Contract Management in International Construction

EPC Contracts
Tim Steadman

Beijing, April 28, 2009

General Overview

Introduction to CC Construction Group Purpose of presentation Outline of presentation

Context Roles Philosophy Structure Form Key risks and contract terms

EPC Contracts - 28 April 2009

Context - Economic

Effect of cycles

Participants Procurement methods and structures Price Risk allocation Funding sources and methods

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Context Business Culture

Most countries embrace market economics (in theory) In practice there are exceptions helpful and otherwise So relationships are to some extent adversarial/competitive And negotiations can be complex (especially if lenders are involved)

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Context Legal/Regulatory

Legal system is part of business culture The rule of law/contract is important, especially in project financed deals Civil and common law systems differ in form and substance Impact of procurement rules

On owners behaviour On bidding tactics

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Roles

Prime contractor (not always EPC) Vendor Technology licensor Investor Funder (deliberate or by default)

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Philosophy

As a contractor

Open bidding or sole source? Immediate profit or market penetration/profile? Sole or in consortium? Legal and practical consequences of joint liability? Equity or contracting role only?

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Philosophy (contd)

As an owner

Alliance or risk transfer? Linked to funding method Some sectoral patterns Also varies between public and private sector

Philosophy is influential only if shared within supply chain

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Structure the Project

Privately procured

On balance sheet Off balance sheet May still be accounting considerations, eg in PPP PPP projects Concessions Others eg PPAs

Publicly procured

Combinations

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Typical PPP Structure

PUBLIC ENTITY
SPONSOR EQUITY CONCESSION CONTRACT INSURERS

THIRD PARTY EQUITY INVESTORS

SPV INVESTORS

SURPLUS REAL ESTATE DISPOSAL

MEZZANINE FUNDERS CONSTRUCTION

OPERATION & MAINTENANC E

DEVELOPER

SENIOR FUNDERS (BANK/BOND)

SUBCONTRACTOR 1

EQUIPMENT SUPPLY SUBCONTRACTOR 3

BONDS & GUARANTEE S

DESIGNERS
DUE DILIGENCE ADVISER 3 DUE DILIGENCE ADVISER 2 SUBCONTRACTOR 2 SURETIES & GUARANTORS

DUE DILIGENCE ADVISER 1

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Structure the Main Construction Contract(s)

EPC/design and build Owner designed EPCM/CM Other variants

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EPC Structure
Traditional OWNER

ARCHITECT/ENGINEER

CONTRACTOR

KEY

SUB-CONTRACTORS

= Building Contract = Sub-Contracts = Appointments

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EPC Structure (contd)

Where does EPC fit in?
Owner assumes risk
Construction Management

RISK SPECTRUM

Contractor retains risk

Traditional

Design & Build

LSTK/ EPC

Except as otherwise stated in the Contract: a) the Contractor shall be deemed to have obtained all necessary information as to risks, contingencies and other circumstances which may influence or affect the Works; b) by signing the Contract, the Contractor accepts total responsibility for having foreseen all difficulties and costs of successfully completing the Works; and c) the Contract Price shall not be adjusted to take account of any unforeseen difficulties or costs.

LSTK Lump Sum Turnkey EPC Engineering Procurement and Construction

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EPC Key Features

Single point responsibility Subject to caps and carve-outs High degree of risk for contractor Also high (but not absolute) degree of contractor control Priced accordingly The preferred structure for project finance/PPP transactions Linkage to shareholder support

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EPC Key Features (contd)

Sensitive to market conditions recent history Wide choice of standard contracts (eg FIDIC Silver and Yellow) Commonly used in infrastructure, thermal power and downstream petchem

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Owner Design
Traditional OWNER

ARCHITECT/ENGINEER

CONTRACTOR
KEY = Building Contract = Sub-Contracts = Appointments
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SUB-CONTRACTORS

Owner Design Key Features

More control for owner Design and other risks also retained by owner History of disputes Use has declined in recent decades but still used in, eg, public civil works and technology projects Incompatible with project finance approach

