A standard based contract

The central document that governs the relation between the ESCO and its customer is the Energy Performance Contract (EPC). For several reasons, the ESCO contracts tend to be more complex than in many other business relationships, as it involves long term agreements and a payment scheme based on performance of the project. Their complexity is consistently one of the most prominent barriers in all ESCO markets for their development and growth. Therefore, the Global ESCO Network recommends that contracts are standardized to the extent possible, such standardization being established by authority rather than by general consent.

The Global ESCO Network recommends that standard based contracts are developed and authorized for use by a recognised entity, public or private (ESCO association as an example in the latter case), with the goals to:

• Ensure quality, transparency and effectiveness in Energy Performance Improvement Actions
• Provide a clear and transparent performance risk allocation as well as any other agreed energy performance criteria and associated payment schemes
• Provide a reference based contractual framework between user and ESCOs that clearly specifies value generation (including multiple benefits or co-benefits of the implemented improvements) and responsibilities of all stakeholders
• Agree on an acceptable dispute resolution scheme

The EPC is the core of the ESCO model. It is exclusive to the ESCO business model, but the term represents several possible alternatives, that effectively result in different contracts, notably “Guaranteed savings” “Shared savings” and “Chauffage” contracts

Standard based contracts must contain both a mandatory structure and a set of mandatory clauses. This oftentimes means that either they are too generic to be of use without heavy modifications, or that they are unable to fit across different legal frameworks. A main feature of a standard based contract, therefore, must be its adaptability and ability to be transposed to different legal frameworks depending on where it is to be applied.

A standard contract can also help in meeting new legal challenges or taxation issues – such as the IFRS 16¹, which has been in effect since the beginning of 2019 (see guidance on taxation) – ensuring that the sector responds cohesively and that companies are not left to compete on their understanding of legal frameworks.

While there can be many variations of such contracts used by different ESCOs, they should all have some basic common elements that qualify them as an EPCs. The standardization will not only reduce operational costs in general. It also provides familiarity with and thus higher confidence in contract terms by all stakeholders, reduces room for deviation and hence eliminates confusion and guesswork in the contracting process. In time, it will equally establish a body of case law for future reference. These are all trust enhancing characteristics that reach beyond the contracting parties to third parties such as financial entities.

¹ 16th policy recommendation from the IFRS Foundation. IFRS 16 introduces a single lessee accounting model and requires a lessee to recognise assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value.