a guiguide-to-epcm-contracts

8/12/2019 A Guiguide-to-epcm-contracts

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A guide toEPCM contracts


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A Norton Rose Fulbright guide

A guide toEPCM contracts


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04 Norton Rose Fulbright

A guide to EPCM contracts

SummaryThis document provides a description of the EPCM procurement structure and some ofthe key issues that should be considered by any junior miner contemplating its use formining infrastructure delivery.


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Norton Rose Fulbright 05

Contract for professional services, not works

Contract for professional services, not worksAn EPCM contractor will not carry out construction works. The EPCM contract isessentially a professional services appointment under which the EPCM contractorsservices will usually be limited to the production of detailed design and the procurement,construction management and coordination of the works necessary to deliver the project.

Whilst often confused with the EPC contracting solution, the EPCM and EPC contractingsolutions are very di erent in terms of the nature of the obligations undertaken and therisk allocation assumed by the respective contractors.

An important di erence between the two is that an EPCM contractor will not accept costand/or time risk for the delivery of the project, this is a risk retained by the employer.The employer will therefore need to manage these risks with the professional assistanceand support of the EPCM contractor through the construction and equipment/plantsupply chain.

Save as highlighted in this document, the quality of the EPCM contractors performancewill generally be determined by reference to the extent to which it has performed itsservices in accordance with the level of skill and care required by the EPCM contract,rather than by reference to the achievement of overall project budgetary or schedulingtargets.

Historically, the mining sector has tended to see quite an unsophisticated approach toEPCM contracting when compared to other sectors where the model is commonly used(for instance, in the petrochemicals industries).

Well advised employers in the mining sector are however seeing that contractorsundertaking EPCM services are increasingly willing to accommodate a more onerousrisk pro le under which the EPCM contractor may be more e ectively incentivisedto manage time and cost overrun exposure for employers (see Incentives below).The drivers for this development are numerous but clearly economic pressure duringa downturn, and so competition for work, is key.


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Advantages to EPCM contractingThe EPCM solution is the preferred procurement structure for junior miners, since it cano er signi cant advantages if properly managed.

Initial capital estimates for completion of the works can be signi cantlylower under the EPCM solution when compared with EPC xed priceturn-key solutionsThis is because EPC turn-key solutions will tend to include signi cant levels ofcontingent pricing introduced to manage overall project delivery risk. The EPCMsolution may therefore assist with project economics and so help to attract debt andequity funding.

The EPCM solution will allow employers to retain ultimate control overdesign development throughout constructionThis will provide exibility to allow employers to adapt design to suit precise (andsometimes changing) requirements and to allow optimisation and value engineeringwhere relevant to control capital costs. Such exibility is not possible under an EPCsolution (at least not without signi cant price consequences) since design developmentwill be controlled by the EPC contractor.

The EPCM solution will allow exibility in the procurement processThis is particularly important where there is an extended build period with a multi-phase construction programme with many distinct and separate packages for overallinfrastructure delivery (eg, process plant, road, rail and port infrastructure etc.).

But the advantage of lower costs and increased exibility under an EPCM solutionshould always be balanced against the signi cant additional risks being retained bythe employer in project delivery. As mentioned above, the employer under an EPCMsolution will not be insulated from cost overrun risk in the same way as they would beunder a xed price EPC solution.

The employers role in the management of the works in parallel with the EPCMcontractor is therefore paramount. For successful project implementation, the EPCMsolution requires a well-equipped and mobilised employers team to take a hands-onand intrusive role in the management and administration of the works.


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Form of contract what should be the starting point?

Form of contract what should be the starting point?There is no international standard form template contract for the EPCM contractingsolution, unlike for EPC turnkey or traditional build contracts.

Is use of standardised forms of contract appropriate?

