Turbine Manufacturer LTSA’s

1. Turbine Manufacturer LTSA’s 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 LTSA’s? 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 Owner’s 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 Manufacturer…which 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 necessarily…the 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 anIndependent Root Cause analysis necessary? RCA’s are essentially impossible without access to the broken part.

9. What if the problem is the Manufacturer’s Fault? Issue #3: Limitation of Manufacturer’s Liability The LTSA limits the Owner’s 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 Manufacturer’s 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 Buyer’s insurer(s) seeking subrogation which should have been waived.”

11. Doesn’t 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”…

14. $ Time, Months

18. Summarizing the bad news, the manufacturer has: Capitalized on the owner’s insecurity and uncertainty about the manufacturer’s product by: 1. “Locking in” a favorable parts/service pricing agreement that 2. Guarantees the manufacturer’s 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 can’t be held liable for his own mistakes.

19. OK, the situation isn’t 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 insurer’s right of subrogation, the insurer will only pay the costs not including the third party’s profits built into the third party’s 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 isn’t 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 Buyer’s 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 insured’s 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 insurer’s 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.

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 party’s 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. Doesn’t the LTSA provide a good deal on Parts and Labor, though?Part 2

28. OK, the situation isn’t 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 insurer’s 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 insurer’s right of subrogation, the insurer will only pay the costs not including the third party’s profits built into the third party’s 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 isn’t 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 insurer’s 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 insurer’s right of subrogation, the insurer will only pay the costs not including the third party’s profits built into the third party’s 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 isn’t 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 insurer’s right of subrogation, the insurer will only pay the costs not including the third party’s profits built into the third party’s 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 isn’t 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 insured’s 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.