Presentation1,2,3 Combine

Basic features of an EPC contract

The key clauses in any construction contract are those which impact on:

• time
• cost, and
• quality.

The same is true of EPC Contracts. However, EPC Contracts tend to deal with issues with greater sophistication than other types of construction contracts. This is because, as mentioned above, an EPC Contract is designed to satisfy the lenders’ requirements for bankability.

EPC Contracts provide for:

• A single point of responsibility. The contractor is responsible for all design, engineering, procurement, construction, commissioning and testing activities. Therefore, if any problems occur the project company need only look to one party - the contractor - to both fix the problem and provide compensation. As a result, if the contractor is a consortium comprising several entities the EPC Contract must state that those entities are jointly and severally liable to the project company.

• A fixed contract price. Risk of cost overruns and the benefit of any cost savings are to the contractor’s account. The contractor usually has a limited ability to claim additional money which is limited to circumstances where the project company has delayed the contractor or has ordered variations to the works.

• A fixed completion date. EPC Contracts include a guaranteed completion date that is either a fixed date or a fixed period after the commencement of the EPC Contract. If this date is not met the contractor is liable for delay liquidated damages (“DLDs”). DLDs are designed to compensate the project company for loss and damage suffered as a result of late completion of the facility. To be enforceable in common law jurisdictions, DLDs must be a genuine pre-estimate of the loss or damage that the project company will suffer if the facility is not completed by the target completion date. The genuine pre-estimate is determined by reference to the time the contract was entered into. DLDs are usually expressed as a rate per day which represents the estimated extra costs incurred (such as extra insurance, supervision fees and financing charges) and losses suffered (revenue forgone) for each day of delay.

In addition, the EPC Contract must provide for the contractor to be granted an extension of time when it is delayed by the acts or omissions of the project company. The extension of time mechanism and reasons why it must be included are discussed below.

• Performance guarantees. The project company’s revenue will be earned by operating the facility. Therefore, it is vital that the facility performs as required in term of output, efficiency and reliability. Therefore, EPC Contracts contain performance guarantees backed by performance liquidated damages (“PLDs”) payable by the contractor if it fails to meet the performance guarantees. The performance guarantees usually comprise a guaranteed production capacity, quality and efficiency. PLDs must also be a genuine pre-estimate of the loss and damage that the project company will suffer over the life of the project if the facility does not achieve the specified performance guarantees. As with DLDs, the genuine pre-estimate is determined by reference to the time the contract was signed.

PLDs are usually a net present value (NPV) (less expenses) calculation of the revenue forgone over the life of the project. For example, for an ammonia and urea plant if the production rate of urea is 50 tonnes less than the specification, the PLDs are designed to compensate the project company for the revenue forgone over the life of the project by being unable to sell that 50 tonnes of urea. It is possible to have a separate contract that sets out the performance requirements, testing regime and remedies. However, this can create problems where the EPC and the performance guarantees do not match. In our view, the preferred option is to have the performance guarantees in the EPC contract itself. PLDs and the performance guarantee regime and its interface with the DLDs and the delay regime is discussed in more detail below.

• Caps on liability. As mentioned above most EPC contractors will not, as a matter of company policy, enter into contracts with unlimited liability. Therefore, EPC Contracts for process plant projects cap the contractor’s liability at a percentage of the contract price. This varies from project to project, however, a cap of 100% of the contract price is common. In addition, there are normally sub-caps on the contractor’s liquidated damages liability. For example, DLDs and PLDs might each be capped at 20% of the contract price with an overall cap on both types of liquidated damages of 30% of the contract price.
  There will also likely be a prohibition on the claiming of consequential damages. Put simply consequential damages are those damages which do not flow directly from a breach of contract but which may have been in the reasonable contemplation of the parties at the time the contract was entered into. This used to mean heads of damage like loss of profit. However, loss of profit is now usually recognised as a direct loss on project financed projects and, therefore, would be recoverable under a contract containing a standard exclusion of consequential loss clause. Nonetheless, care should be taken to state explicitly that liquidated damages can include elements of consequential damages. Given the rate of liquidated damages is pre-agreed most contractors will not object to this exception.
  
  

In relation to both caps on liability and exclusion of liability it is common for there to be some exceptions. The exceptions may apply to either or both the cap on liability and the prohibition on claiming consequential losses. The exceptions themselves are often project specific, however, some common examples include in cases of fraud or wilful misconduct, in situations where the minimum performance guarantees have not been met and the cap on delay liquidated damages has been reached and breaches of the intellectual property warranties.

