The life of the ­conversion contract – mitigation of risks and liability

These complexities and the lack of industry standard contracts often leads to high risk in these projects. Due consideration needs to be given when drafting and negotiating conversion contracts to avoid failed projects and disputes.

The role of the conversion contracts in norwegian law

In Norwegian law, the concept of a “conversion contract” lacks a fixed definition, and it has not been extensively discussed in legal literature. These contracts typically concern the reconstruction or alteration of ships, rigs, and offshore installations, distinguishing them from newbuild agreements. The scope of such contracts can vary significantly, ranging from de facto repair contracts and simple purchase contracts with minor modifications, to complex Engineering, Procurement, Construction, and Installation (EPCI) contracts that closely resemble newbuild projects.

Norwegian contract law does not provide a dedicated standard contract specifically for the conversion of ships, rigs or other offshore installations. The General Conditions of Contract for Repair Work on Ships and Offshore Vessels at Norwegian Workshops (2 December 1985, revised 1997) offers limited guidance on conversion work, mainly concerning repairs rather than modifications. 

The closest alternative to a standardized conversion contract is the Norwegian Total Contract Module & Modification 2015 (NTK 15 MOD), based on the EPC contract NTK 15, primarily designed for the design, fabrication, and installation of new topside modules on existing production facilities.

However, NTK 15 MOD’s focus on newbuild components means it does not explicitly address the risks related to hidden defects in existing assets, such as structural fatigue in a vessel’s hull. 

Given the absence of a dedicated contractual framework, conversion projects often face significant challenges, particularly due to (lack of) information about the current status of the existing assets, unknown risks or defects associated with existing assets and integration of these assets with new parts. In practice, parties typically adapt fabrication contracts to suit conversion work, adjusting risk allocation to address these uncertainties. If responsibility for such risks is not addressed or allocated in the contract, one must rely on relevant background law. Since conversion contracts naturally combine the existing structure with new materials and components, such contracts blend elements of both construction and sales, meaning the relevant background law may vary, even within the same contract. 

With these complexities in mind, the following sections will examine four key risks in conversion contracts and strategies for effective mitigation, ensuring a fair allocation of responsibilities. 

Four risks associated with conversion contracts 

The responsibility for the condition of the contractual object

One challenge in conversion contracts is determining who bears responsibility for the condition of the unit being modified. The condition of the unit may not be fully known at the time of contracting, leading to unplanned expenses and delays. For example, when converting a tanker into a Floating Production Storage and Offloading unit (FPSO), the contractor cannot assume the hull is suitable. If it has experienced more fatigue than expected, structural reinforcements may be required, increasing costs and delaying the project.

This challenge is similar to differing site conditions in construction contracts. Under NS 8406:2009 section 18.1, unless otherwise agreed, the owner is responsible for providing necessary and accurate design documents, including the basis for pricing. This includes responsibility for the content of the tender documents and the accuracy of quantity estimates. The owner must ensure a clear and precise tender basis, which must be thoroughly prepared and consistent with industry standards. On the other hand, the contractor assumes the risk for their own cost calculations, ensuring that pricing covers expenses and profit. Courts have emphasized that if descriptions in the contract documents are unclear, the decisive factor is how a “reasonably prudent bidder” would interpret them. 

If the contract does not specify otherwise, there is a risk that the allocation of responsibility under NS 8406 may apply as relevant background law. Applied to a conversion contract, this responsibility allocation is comparable to the risk of differing site conditions: the owner may be held responsible for the condition of the unit, while the contractor assumes the risk for unforeseen issues, as ambiguities in contract documents require interpretation by how a “reasonably prudent bidder” would understand them. 

Clearly defined responsibility for the unit’s condition and the risk of hidden defects or pre-existing damage is therefore key to a conversion contract. To avoid untended liability in conversion contracts, responsibility for the unit’s condition can be allocated in different ways. The company may be required to deliver the unit in a specified condition, ensuring that any defects or deficiencies are addressed before the contractor begins work. Alternatively, if the company wishes to take a reservation regarding the unit’s condition, this must be explicitly stated in the contract.

However, responsibility may also shift depending on the contractor’s obligations. If the contract requires the contractor to have extensive knowledge of the unit, some responsibility for its condition may shift from the company to the contractor. Such an allocation of responsibility could be relevant in the FPSO example mentioned above, where the contractor may be obligated to acquire thorough knowledge of the vessel’s condition. The vessel’s age alone could indicate to the contractor that he should expect hidden defects or wear, which could impact the conversion. If defects or system degradation require additional work to meet new operational standards, the contractor may be responsible for these costs and delays due to their duty to have thorough knowledge of the unit.

