurance . .
  . except the property damage policy.
• Most importantly, all policies furnished by the
  Owner shall include waivers of subrogation
  rights against the Manufacturer. If the Owner
  does not obtain a waiver of subrogation, the
  Owner is required to defend, indemnify, and hold
  the Manufacturer and its Affiliates harmless in
  and from any claim or proceeding by Buyers
  insurer(s) seeking subrogation which should have
  been waived.

11
Doesnt the LTSA provide a good deal on Parts and
Labor, though?

• Issue 5 LTSA Repair Costs for Unscheduled
  Events
• Unscheduled Outage
• If, during the Term, an Unscheduled Outage
  occurs, then Buyer shall, pursuant to a Change
  Order, hire Seller to, and Seller shall, supply
  any additional New Program Parts, Miscellaneous
  Hardware, Shop Repairs or Services
• (i) Services will be provided at the prices
  specified in Seller's then current domestic Price
  List(s) in effect at the time for elements not
  included in Seller's domestic Price List(s) and
  (ii) Program Parts and Miscellaneous Hardware
  will be supplied at the prices set forth in the
  Contract
• Contract pricing benefit is only for Program
  Parts, i.e., normal replacement items.
  Everything else priced per Price List

12
(No Transcript)
13
(No Transcript)
14
(No Transcript)
15
(No Transcript)
16
(No Transcript)
17
(No Transcript)
18
Summarizing the bad news, the manufacturer has

• Capitalized on the owners insecurity and
  uncertainty about the manufacturers product by
• 1. Locking in a favorable parts/service
  pricing agreement that
• 2. Guarantees the manufacturers market and
  eliminates his competition, but
• 3. Excludes any unscheduled problem from the
  favorable price schedule, knowing that Insurers
  will pay for this type of event, and
• 4. Guarantees that the manufacturer cant be
  held liable for his own mistakes.

19
OK, the situation isnt good for Insurers. What
options exist?

• 1. Get More Information?
• Underwriters could require that the potential
  insured provide the Underwriter with all
  contracts that the potential insured has entered
  into that have waived subrogation. This will
  allow underwriters to better assess the potential
  exposure that they may have and adjust the
  premium and deductible accordingly.
• 2. Modify the Policy to only Pay the Cost of the
  Parts and for any Covered Loss and not for the
  Total Cost Including Profits?
• Underwriters could also modify the insurance
  policy to pay a different amount of damages for
  any losses where the insured has waived
  subrogation rights. A clause could be included
  in the policy that states that for any loss where
  the insured has waived the insurers right of
  subrogation, the insurer will only pay the costs
  not including the third partys profits built
  into the third partys quote. Effectively, this
  allows the insured to only pay the wholesale cost
  of the damages which would not include any profits

20
OK, the situation isnt good for Insurers. What
options exist?

• 3. Tell the potential insured that underwriters
  will not waive subrogation?
• Underwriters could tell the insured that they
  will not agree to waive their subrogation rights
  on any new contract entered into by the insured.
  If the insured still wishes to still obtain
  insurance given this fact, then Underwriters can
  now issue the policy. Under the LTSA, if the
  insured (buyer) does not obtain a waiver of
  subrogation, the insured (buyer) will be required
  to defend, indemnify, and hold Seller and its
  Affiliates harmless in and from any claim or
  proceeding by Buyers insurer(s) seeking
  subrogation which should have been waived.
  Then, the insurer could still pursue subrogation.
  As a result, the insurer would make a claim
  against the seller (OEM) and the seller (OEM)
  will go back to the insured (buyer) for defense
  and indemnification. As a result, the insured
  (buyer) would then have to submit this claim to
  their CGL carrier for defense.

21
Extreme Measures

• 4. Increase the Premium?
• Underwriters could increase the premiums of any
  insured that has agreed to provide an OEM with a
  waiver of subrogation. This will guarantee more
  upfront profit in exchange for the risk of not
  being able to pursue subrogation in the event of
  a loss. The downside to this is the possible
  loss of insureds that go elsewhere to find
  insurance.
• 5. Require Prior Written Consent to Waive
  Subrogation on any New Contracts or Renewed
  Contracts?
• Underwriters could place a clause in their
  insurance policy that requires prior written
  consent with the insurer to waiver the rights of
  subrogation on any new contract or any contract
  that is to be renewed during the policy period.
  This makes the insured get consent from the
  insurer to waive subrogation on any new or
  renewed contract that is entered. If the insured
  does not get prior written consent, the policy
  will not pay for the loss because there was no
  prior written consent to waive the insurers
  subrogation rights.