• Security. It is standard for the contractor to provide performance security to protect the project company if the contractor does not comply with its obligations under the EPC Contract. The security takes a number of forms including:

• Variations. The project company has the right to order variations and agree to variations suggested by the contractor. If the project company wants the right to omit works either in their entirety or to be able to engage a different contractor this must be stated specifically. In addition, a properly drafted variations clause should make provision for how the price of a variation is to be determined. In the event the parties do not reach agreement on the price of a variation the project company or its representative should be able to determine the price. This determination is subject to the dispute resolution provisions. In addition, the variations clause should detail how the impact, if any, on the performance guarantees is to be treated. For some larger variations the project company may also wish to receive additional security. If so, this must also be dealt with in the variations clause.

• Defects liability. The contractor is usually obliged to repair defects that occur in the 12 to 24 months following completion of the performance testing. Defects liability clauses can be tiered. That is the clause can provide for one period for the entire facility and a second, extended period, for more critical items.

• Intellectual property. The contractor warrants that it has rights to all the intellectual property used in the execution of the works and indemnifies the project company if any third parties’ intellectual property rights are infringed.

• Force majeure. The parties are excused from performing their obligations if a force majeure event occurs. This is discussed in more detail in below.

• Suspension. The project company usually has right to suspend the works.

• Termination. This sets out the contractual termination rights of both parties. The contractor usually has very limited contractual termination rights. These rights are limited to the right to terminate for non-payment or for prolonged suspension or prolonged force majeure and will be further limited by the tripartite or direct agreement between the project company, the lenders and the contractor. The project company will have more extensive contractual termination rights. They will usually include the ability to terminate immediately for certain major breaches or if the contractor becomes insolvent and the right to terminate after a cure period for other breaches. In addition, the project company may have a right to terminate for convenience. It is likely the project company’s ability to exercise its termination rights will also be limited by the terms of the financing agreements.

• Performance specification. Unlike a traditional construction contract, an EPC Contract usually contains a performance specification. The performance specification details the performance criteria that the contractor must meet. However, it does not dictate how they must be met. This is left to the contractor to determine. A delicate balance must be maintained. The specification must be detailed enough to ensure the project company knows what it is contracting to receive but not so detailed that if problems arise the contractor can argue they are not its responsibility.

Source: http://www.mallesons.com/publications/update-combine.cfm?id=481 (Access on 22 July 22, 2010)

Factors Affecting Constructability Practices in Hydropower Construction in Nepal

Nepal has favorable condition to develop numerous hydropower plants yet it is facing eighteen hour load shedding per day during dry season. Traditional approach adopted in Nepal for hydropower construction involves many problems such as design changes, reworks, poor safety practices, time delays, cost overruns, disputes, claims which hampers constructability of the project. In this context, it is worthwhile to conduct research which focuses on investigation of the degree of importance and level of application of constructability concepts and identifying the major barriers hindering effective implementation of those concepts. The findings would be appropriate for the preparation of baseline required in constructability improvement guideline for hydropower construction in Nepal.

Thirty-six constructability concepts and forty-nine implementation barriers related to hydropower construction in Nepal were selected for detail study after extensive literature review and expert verification. Through questionnaire survey, opinions on those constructability concepts and implementation barriers were collected from fifty-three managers/engineers associated with hydropower developers, consulting firms and construction companies involved in hydropower construction in Nepal. The quantitative data gathered were then analyzed using various statistical techniques to conclude and recommend further studies. The result of this study revealed that six constructability concepts were accepted as very important concepts by overall respondents and the remaining concepts were considered to be important. To the contrary, none of the concepts are being highly applied in hydropower construction in Nepal. Further, ten major constructability implementation barriers were identified and grouped as ineffective communication and coordination, socio-political influences, and insufficient resources using factor analysis.

The effective implementation of constructability concepts in hydropower projects in Nepal can be attained by developing guidelines for the application of those concepts. For preparation of the guidelines the concepts identified by the study need to be verified with hydropower projects of various sizes and different financing models and detail procedures for applying those concepts should be documented. Also, identification of specific barriers for each constructability concept is necessary in milieu of developing guidelines for hydropower projects.

Keywords: constructability, implementation barriers, hydropower, Nepal