What is an EPC Contract?
There are many companies within the development and infrastructure, renewable energy and power industries that prefer the use of Engineering, Procurement and Construction contracts to manage complex projects. An Engineering, Procurement and Construction Contract (“EPC Contract”), occasionally known as a “Turnkey Contract”, is a construction contract where the contractor (“EPC Contractor”) holds the responsibility towards the design, procurement, construction, commissioning and handover of a project (“Project”).
In essence, an employer (“Employer”) will provide the EPC Contractor with a detailed scope of work including the technical and functional specifications of any machinery or facility to be constructed, and the EPC Contractor develops the Project from its commencement to final completion. Thereafter, the EPC Contractor will hand over the Project to the Employer to operate the Project at the “turn of a key”, hence the term “turnkey”. The amount of technical specifications and its complexity depend on whether the project includes a facility encompassing electrical and mechanical equipment.
In any construction contract, the key considerations between the parties lie with the aspects of time, cost and quality. Although FIDIC Contracts are recognised as the international standard for construction contracts and the FIDIC General Conditions of Contract is deemed suitable in all cases, there are certain terms and conditions that the contracting parties should be aware of and consider whether such terms and conditions may be subject to further negotiations.
There are several features in an EPC Contract, one of them being that it is an all encompassing Contract which sets out the scope of work to be carried out with a single point of responsibility (“Works”). Other features include completion details, a guaranteed contract sum and quality within a fixed period. We set out below some of the main features of an EPC Contract and the general terms contained therein.
Single Point of Responsibility
One of the main distinctive features of an EPC Contract is that the EPC Contractor is solely responsible for the Project. An EPC Contractor would undertake works such as designing, engineering, procurement, construction, commissioning and testing works. Hence, in the event there is an issue arising out of or in connection with the Project, the Employer will only need to refer the said issue to the EPC Contractor.The EPC Contractor would then be liable for any defects and rectifications of the same or to provide compensation to the Employer.
In cases where the EPC Contractor is a consortium comprising several entities, the EPC Contractor will typically state in the EPC Contract that such entities are jointly and severally liable to the Employer. The EPC Contractor will also be responsible for the works carried out by any appointed Subcontractor (as defined below) and for any acts or omissions of the Subcontractor.
Fixed Contract Price
An EPC Contract requires the Works to be carried out and completed at a fixed price, which means that the EPC Contractor will be responsible for cost overruns and cost savings (“Contract Price”). However, the EPC Contractor may be able to claim additional costs in circumstances where the Employer has caused a delay to the completion of the Project or has placed a change order to the Works. Although it is common for Employers to receive a lump-sum payment, this does not prevent the EPC Contractor from negotiating with the Employer for a schedule of payments to be included to cater for an alternative payment method such as milestone payments.
In most, if not all, construction contracts, it is common that the contractor provides a performance bond to protect the interests of the employer in the event the contractor fails to comply with its obligations under the contract. This is also applicable to EPC Contracts. Performance security may take the following forms:
- Bank Guarantee;
- Parent Company Guarantee;
- Advance Payment Guarantee (if an advance payment is made by the Employer); and/or
- Retention Security.
Performance Guarantees are in direct relation to the EPC Contract’s feature of having a guaranteed quality, in view of the EPC Contractor’s performance of its obligations under the EPC Contract. It is common for an EPC Contract to contain a provision stating that the EPC Contractor is required to provide performance guarantees backed by performance liquidated damages payable by the EPC Contractor to the Employer in the event of an under-achieving performance.
The performance guarantees are secured under the EPC Contract by way of performance liquidated damages given that such lack of performance may have a significant impact on the success of and revenue generated by the operations of the completed Project. Performance liquidated damages are pre-estimated damages intended to compensate the Employer for the loss and damage suffered by the Employer as a result of the under-achieving performance guarantees towards the completed Project.
Handover, Testing and Commissioning
The concept of handover under an EPC Contract is of fundamental importance given the turnkey aspect. Testing and commissioning are the EPC Contractor’s responsibilities, which are part of the Works, before the handover and completion of the Project. Clauses pertaining to handover, testing and commissioning will set out the procedure as to when the Employer will take possession of the site and the facility constructed.