EPCM contracting is essentially contracting for the delivery of professional services.There are numerous published standard forms of contract (the most popular being theFIDIC White Book) that could be adopted for these purposes. It is important however foremployers to recognise that:

the published standardised contract forms are typically developed to be consultant/contractor friendly

simple professional services appointments will tend to lack the sophisticationnecessary to readily address many of the issues that arise in a mining project.

In our experience:

signi cant amendment will be required to standardised forms of professionalservices appointment to generate a form of EPCM contract that could be reasonablyacceptable to well advised employers in the mining sector

licences to amend such forms are not easily obtained

di culties may be encountered from a negotiating perspective when attemptingto justify to the EPCM contractor (and its board of directors) the reasons for a moveaway from what are internationally accepted contracting principles, ignoring, ofcourse, that the terms were not appropriate for the employer in the rst place.


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Suggested approach to contract form selection

The format should always be driven by the requirements of the employer and hisbackers and not by a format that the contractor has delivered services on in the past.The fact that the contractor has used a particular form previously says nothing of theappropriateness of the form proposed.

In our experience, signi cant time and cost can be saved by the employer taking theinitiative in this regard and delivering terms to the EPCM contractor which representthose on which it is prepared to negotiate.


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EPCM services

EPCM servicesEPCM services typically fall into the following categories:

E Engineering servicesThis is the design of the process plant, the buildings housing the process plant and anyassociated infrastructure. The EPCM contractor may or may not have been involved inproducing the basic design and/or the process ow design at feasibility stage.

Where the EPCM contractor has not produced basic design, the EPCM contractor shouldaccept the risk of the accuracy and completeness of the basic design or at least verifyingthe same to the employer.

The EPCM contractor should be allocated responsibility for overall co-ordination ofdesign for the project to ensure that the completed works meet the required technicaland performance speci cation (but note Price certainty on the cost of the worksand Incentives below describing the limited liability typically accepted by EPCMcontractors in this regard).

P Procurement servicesThe EPCM contractor should be allocated responsibility for the overall procurementstrategy. He will also source contractors, consultants and the necessary plant andequipment in consultation with the employer and in accordance with the employersrequirements and the assumptions established at feasibility stage.

The EPCM will advise on the timing of the letting of the relevant packages and willadvise the employer on the terms available and will typically negotiate the contractpackages on the employers behalf.

It is usual for the employer to enter into the works and supply contracts directly butwe have seen exceptions to this approach under which the EPCM contractor enters intocontracts as the employers agent.


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CM Construction Management servicesThe EPCM contractor should be allocated responsibility for overall management of thecarrying out and completion of the works. This will include the co-ordination of theworks and services being procured on the employers behalf to achieve completion ofthe works in accordance with the project schedule, the project budget and to meet therequired technical and performance speci cation (but, again, note Price certainty onthe cost of the works and Incentives below and the limited liability typically acceptedby EPCM contractors in this regard).

The construction management services will also typically include the management ofhealth and safety at the site, the management of disputes between the employer, theworks contractors and/or the suppliers, the establishment of quality assurance systemsand the management of the remedying of defective works and/or services provided byother parties.

In all cases, it is important that the nature and extent of the services being provided arewell de ned and that appropriate levels of contractual exibility are created to allow thescope of services to be adapted through the execution of the project in a manner whichdoes not expose the employer to de-scoping penalties or in ated pricing for enhancedservices.

The above allocation of responsibility is not the only solution. Hybrid solutions have alsobecome more common, for instance where employers wholly retain the managementfunction through the owners team to create an EP/CM split. The appropriateness of thestructure proposed will always be something that the employer should consider with itstechnical, commercial and legal advisers on a case-by-case basis.


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Price certainty on the cost of the works

Price certainty on the cost of the worksWhilst an EPCM contractor may accept some limited risk in delivering a projecton-time and on-budget (see Incentives below), EPCM contracting does not o er a

xed price solution.

Cost control must ultimately be achieved through the implementation of a robustprocurement strategy, typically developed and managed by the EPCM Contractor inconsultation with the employer, as outlined above.