Liability for the information about the contractual object 

Another challenge is the limited availability of detailed information about the unit subject to conversion. When a ship or rig is converted, especially if it has been in operation for several years, it can be difficult to obtain complete and accurate information such as as-built drawings, calculations, and classification documents. This can be particularly problematic when the conversion is being handled by a different shipyard than the one that originally built the vessel.

The lack of accurate documentation could lead to difficulties in assessing the structural integrity of the hull or the condition of critical systems. If the available information is incomplete or inaccurate, the contractor may face unexpected challenges during the conversion, leading to potential delays and additional costs to meet the new operational standards.

Moreover, if a long time has passed since the last classification inspection, it can be challenging to assess the exact condition of the unit, especially if the vessel or rig is still in active use. This situation is often exacerbated by the fact that ships or rigs are typically in service when conversion contracts are signed, making it difficult or impossible to carry out proper inspections prior to the contract.

Given these challenges, it is crucial for the contract to specify who is responsible for ensuring the accuracy of the information provided. The company may be responsible for ensuring that the information provided is as up-to-date and complete as possible. Alternatively, the contractor could be required to conduct its own inspections and tests, and verify the condition of the unit before proceeding.

Interfaces between new and old during the conversion 

A third risk factor in conversion contracts is managing the interface between the existing unit and new components. In newbuild contracts, components are typically designed from the outset to work together as part of an integrated system. However, in conversion projects, existing components – such as a ship’s main engines and gearboxes - must often be integrated with newly designed modules or systems. This integration does not always proceed as anticipated. Unforeseen complications can arise when the new systems fail to interact as intended with the older components, resulting in issues that were not accounted for during the contracting phase.

For example, upgrading a ship may require replacing outdated systems to meet new specifications. In such cases, enabling the replacement of old modules may involve reinforcing foundations, relocating equipment, and upgrading electrical systems. These changes introduce complexities, especially when it comes to ensuring that the new systems integrate seamlessly with the older components.

Managing these interfaces requires careful planning and engineering expertise. If the integration between new and old parts is not carefully coordinated, this may result in additional modifications, significant delays, and possibly failures in operations. The responsibility for managing these interfaces and who bears the cost for any unforeseen complications should be clearly outlined in the contract to mitigate the risk of cost overruns and performance issues.

To manage the risks of integrating old and new components, the contract must clearly define each party’s responsibilities. The company can mitigate its risk by requiring the contractor to conduct thorough inspections and verify documentation before work begins. ­Additionally, imposing fit-for-purpose warranties ensures the contractor is responsible for seamless integration. A fixed-price contract shifts the financial burden to the contractor, making them liable for unforeseen interface issues unless specifically excluded. The contractor can protect itself by requiring the company to guarantee the accuracy of provided information. 

The risks of incorrect or incomplete information

In ship and rig conversion projects, extensive information and documentation are exchanged between the parties. From the outset, the company provides technical details in the Invitation to Tender (ITT), including as-built drawings and classification documents. This information enables potential contractors to assess project feasibility and price their bids. However, in conversion projects, the accuracy and completeness of these documents are often uncertain, as they may naturally lose relevance over time. This is not necessarily due to lack of diligence by either party, but some information might be outdated, inconsistent, or even incorrect, creating a significant risk for both parties.

Incorrect assumptions based on unreliable documen­tation can lead to delays and additional costs. For example, in a project converting an aging drilling rig for extended service in harsh environments, the company might supply historical classification records and technical drawings from its original construction. However, if these documents fail to reflect later modifications or accumulated structural fatigue, the contractor may meet unexpected challenges once work begins. 

The risk of misinformation affects both the company and the contractor. The company risks liability if provided information turns out to be incorrect, leading to additional compensation claims or project delays. Simultaneously, the contractor faces financial exposure if it relies on incomplete or inaccurate documentation without verifying the actual condition of the unit. 

The question, then, is how each party can mitigate its risk through contractual mechanisms. A common approach is for the contract to distinguish between different categories of documents. The company may classify some documents as Company Document I, for which it guarantees accuracy and completeness, while other documents, such as FEED studies and historical reports, are labelled Company Document II and provided strictly “for information only.” By doing so, the company limits its liability for errors in certain documents while still allowing the contractor to use them as background information.

In turn, the contractor can mitigate some of the liability by insisting on the right to conduct its own inspections before work begins. The contract may also specify that the contractor bears the risk for relying on Company Document II but is entitled to additional ­compensation if discrepancies are found in Company Document I. Further­more, including a variation order mechanism can address unforeseen issues, allowing for scope adjustments rather than absorbing them as fixed-price risks.