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EPCM/CM
OWNER
KEY

CONSTRUCTION MANAGER PROFESSIONAL TEAM ARCHITECT STRUCTURAL ENGINEER M&E ENGINEER QUANTITY SURVEYOR CDM CO-ORDINATOR

= Trade Contract = CMA = Appointments

TC

TC

TC

TC

TC

TC

TC

TC

TC

TC = TRADE CONTRACTOR
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EPCM/CM Key Features

EPCM contractor is essentially a consultant Owner bears substantial risk

Interface Recourse/leverage

Can produce the lowest cost and fastest completion But is heavily dependent on specialist skills, experience and resources Can be disastrous if those are not present examples Widely used in upstream oil and gas, renewables and some real estate markets
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Variants

Timing two-stage contracting

Market driven and mixed feedback Conversion mechanism Scope is FEED included? Can be attractive for contractors Usually a consequence rather than a choice Examples eg 2012 Link to philosophy

Pricing target cost/GMP

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Forms of Contract

a profusion of colour and variety!

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Forms of Contract

Standard or specially drafted? Relevance of wider structure Origin of standard forms Example of FIDIC Other standard forms, eg NEC, AIA, ENAA, EIC Why amend a proven form?

To correct perceived anomalies or bias (examples)

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Forms of Contract (contd)

To reflect deal specifics or sector practice (examples) To incorporate material from other contracts (eg in PPP) To reflect requirements of funding (which may be owner or contractor sourced) For legal reasons (examples)

Who drafts owner or contractor?

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Key Risks and Contract Terms

Law and language

English language and style commonly used Precedence and integration of documents Distinguish language of contract and of communications Common law preferred but less strongly these days Impact of local law in any event Wide choice of methods and places for dispute resolution

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Key Risks and Contract Terms (contd)

Quality and scope

Wrapping eg of technology or existing works or design Fitness for purpose and reasonable skill and care Insurance and risk retention implications Compliance with laws and consents Special importance of environmental requirements Pass-down from other project documents

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Key Risks and Contract Terms (contd)

Intellectual property

Ownership by contractor Assigned or licensed to owner? Scope of license Indemnities for infringement capped or not?

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Key Risks and Contract Terms (contd)

Performance Security

Joint liability Guarantees Bonds

Types and purposes Issues with on-demand bonds Credit issues in current market

Retention funds

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Key Risks and Contract Terms (contd)

Subcontracting
Approval Step-in rights

Site conditions
Can threaten viability of project/parties Mitigants

An open-minded approach Government support Surveys and staging Flexibility in design

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Key Risks and Contract Terms (contd)

Labour
Local laws Local preference

Time
Status of programme Remedies for delay

Liquidated damages (LDs) for delay Enforceability issues with delay LDs Acceleration Milestones Look-forward default

Calculation and capping of LDS

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Key Risks and Contract Terms (contd)

Completion, commissioning and testing

Sector differences Performance LDs and make-good

Defects liability
Typical periods Evergreen clauses Latent and patent defects Remedies under the general law

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Key Risks and Contract Terms (contd)

Variations
Instructed by the owner Resulting from changes in law or standards

Examples of risk allocation

Price and payment

Lump sum or other? Currency issues Input cost fluctuation Milestones or measurement? Offsite materials

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Key Risks and Contract Terms (contd)

Advance payments Cashflow neutrality Payment security for contractor Set-off and correction ECA requirements Remedies for non-payment Role of lenders engineer

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Key Risks and Contract Terms (contd)

Termination

For owner convenience

Payment of profit

For force majeure For owner default

Typical grounds Remedies

For contractor default

Typical grounds Remedies (to include rejection?)

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Key Risks and Contract Terms (contd)

Risk

Indemnities Treatment of hazardous sites Care of the works Excepted risks Link to insurance Liability cap Exclusion of consequential loss Exceptions
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Liability

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Key Risks and Contract Terms (contd)

Insurance

Main categories
CAR/EAR TPL/PL PII Plant and vehicles DSA/ALOP Latent defects Operational insurance

Who arranges cover? Other contract terms

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Key Risks and Contract Terms (contd)

Force Majeure

Open or closed clause? Territorial limits? Exclusions Consequences

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Contract Management in International Construction

Beijing, April 28, 2009

EPC Contracts

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