Key to this will be the separation of the works into appropriate works and supplypackages which should each be procured on robust terms which seek to insulate theemployer from time and cost overrun risk. The procurement strategy should seek toavoid where possible the creation of time, design and works interfaces and wherethe creation of such interfaces is unavoidable, a clear strategy for the managementof them should be established by the EPCM contractor (and indeed this should be acontractual requirement).

The role of the employers team in monitoring, supporting and supplementing theservices of the EPCM contractor is extremely important to achieve successful projectexecution and delivery within project budgetary constraints.


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PaymentThe 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 re ect the actual and veri able cost and the contract should expresslyprovide that these rates should usually NOT include pro t) plus

overhead payments that will be charged at a xed percentage of the reimbursablerate plus

a xed fee element representing the EPCM contractors pro t. Employers shouldseek to agree to x this amount at day 1 and not permit any increase in the event ofproject cost and/or time overruns (ie, to avoid any indirect disincentive to the controlof overruns).

The EPCM contractor should warrant that the agreed rates in that the agreed rates inthe rst two bullet points above do not contain any pro t element, and the employershould have the right to claw-back any pro t element subsequently identi ed throughagreed audit rights or as disclosed by the EPCM contractor.

The value of the hours expended by the EPCM contractor in providing the requiredservices are not typically subject to an overall cap or limit, although employerssometimes o er incentive payment for the achievement of budgeted man hours.

However, with a competitive market, there are contractors who may be willing to acceptdelivery of all the EPCM services for a xed amount. The only exceptions to this wouldbe 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 forcemajeure type events.

On the face of it, capping the amounts payable to the EPCM contractor appearscommercially sensible but employers need to be aware that where matters havetaken a turn for the worse for instance where the project has fallen into delay (whichmay be for reasons beyond the reasonable control of the EPCM contractor), employerswill want to avoid e ectively putting a halt to the services or disincentivising the EPCMcontractor from applying appropriate resource to the project to assist in rectifying therelevant issues.


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Incentives

Incentives

The EPCM contractor will not backstop project delivery risk and, importantly, theachievement of key project targets. The EPCM contractor will however be responsiblefor managing the same on behalf of the employer.

The challenge for employers will be to incentivise the EPCM contractor to e ectivelyand proactively manage project delivery and the achievement of key project targets.

The approach typically adopted relies on an incentive structure which providespositive (and sometimes negative) incentives to the achievement of key project targets.These provisions are generally bespoke and may be underpinned by fairly complexcalculations but equally can be fairly straight forward depending on the approachpreferred by employers.

Typically, incentive regimes cover the following:

bonus payments for the works being completed on time or within a xed periodfollowing the scheduled completion date

bonus payments for the works being completed for an overall outturn cost below orwithin a xed 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 projectedbudget 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 proposedapproach will tend to be shaped by the concerns the employer may have in respect ofkey aspects of project delivery.


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It will be a matter for the employer to consider commercially whether the incentivesshould remain payable where extraneous circumstances outside of the control of theEPCM contractor have undermined the achievement of the relevant project targets. Wehave seen varying approaches in this regard.

Since the EPCM contractor will typically set key project targets (eg, the project budgetand the project programme), appropriate due diligence will need to be undertakenby the employer to establish that the project targets are sensible in the context of theproject proposed.

More recently, we have seen EPCM contractors willing to accept negative incentivesaround the achievement of the key project targets, such that they are prepared to placean element of their pro t at risk. This approach has been commonplace in other sectorsusing the EPCM model for some time but it is now becoming more common now in themining sector.


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the extent of liability typically accepted by EPCM contractors will leave the employerexposed given the likely quantum of these liabilities

professional indemnity insurance should therefore be arranged to cover these typesof losses (either procured by the EPCM contractor or by the employer as part of thewider project insurances)

where professional indemnity insurances is available, such liability should beuncapped to the extent it is recoverable under the relevant policy. This would permitfull 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.

