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Cogeneration Plant Builders Risk Insurance Dispute

The following is an excerpt from an Interface Consulting work product issued for use in litigation, arbitration, or mediation (dispute resolution). Names, dates, and other information has been modified for client confidentiality purposes.

 

Davis/Hill v. Fallbrook Litigation

I.    Introduction

I.A. The Dispute

The subject of this dispute stems primarily from a Builders Risk insurance policy issued to Bass Electric Company (Bass Electric or BE) and Sanford Engineering & Construction Company (Sanford), by Fallbrook at Gills of Chicago (Fallbrook) relating to the Davis/Hill Cogeneration Plant in Árbol Verde, Dominican Republic (the Plant). Davis/Hill Cogeneration Limited Partnership (Davis/Hill or DHCLP) was named as an additional insured on the policy. In its Second Amended Original Petition, Davis/Hill states that “[a]t the expiration of the ARBR Policy, the value of the [Plant] was substantially diminished by the inability of the Power Boilers to produce at rated capacity due to slag buildup. Plaintiffs have incurred substantial losses and damages in an amount of not less than $32,000,000 or as will be proven at trial.”

 

I.B. Project Background

On November 26, 1993, Davis/Hill issued a Notice to Proceed to Bass Electric for the design, supply, construction, installation, start-up, and testing of a 185-megawatt cogeneration plant in Árbol Verde, Dominican Republic, named the Davis/Hill Power Plant Project. The following graphic illustrates the relationship of the parties as we understand them.

 

Relationship Among the Parties

 

The plant consisted of a combustion turbine generator and associated equipment, heat recovery steam generator (HRSG), two (2) Jackson Montgomery power boilers, and a steam turbine generator and associated equipment. The equipment described above was constructed and placed on two (2) barges for shipment to Árbol Verde. The work consisted of two (2) phases of work: the simple cycle Phase 1 and the combined cycle Phase 2. Phase 1, which consisted of the combustion turbine generator and associated equipment, was constructed and placed on the first barge. Phase 2, which included the remainder of the facilities, was constructed and placed on the second barge. The layout and configuration of the cogeneration facility is illustrated below.

 

Layout and Configuration of the Davis/Hill Power Plant
(For Illustrative Purposes)

Source: ...

 

Davis/Hill provided a notice to proceed to Bass Electric in November 1993. The design, procurement, and construction of the plant was completed in the summer of 1995, and Davis/Hill initially accepted the plant on August 3, 1995, which we believe was effective on August 1, 1995.

Subsequent to Davis/Hill accepting the plant on August 1, 1995, Davis/Hill alleged significant reliability and operational issues existed. A dispute arose as to when Davis/Hill accepted the plant.

Modifications and repairs were made to various parts of the plant from August 1995 through January 1996. During this time period, Davis/Hill was operating the plant in both single and combined cycle mode, producing and selling electricity. Eventually, Davis/Hill again accepted the plant on January 12, 1996, although Bass Electric and Sanford continued to assert that the completion date was August 1, 1995. For the purposes of this opinion, we will assume that Davis/Hill finally accepted the plant on August 1, 1995 and/or January 12, 1996.

In March 1996, while the power boilers were undergoing normal maintenance and unrelated repairs, slag was observed in the power boilers. Mattie Corporation (Mattie), which we understand is one of Davis/Hill’s contractors, observed the slag on March 13, 1996. Mattie’s March 26, 1996, letter to Davis/Hill states, “On March 13th we had the opportunity to inspect and observe the slag build up in Power Boilers 1A and 1B.” (KE...)

From this point forward, Davis/Hill made several attempts to clean the slag off the boiler tubes. On May 12, 1998, over two years later after the slag was first noticed, Davis/Hill notified the Fallbrook that it would be submitting a claim related to the slagging issue.

 

I.C. Builders Risk Insurance Policy Coverage

Fallbrook issued a Builders Risk insurance policy (policy #MOA941181L/C) to Sanford relative to the Davis/Hill Cogeneration Plant Project. The policy states that the interest and period of coverage are as follows....

Davis/Hill accepted the plant on August 1, 1995, thus ending the policy’s coverage on this date relating to the construction of the plant. From this date until August 1, 1996, a 12-month (maximum) maintenance policy period was in place subject to various endorsements. Alternatively, subject to the disputes that developed, Davis/Hill accepted the plant on January 12, 1996, thus ending the policy’s coverage on this date relating to the construction of the plant. From this date until January 12, 1997, a 12-month (maximum) maintenance policy period was in place subject to various endorsements.

