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Guide For EPCM Contracts
Guide For EPCM Contracts
Energy
Infrastructure, mining and commodities
Transport
Technology and innovation
Life sciences and healthcare
A guide to
EPCM contracts
A guide to
EPCM contracts
Contents
Summary 04
Contract for professional services, not works
05
06
07
EPCM services
09
11
Payment 12
Incentives 13
Limitations on liability
15
17
19
Contacts 20
Summary
This document provides a description of the EPCM procurement structure and some of
the key issues that should be considered by any junior miner contemplating its use for
mining infrastructure delivery.
The EPCM solution will allow employers to retain ultimate control over
design development throughout construction
This will provide flexibility to allow employers to adapt design to suit precise (and
sometimes changing) requirements and to allow optimisation and value engineering
where relevant to control capital costs. Such flexibility is not possible under an EPC
solution (at least not without significant price consequences) since design development
will be controlled by the EPC contractor.
This is particularly important where there is an extended build period with a multiphase construction programme with many distinct and separate packages for overall
infrastructure delivery (eg, process plant, road, rail and port infrastructure etc.).
But the advantage of lower costs and increased flexibility under an EPCM solution
should always be balanced against the significant additional risks being retained by
the employer in project delivery. As mentioned above, the employer under an EPCM
solution will not be insulated from cost overrun risk in the same way as they would be
under a fixed price EPC solution.
The employers role in the management of the works in parallel with the EPCM
contractor is therefore paramount. For successful project implementation, the EPCM
solution requires a well-equipped and mobilised employers team to take a hands-on
and intrusive role in the management and administration of the works.
Form of contract
what should be the starting point?
There is no international standard form template contract for the EPCM contracting
solution, unlike for EPC turnkey or traditional build contracts.
EPCM services
EPCM services
EPCM services typically fall into the following categories:
E Engineering services
This is the design of the process plant, the buildings housing the process plant and any
associated infrastructure. The EPCM contractor may or may not have been involved in
producing the basic design and/or the process flow design at feasibility stage.
Where the EPCM contractor has not produced basic design, the EPCM contractor should
accept the risk of the accuracy and completeness of the basic design or at least verifying
the same to the employer.
The EPCM contractor should be allocated responsibility for overall co-ordination of
design for the project to ensure that the completed works meet the required technical
and performance specification (but note Price certainty on the cost of the works
and Incentives below describing the limited liability typically accepted by EPCM
contractors in this regard).
P Procurement services
The EPCM contractor should be allocated responsibility for the overall procurement
strategy. He will also source contractors, consultants and the necessary plant and
equipment in consultation with the employer and in accordance with the employers
requirements and the assumptions established at feasibility stage.
The EPCM will advise on the timing of the letting of the relevant packages and will
advise the employer on the terms available and will typically negotiate the contract
packages on the employers behalf.
It is usual for the employer to enter into the works and supply contracts directly but
we have seen exceptions to this approach under which the EPCM contractor enters into
contracts as the employers agent.
The EPCM contractor should be allocated responsibility for overall management of the
carrying out and completion of the works. This will include the co-ordination of the
works and services being procured on the employers behalf to achieve completion of
the works in accordance with the project schedule, the project budget and to meet the
required technical and performance specification (but, again, note Price certainty on
the cost of the works and Incentives below and the limited liability typically accepted
by EPCM contractors in this regard).
The construction management services will also typically include the management of
health and safety at the site, the management of disputes between the employer, the
works contractors and/or the suppliers, the establishment of quality assurance systems
and the management of the remedying of defective works and/or services provided by
other parties.
In all cases, it is important that the nature and extent of the services being provided are
well defined and that appropriate levels of contractual flexibility are created to allow the
scope of services to be adapted through the execution of the project in a manner which
does not expose the employer to de-scoping penalties or inflated pricing for enhanced
services.
The above allocation of responsibility is not the only solution. Hybrid solutions have also
become more common, for instance where employers wholly retain the management
function through the owners team to create an EP/CM split. The appropriateness of the
structure proposed will always be something that the employer should consider with its
technical, commercial and legal advisers on a case-by-case basis.
Payment
The usual basis of payment for EPCM contractors is as follows:
payment on a cost reimbursable basis for the man hours expended at agreed rates
(rates should reflect the actual and verifiable cost and the contract should expressly
provide that these rates should usually NOT include profit) plus
overhead payments that will be charged at a fixed percentage of the reimbursable
rate plus
a fixed fee element representing the EPCM contractors profit. Employers should
seek to agree to fix this amount at day 1 and not permit any increase in the event of
project cost and/or time overruns (ie, to avoid any indirect disincentive to the control
of overruns).
The EPCM contractor should warrant that the agreed rates in that the agreed rates in
the first two bullet points above do not contain any profit element, and the employer
should have the right to claw-back any profit element subsequently identified through
agreed audit rights or as disclosed by the EPCM contractor.
The value of the hours expended by the EPCM contractor in providing the required
services are not typically subject to an overall cap or limit, although employers
sometimes offer incentive payment for the achievement of budgeted man hours.
However, with a competitive market, there are contractors who may be willing to accept
delivery of all the EPCM services for a fixed amount. The only exceptions to this would
be subject to negotiation but might include: variations to the EPCM or trade contracts;
breach by the Employer of the EPCM contract or trade contracts and possibly force
majeure type events.
On the face of it, capping the amounts payable to the EPCM contractor appears
commercially sensible but employers need to be aware that where matters have
taken a turn for the worse for instance where the project has fallen into delay (which
may be for reasons beyond the reasonable control of the EPCM contractor), employers
will want to avoid effectively putting a halt to the services or disincentivising the EPCM
contractor from applying appropriate resource to the project to assist in rectifying the
relevant issues.
