A Few Key Points to Help You Successfully Negotiate EPC Contracts

Practically everyone involved in the energy and infrastructure industry has heard of EPC (Engineering, Procurement and Constructions) contracts. These massive agreements (often over 100 pages long!) cover all aspects of the project – from setting out the project design and scope, through procurement of special equipment for the facility, management of all civil and electrical construction work on the site and up to the warranties supplied by the contractor and its vendors.

The sheer scope of the EPC can be overwhelming but attention to detail is crucial. It is easy to get lost amidst those hundreds of pages and miss something important, a crucial detail that will either lead the owner to waste more money on the project or, at worst, leave them with insufficient protection or result in a great loss of revenue.

Over a career spent drafting and reviewing EPC contracts, I have noticed the same issues come up time and again. Most of these relate to key aspects of the project that are often missed when handling complex transactions over a long period of time. Here are three tips to assist project managers and their legal advisors in successfully negotiating an EPC contract:

1)????Integration – No, I don’t mean just the integration of the facility’s parts (that obviously requires attention as well) but the integration between the different contractors, suppliers and personnel operating on the site (either simultaneously or on different occasions). Erecting a power plant, for example, could involve different contractors and suppliers, sometimes all at once. These would include the civil contractor responsible for the civil works (excavations, castings, fencing, etc.); the electrical contractor in charge of laying out the electric cables and making sure the plant is properly connected to power lines; the major equipment supplier, such as solar panels or wind turbines manufacturer; and the O&M (Operation and Maintenance) Contractor, charged with keeping the facility operational throughout its lifetime. Each of these actors, as well as external advisors, would likely warrant a separate and direct agreement between them and the project owner.

The project owner should always keep in mind that if something were to fall through the cracks and is not covered as part of those agreements, then by default it will be their responsibility. In other words, any expense incurred to remedy an unfavourable situation will ultimately be payable by the owner. It is therefore crucial to make sure that each possible scenario is properly accounted for by the relevant agreement and that all different contractors and suppliers are aware of each other’s respective obligations. There should be a good flow of information between all of them and the owner, at all times. It would also be wise to have in place a provision that allows the owner to step in as a mediator or arbitrator in the event a dispute arises between two or more of the contractors with respect to the project, or at least enabling the owner to handle all disputes under the same venue and at the same time (this will save a lot of time, money and effort).

2)????Insurance – We all know that a job, especially of this size, requires proper insurance policies to cover all aspects of the construction works and, later on, the operation and maintenance services. Most owners require that their contractors, vendors and suppliers take out insurance policies on their own account to cover their activities on site and their responsibilities towards the owner. It would be stating the obvious (hopefully…) that each project must be taken on its own merits and the owner must take the advice of an insurance agent who specialises in those types of projects. The policies themselves should be properly negotiated.

Surely the facility owner would rather not deal with 3-4 different insurance companies, each representing a different party and all alleging that the other contractor is the one responsible for the owner’s claim. It would therefore be wise for the owner to consider taking out their own insurance policies to cover themselves from damages and liabilities they could potentially suffer. This way, the owner can make sure it is properly covered and can always negotiate with the contractors to have them bear the premiums. Of course, if the contractor is to blame for the damages, it will also bear the deductibles in accordance with the policies. The owner should leave the contractors to insure their own equipment and personnel and make sure that their facility is properly insured by an insurer of their choice.

3)????Warranties and Guarantees – as a layered project, the owner must make sure it holds a proper and sufficient warranty to accommodate the the work. The contractor will usually deliver to the owner a bank guarantee (usually worth 10% of the consideration of the contract) as well as a PCG (parent company guarantee) when necessary, all to ensure the proper performance of the works. However, since we’re dealing with (a) contracts worth huge amount of money and (b) contractor markups being eaten away by banks for issuing and maintaining the guarantee for months on end, it is customary to have the guarantee reduced in stages, whenever the relevant milestone has been reached. It is therefore crucial that the owner keeps its prerogative to authorise the replacement of the guarantee with a reduced one. This way the owner can make sure not only that the milestone has indeed been achieved, but also that there are no anticipated hindering events (for example: an out of the ordinary punch list, which is expected to contain too many items than originally anticipated). In addition, it is important to set out exactly what is covered in the contractor’s warranties during the ‘make good period’ (mostly 3 years after the takeover, with some longer exceptions in place) and to ensure that the remaining guarantee covers those obligations. It is also important to make sure that the guarantee not only covers the contractor’s obligations to repair defects, but also its obligations to have the facility properly operational with respect to availability and performance ratio of the plant. Suffice to say, that if the owner pays the contractor money on account, it must ensure it holds a proper advance payment guarantee as well to cover any chance of the contractor not paying back the money and not doing its job.

We hope these tips gave you something to think about and consider the next time you negotiate an EPC contract. Obviously, there’s a lot more to know and understand about this type of contract and to successfully protect your interests, whether you are the owners of the project or one of the contractors working on it (it goes both ways!). If you have any questions or would like our assistance in helping you with your new (or current) projects – we’d be happy to hear from you.