The level of detailed inspections, testing and commissioning will depend on the complexity of the Project and/or facility constructed. The complexity of contracts will depend on its functionality and specifications. For example, if the Project entails a construction of an infrastructure, it is less likely that detailed testing and commissioning will be included. However, if the Project entails a construction of a power plant, detailed testing and commissioning will take place to determine the stability and/or usage of the power plant to ensure that all aspects are in full working order, according to specifications, before handover. Functional testing is also a key aspect in all EPC Contracts where the Project includes mechanical and electrical equipment.
Fixed Completion Date
The Completion Date comes in the form of either a fixed date or a specified period from the commencement of the EPC Contract, by which the EPC Contractor is required to complete the Project. If the Guaranteed Completion Date is not achieved, the EPC Contractor will be liable for liquidated damages. The Employer does not need to prove that it has suffered actual losses to claim liquidated damages.
Delay liquidated damages are pre-estimated damages generally intended to compensate the Employer for loss and damage suffered as a result of the delay to the Guaranteed Completion Date. Delay liquidated damages are commonly calculated at a rate which represents the estimated extra costs incurred and losses suffered for each day of delay. An example of a “delay liquidated damages” clause, extracted from the FIDIC Conditions of Contract for EPC/Turnkey Projects, is as follows:
“8.7 If the Contractor fails to comply with Sub-Clause 8.2 [Time for Completion], the Contract shall subject to Sub-Clause 2.5 [Employer’s Claims] pay delay damages to the Employer for this default. These delay damages shall be the sum stated in the Particular Conditions, which shall be paid for every day which shall elapse between the relevant Time for Completion and the date stated in the Taking-Over Certificate. However, the total amount due under this Sub-Clause shall not exceed the maximum amount of delay damages (if any) stated in the Particular Conditions.”
Limitation of Liability
A limitation of liability clause limits the liability of the EPC Contractor up to a specified percentage of the contract sum. Although different contracts have different percentages of limitation, the common limitation of liability is capped at 100% of the contract sum. A limitation of liability is the best method for the EPC Contractor to limit its total exposure. An example of a “limitation of liability” clause, extracted from the FIDIC Conditions of Contract for EPC/Turnkey Projects, is as follows:
“17.6 The total liability of the Contractor to the Employer, under or in connection with Contract other than under Sub-Clause 4.19 [Electricity, Water and Gas], Sub-Clause 4.20 [Employer’s Equipment and Free-Issue Material], Sub-Clause 17.1 [Indemnities] and Sub-Clause 17.5 [Intellectual and Industrial Property Rights], shall not exceed the sum stated in the Particular Conditions or (if a sum is not so stated) the Contract Price stated in the Contract Agreement.”
Subcontracts and Assignment
The EPC Contract may allow the EPC Contractor to subcontract or assign some of its obligations to third-party subcontractors (“Subcontractors”). It is common for the EPC Contractor to notify the Employer of its intention to appoint a Subcontractor and to obtain the Employer’s approval towards the appointment of the Subcontractor. However, the Employer may reserve the right, for reasonable cause and in good faith, to object to the intended appointment of the Subcontractor. In the event a Subcontractor is appointed for a specified portion of the Works, the EPC Contractor will be fully responsible for the specified portion of the Works performed by the Subcontractor and for any act or omission of the Subcontractor. This is in direct relation to the EPC Contract’s feature of a single point of responsibility.
An example of a “subcontracts and assignment” clause, extracted from the FIDIC Conditions of Contract for EPC/Turnkey Projects, is as follows:
“4.4 The Contractor shall not subcontract the whole of the Works.
The Contractor shall be responsible for the acts or defaults of any Subcontractor, his agents or employees, as if they were the acts or defaults of the Contractor. Where specified in the Particulars Conditions, the Contractor shall give the Employer not less than 28 days’ notice of:
a) the intended appointment of the Subcontractor, with detailed particulars which shall include his relevant experience,
b) the intended commencement of the Subcontractor’s work, and
c) the intended commencement of the Subcontractor’s work on the Site.”
A governing law clause is commonly used and allows parties to the contract to specify which country’s law will apply to the interpretation of the contract and determination of any dispute arising out of the contract. It is of particular importance in any contract, especially if a contract involves parties from different jurisdictions.