12 Norton Rose Fulbright
Incentives
Incentives
The EPCM contractor will not backstop project delivery risk and, importantly, the
achievement of key project targets. The EPCM contractor will however be responsible
for managing the same on behalf of the employer.
The challenge for employers will be to incentivise the EPCM contractor to effectively
and proactively manage project delivery and the achievement of key project targets.
The approach typically adopted relies on an incentive structure which provides
positive (and sometimes negative) incentives to the achievement of key project targets.
These provisions are generally bespoke and may be underpinned by fairly complex
calculations but equally can be fairly straight forward depending on the approach
preferred by employers.
Typically, incentive regimes cover the following:
bonus payments for the works being completed on time or within a fixed period
following the scheduled completion date
bonus payments for the works being completed for an overall outturn cost below or
within a fixed amount over the outturn cost budget
bonus payments based on the health and safety record at the site
bonus payments for completing the required EPCM services within the projected
budget for such services (based on projected man hours at the agreed rates)
but there will always be variations on the approaches outlined above and the proposed
approach will tend to be shaped by the concerns the employer may have in respect of
key aspects of project delivery.
It will be a matter for the employer to consider commercially whether the incentives
should remain payable where extraneous circumstances outside of the control of the
EPCM contractor have undermined the achievement of the relevant project targets. We
have seen varying approaches in this regard.
Since the EPCM contractor will typically set key project targets (eg, the project budget
and the project programme), appropriate due diligence will need to be undertaken
by the employer to establish that the project targets are sensible in the context of the
project proposed.
More recently, we have seen EPCM contractors willing to accept negative incentives
around the achievement of the key project targets, such that they are prepared to place
an element of their profit at risk. This approach has been commonplace in other sectors
using the EPCM model for some time but it is now becoming more common now in the
mining sector.
Limitations on liability
Limitations on liability
All EPCM Contractors will expect to cap their liability under the terms of the
EPCM contract.
The liability accepted by the EPCM contractor must be appropriately sized but the ethos
of EPCM contracting is that the EPCM contractor is providing consultancy services
only and is not underwriting project risk. The size of the liability caps under the EPCM
contract (compared to the overall project cost) and security package (if any) supporting
the EPCM contract will be reflective of this.
Certain defined liabilities must be uncapped and so excluded from any limitation on
liability. These liabilities should include those which can not be limited at law (eg,
fraud, death and personal injury etc.).
In addition, there is usually an agreed list of further liabilities that will not count
towards the liability limit. This is usually a matter for commercial negotiation and will,
to a certain extent, be driven by project specific concerns.
Consequential losses
Liability for consequential losses (ie, the losses that arise indirectly from the failure,
act or omission of the EPCM contractor) is a key issue:
employers will be concerned about the cost of its trade contractors having to reperform works as a result of defective services or design by the EPCM contractor
the extent of liability typically accepted by EPCM contractors will leave the employer
exposed given the likely quantum of these liabilities
professional indemnity insurance should therefore be arranged to cover these types
of losses (either procured by the EPCM contractor or by the employer as part of the
wider project insurances)
where professional indemnity insurances is available, such liability should be
uncapped to the extent it is recoverable under the relevant policy. This would permit
full recovery by the employer (subject to the extent of the insurance cover)
the allocation of insurance deductible risk will be a matter for commercial negotiation.
It is important therefore that these contracts are well drafted and dovetail together so
that they include, at least, the following provisions:
a recognition of the joint objectives across the two contracts and a requirement for
coordination
an acknowledgment by each entity of the scope of the services being performed by
the other and an allocation of responsibility for any gaps between the two scopes
an obligation to not interfere with or impede the other entity
an acknowledgement that any act, omission or default by one entity will not give rise
to any right of the other entity to relief from or a right to claim against the employer
default termination triggers in one contract automatically triggering termination of
the other contract (so called, cross default provisions)
a right for the employer to consolidate any dispute against one entity with any
dispute against the other.
The employer will usually look to limit its exposure to breach by the separate on-shore
and off-shore contractors by putting in place further contractual arrangements which
provide for the off-shore EPCM contractor entity (or a suitable parent) providing a
performance and financial guarantee (backed by indemnities and, possibly, suitable
financial security) in respect of discharge by both the on-shore and off-shore entities
of their respective and collective obligations. This guarantee (which could be wrapped
into the off-shore contract) is often referred to as an umbrella agreement.
However, in jurisdictions where the tax authorities do not recognise this split due to
the presence of the guarantee (or wrap) provided by the umbrella agreement, then
further careful consideration is required in the drafting of the on-shore and off-shore
contracts in order to deal specifically with the above concerns.
English law is the preferred governing law for substantial international contracts
because it carries a guarantee of impartiality and integrity that is recognised worldwide
and provides the ideal balance of predictability and flexibility. It is invariably the
preferred choice of lenders in the EPCM market.
Contacts
Martin McCann
Global head of mining,
infrastructure and commodities
Norton Rose Fulbright LLP
Tel +44 20 7444 3573
martin.mccann@nortonrosefulbright.com
Mark Berry
Partner, London
Norton Rose Fulbright LLP
Tel +44 20 7444 3531
mark.berry@nortonrosefulbright.com
Matthew Hardwick
Senior associate, London
Norton Rose Fulbright LLP
Tel +44 20 7444 5550
matthew.hardwick@nortonrosefulbright.com
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