Another key provision of the Builders Risk policy, and what appears to be the basis of Davis/Hill’s lawsuit against the Fallbrook, is highlighted below....

The Builders Risk insurance policy does not include “faulty design”....

 

II. Summary of Opinions

Based on Interface Consulting’s review of certain project documents listed in Exhibit 1, we have observed and concluded the following:

  • Any reduction in the value of the plant in the time period from 1995 to 1997 was due to a series of events which relate to “faulty design” and maintenance/operation issues and which are not covered by the Builders Risk insurance policy.

Mr. Heath Atlas of Davis/Hill acknowledges in his deposition that there are many contributing factors to the formation of slag and that Davis/Hill considers the slagging issue to be “…a problem with design…” of the power boilers....

The cogeneration facility experienced significant problems due to faulty design and maintenance issues that impacted the operation and reliability of the plant including the following:

  • Air Filtration System Problems: The combustion turbine was damaged as a result of defects in the air filtration system.

  • Circulating Water System Problems: Defects in the underwater circulating cooling line had to be repaired.

  • Boiler Feedwater Problems: The boiler feedwater system was contaminated and caused corrosion and tube failures in the HRSG, power boilers, and steam turbine.

  • HRSG Deaerator Problems: Corrosion in the deaerator vessel of the HRSG required it to be replaced.

  • Slagging Problems: Slag deposits on the power boiler tubes reduced the power boilers’ ability to produce steam.

  • Miscellaneous Problems: Other significant problems impacted the ability of the plant to operate in a reliable and proper manner.

    • Numerous power boiler tube failures

    • Combustion turbine damages due to fuel pump failures

    • Catastrophic tube failures in power boiler B

  • The slagging issue was addressed in detail as this is the focus of Davis/Hill’s Builders Risk Insurance claim for diminished value. The following are the three primary issues that contributed to the accumulation of slag in the power boilers, all of which relate to faulty design and maintenance:

    • Davis/Hill provided and burned a dirty fuel oil that was not as specified in the contract.

    • Davis/Hill misoperated the boilers resulting in incomplete combustion.

    • The power boilers design was defective, which led to the formation of slag.

  • Any diminution of the plant’s value due to slagging as of January 1997 was approximately $700,000. The diminution of the plant’s value due to slagging would be somewhat less than $700,000 as of August 1996. Thus, the damages alleged by Davis/Hill of $32,000,000 for “…diminution of the Plant’s market value…” are not valid. The diminished value calculation developed by Mr. Cox in his August 1, 2006, report is incorrect. Mr. Cox’s calculation is fundamentally flawed as it appears to be based on the premise that the power boilers were not operational after January 1, 1997, which is not true. The power boilers were operational up until mid-2003 and power was being produced by the plant.

 

III. Discussion of Opinions

III.A. Diminished Value of the Plant

Faulty Design and Maintenance/Operation Issues

As stated....

Air Filtration System and Circulating Water System Defects

Boiler Feedwater System Contamination

HRSG Deaerator Corrosion

Accumulation of Slag

Other Significant Events

III.B. Accumulation of Slag

Accordingly....

Discussion of Slag

Slag Formation

Conclusion

In this section....

 

Davis/Hill Burned a Dirty Fuel Oil and One That Was Not as Specified in the Contract

Davis/Hill Mis-Operated the Boilers Resulting in Slag Formation

The Design of the Power Boilers was Defective

III.C. Davis Hill’s Diminished Value Calculation Is Incorrect

…In the absence of reliable offers to sell and corresponding offers to buy, DHCLP’s construction cost of the plant of approximately..., is the value of the plant as of August 1995. Using that figure as a base, we analyzed available documentation in order to determine any reduction in actual plant market value that could have resulted due to the reported power boiler slagging.

…We conclude that any diminution of the plant’s value due to slagging as of January 1997 was approximately…. As of August 1, 1996, because of the progressive nature of slagging, the diminutive value of the plant would be somewhat less than $700,000. Thus, the damages alleged by DHCLP of $32,000,000 for “…diminution of the Plant’s market value…” are not valid.

III.D. Conclusion

In conclusion....

 

IV. Signature

 

 

V. Exhibits