22
Presented by
DONATO, MINX BROWN, P.C. ATTORNEYS AT LAW 3200
Southwest Freeway, Suite 2300 Houston, Texas
77027-7525 www.donatominxbrown.com
M.G. THOMAS ASSOCIATES, INC.
23
(No Transcript)
24
(No Transcript)
25
Payment Schedule
26
Continuing the bad news, by entering the LTSA,
the Owner has

• Seriously limited the opportunity for equitable
  treatment of his Insurers by
• 1. Engaging a third party who arguably has
  insurable interest in the turbine, but has no
  responsibility to Insurers, which
• 2. Allows the principle of indemnity to be
  violated by the third partys direct enrichment
  in the event of a claim (even when the claim is
  the responsibility of the third party), and
• 3. Allows the third party to avoid
  accountability at any level

27
Doesnt the LTSA provide a good deal on Parts and
Labor, though?Part 2

28
OK, the situation isnt good for Insurers. What
options exist?

• Require Prior Written Consent to Waive
  Subrogation on any New Contracts or Renewed
  Contracts?
• Underwriters could place a clause in their
  insurance policy that requires prior written
  consent with the insurer to waiver the rights of
  subrogation on any new contract or any contract
  that is to be renewed during the policy period.
  This makes the insured get consent from the
  insurer to waive subrogation on any new or
  renewed contract that is entered. If the insured
  does not get prior written consent, the policy
  will not pay for the loss because there was no
  prior written consent to waive the insurers
  subrogation rights.
• Modify the Policy to only Pay the Cost of the
  Parts and for any Covered Loss and not for the
  Total Cost Including Profits?
• Underwriters could also modify the insurance
  policy to pay a different amount of damages for
  any losses where the insured has waived
  subrogation rights. A clause could be included
  in the policy that states that for any loss where
  the insured has waived the insurers right of
  subrogation, the insurer will only pay the costs
  not including the third partys profits built
  into the third partys quote. Effectively, this
  allows the insured to only pay the wholesale cost
  of the damages which would not include any
  profits.

29
OK, the situation isnt good for Insurers. What
options exist?

• Require Prior Written Consent to Waive
  Subrogation on any New Contracts or Renewed
  Contracts?
• Underwriters could place a clause in their
  insurance policy that requires prior written
  consent with the insurer to waiver the rights of
  subrogation on any new contract or any contract
  that is to be renewed during the policy period.
  This makes the insured get consent from the
  insurer to waive subrogation on any new or
  renewed contract that is entered. If the insured
  does not get prior written consent, the policy
  will not pay for the loss because there was no
  prior written consent to waive the insurers
  subrogation rights.
• Modify the Policy to only Pay the Cost of the
  Parts and for any Covered Loss and not for the
  Total Cost Including Profits?
• Underwriters could also modify the insurance
  policy to pay a different amount of damages for
  any losses where the insured has waived
  subrogation rights. A clause could be included
  in the policy that states that for any loss where
  the insured has waived the insurers right of
  subrogation, the insurer will only pay the costs
  not including the third partys profits built
  into the third partys quote. Effectively, this
  allows the insured to only pay the wholesale cost
  of the damages which would not include any
  profits.

30
OK, the situation isnt good for Insurers. What
options exist?

• 2. Modify the Policy to only Pay the Cost of the
  Parts and for any Covered Loss and not for the
  Total Cost Including Profits?
• Underwriters could also modify the insurance
  policy to pay a different amount of damages for
  any losses where the insured has waived
  subrogation rights. A clause could be included
  in the policy that states that for any loss where
  the insured has waived the insurers right of
  subrogation, the insurer will only pay the costs
  not including the third partys profits built
  into the third partys quote. Effectively, this
  allows the insured to only pay the wholesale cost
  of the damages which would not include any
  profits.

31
OK, the situation isnt good for Insurers. What
options exist?

• Increase the Premium?
• Underwriters could increase the premiums of any
  insured that has agreed to provide an OEM with a
  waiver of subrogation. This will guarantee more
  upfront profit in exchange for the risk of not
  being able to pursue subrogation in the event of
  a loss. The downside to this is the possible
  loss of insureds that go elsewhere to find
  insurance.
• Get More Information?
• Underwriters could require that the potential
  insured provide the Underwriter with all
  contracts that the potential insured has entered
  into that have waived subrogation. This will
  allow underwriters to better assess the potential
  exposure that they may have and adjust the
  premium and deductible accordingly.