The dispute resolution clause sets out the mode(s) of dispute resolution and the procedure of which the parties will resolve any disputes arising out of the contract. Modes of dispute resolution include negotiations, mediation, conciliation, court proceedings, adjudication and arbitration. An example of a dispute resolution clause is as follows:
“In the event any dispute, difference, claim or question arises out of this Contract, the Parties shall exhaust all reasonable efforts to amicably resolve such dispute, difference, claim or question by way of negotiations between the Parties.
In the event the Parties fail to resolve such dispute, difference, claim or question by way of negotiations within thirty (30) days from the date of the first negotiation, such dispute, difference, claim or question shall be referred to arbitral proceedings. The arbitral proceedings shall be conducted in accordance with the following manner:
a) The place of arbitration shall be the Asian International Arbitration Center in Kuala Lumpur, Malaysia;
b) The dispute, difference, claim or question shall be resolved in accordance with the Arbitration Rules of the Asian International Arbitration Center (“AIAC Rules”) for the time being in force;
c) The arbitral tribunal shall consist of three (3) arbitrators;
d) The arbitral proceedings shall be conducted in the English language; and
e) The decision of the arbitral tribunal shall be final and binding upon the Parties.”
Contract Language and Prevalence
In the case where a contract involves international parties, it may be possible that there will be a use of different languages. Accordingly, a language clause should be included in the contract and such a clause should also specify the prevailing version of the contract in the event there is a discrepancy or dispute. An example of a language clause is as follows:
“This Contract is drawn up in the English language. In the event there are any discrepancies between the English version of this Contract and any translation of this Contract, the English version shall prevail.”
Advantages and Disadvantages
Given the above, there are several advantages and disadvantages to both the Employer and the EPC Contractor in an EPC Contract. Under certain circumstances, an advantage to the EPC Contractor may be a disadvantage to the Employer.
Advantages and Disadvantages to the Employer
Some of the advantages and disadvantages of an Employer in an EPC Contract include the following:
- The Employer is only required to communicate and engage with one party being the EPC Contractor;
- The Employer transfers the risks of the Project to the EPC Contractor;
- The Employer is provided cost and deliverables certainty by way of the fixed contract price and fixed completion date as set out in the EPC Contract;
- The Employer mainly focuses on and monitors the general progress of the Project;
- The Employer has a lesser degree of control over the Project; and
- The Employer has limited participation and intervention in the execution of the Project.
Advantages and Disadvantages to the EPC Contractor
On the other hand, some of the advantages and disadvantages of an EPC Contractor in an EPC Contract include the following:
- The EPC Contractor retains control and holds the final decision over the execution of the Project with minimal interference from the Employer;
- The EPC Contractor may, due to its exposure to the highest degree of risk, implement a substantial risk premium to the contract price as a safeguard to minimise the impacts of the risks involved;
- The EPC Contractor may, with the control over the Works, be in a position to lower costs to be incurred;
- The EPC Contractor is responsible for the appointment of its Subcontractors subject to the Employer’s approval, and is further responsible for the scope of Works for which the Subcontractor is appointed and for any acts or omissions on the part of the Subcontractor; and
- The EPC Contractor has to ensure that the performance of the completed Project achieves the performance guarantees provided to the Employer in the EPC Contract.
EPC Contract is essentially a form of construction contract that transfers the risks and responsibilities of a Project from the Employer to the EPC Contractor. As the EPC Contractor is provided with a much higher degree of control over the Project, the contracting parties should consider negotiating on the relevant terms and ensuring that the Project’s milestones are clearly set out in the EPC Contract. Although there are various standard forms of contract towards an EPC Contract, the contracting parties should always ensure that all relevant terms and milestones are clearly set out in the EPC Contract in order to cater to their respective business needs and requirements bearing in mind that each project and contract are unique and different. A carefully drafted and reviewed EPC Contract will minimise the risks of future disputes between the parties.
Note: This article does not constitute legal advice to any specific case. The facts and circumstances of each and every case will differ and therefore will require specific legal advice. Feel free to contact us for complimentary legal consultation.