Mary Anne Roff and Andrea Gardner on how to use EPC contracts effectively and avoid the pitfalls
Engineering, procurement and construction (EPC) contracting has been the favoured procurement route for large-scale infrastructure projects. An EPC contract is, in simplistic terms, a risk transfer mechanism. A true EPC contract transfers the risk of design, engineering, construction, commissioning and handover to the contractor.
The project owner should achieve cost and risk certainty and for this reason EPC contracting is highly favoured by lenders providing project finance.
The EPC contractor is contracted to deliver a commissioned and operational facility at a guaranteed price to a guaranteed programme. Furthermore the facility must perform to the project owner’s performance requirements.
It is rare to see a “pure” EPC contract and contractors’ appetite for accepting EPC risk varies, depending on the state of the economy, the particular organisation’s attitude to risk, funding pressures and the insurance market. EPC may not always be the correct strategy.
Allocation of risk
The reality in the market is that many EPC contractors are either unwilling or unequipped to take all the risk of a project. Even under an EPC structure, risk can come back to the project owner through claims or delivery failure so all parties must be realistic and ensure that risk sits with the party best able to manage that risk.
Factors such as challenging ground conditions can create huge difficulties for the project programme and significantly increase costs. Have both owner and contractor stress-tested how and by whom the costs of such unforeseen risks will be absorbed?
A poor or inadequate project scope creates a greater risk of quality or performance failures or project owners not receiving the facility they expected. EPC contracting is not appropriate where the performance criteria and scope are not clearly defined. If a project has a fixed price without clearly defined quality and scope parameters there is a risk of a poor-quality product.
Always ensure that the valuation of variations is clearly set out in the contract documents
Contractors can also come under pressure to implement changes to the design, even though the original design is fit for purpose and arguably satisfies the specified performance requirements. This opens up a potential dispute avenue. Be clear what could be considered design development and what could be a variation.
To quote Heraclitus, change is the only constant in life. So variations are a certainty in every project. If variations are not managed correctly, then communication between project owner and contractor can break down, leading to cost overruns and potentially disputes. Investment in project controls systems and experienced staff can help avoid surprises.
Always ensure that the valuation of variations is clearly set out in the contract documents. This allows for greater cost control. Document management falls under this heading and if there is a breakdown in compliance with a formal procedure, claims can result.
Governance and dispute resolution
Claims occur on every project. Not all claims, however, need be contentious. How the parties handle these situations can make the difference between an efficient and effective outcome and highly contentious and protracted formal proceedings.
Having structured and accessible governance procedures for resolving situations can help avoid unnecessary conflict. Consider a collaborative approach to claims management.
Clarity in drafting
Whatever risk allocation is decided upon, it is important to ensure that this is clearly set out in the contract. Consider pressure testing your contracts by evaluating the impact of different scenarios to ensure that the contract documents will perform in the manner you expect.
Time and money will be saved if the parties are realistic about the risks of the project, identify how those risks are to be allocated, provide clear drafting in the contract, and ensure proper handover from those who negotiated the contract to those who must manage and deliver the project.
Mary Anne Roff is a partner and Andrea Gardner legal director at Clyde & Co