Re-performance of defective servicesMany EPCM contractors look to limit their liability to re-performance of defectiveservices only:

this is a di cult concept for an employer to accept particularly given the abovedescribed trade contractor losses

employers should resist this since any such re-performance should be treated as acost of performing the services and is not a liability as such

many liabilities that should be captured by the EPCM contract liability regimemay not be remediable through re-performance of defective services alone, so thisapproach will not provide for an appropriate remedy in many circumstances

it ignores the purposes of professional indemnity insurance cover.


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Tax issues on-shore/o -shore

Tax issues on-shore/o -shoreMost developing countries have tax regimes which seek to control, through taxation,the amount of investment in a mine development that does not become directlyinvested in the country (so for example, professional services fees). Withholding tax isthe most common form of taxation that needs to be considered when structuring theconstruction development stage of any mining project.

It would be unusual for any contractor to bear withholding tax risk and, if it did, thenit would simply become a cost to the project that would add to the overall projecteconomics. It is important therefore:

to give proper consideration to structuring the construction contractingarrangements very early in the procurement of a mining project

to obtain the early buy-in by the local tax authorities (either directly or throughlocal advisers) to those arrangements.

One of the most common means of mitigating withholding tax exposure is to adopt asplit on-shore and o -shore contract structure. This usually means that there willbe two contracts, each entered into by a di erent EPCM contractor entity and eachcontaining di erent scope of services. For example, there will usually be:

one contract for those services which may take place outside of the country in whichthe works are being delivered, payment for which may therefore be structured toavoid withholding tax. This contract will typically be entered into by a non-localEPCM contractor entity, (the o -shore contract)

one contract for those services which must be performed in the country in whichthe works are being delivered, such as the EPCM construction management services(because there must be personnel presence on the ground in order to carry out thesupervision), payment for which may be subject to the relevant local withholdingtax regime. This contract will typically be entered into by a locally registered EPCMcontractor entity (the on-shore contract).

The obvious risk to the employer with a split structure is that he is required to deal withtwo contractors each with a separate scope of work and separate rights and obligations.


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It is important therefore that these contracts are well drafted and dovetail together sothat they include, at least, the following provisions:

a recognition of the joint objectives across the two contracts and a requirement forcoordination

an acknowledgment by each entity of the scope of the services being performed bythe 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 riseto 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 ofthe other contract (so called, cross default provisions)

a right for the employer to consolidate any dispute against one entity with anydispute against the other.

The employer will usually look to limit its exposure to breach by the separate on-shoreand o -shore contractors by putting in place further contractual arrangements whichprovide for the o -shore EPCM contractor entity (or a suitable parent) providing aperformance and nancial guarantee (backed by indemnities and, possibly, suitable

nancial security) in respect of discharge by both the on-shore and o -shore entitiesof their respective and collective obligations. This guarantee (which could be wrappedinto the o -shore contract) is often referred to as an umbrella agreement.

However, in jurisdictions where the tax authorities do not recognise this split due tothe presence of the guarantee (or wrap) provided by the umbrella agreement, thenfurther careful consideration is required in the drafting of the on-shore and o -shorecontracts in order to deal speci cally with the above concerns.

English law is the preferred governing law for substantial international contractsbecause it carries a guarantee of impartiality and integrity that is recognised worldwideand provides the ideal balance of predictability and exibility. It is invariably thepreferred choice of lenders in the EPCM market.


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When things go wrong choice of law and dispute resolution

When things go wrong choice of lawand dispute resolution The dispute resolution clause can provide for a tiered approach involving high level

commercial negotiation then alternative dispute resolution (mediation usually) witharbitration only to follow after those processes are exhausted.

Arbitration (contrasted with court proceedings) has the advantages of easyenforcement of an award as the New York Convention is in force in 148 countries.There is no comparable treaty in place to enforce court jurisdictions which are onlygenerally enforceable where there are reciprocal enforcement arrangements in place(for example, within the EU). Further, arbitral proceedings are con dential and anyaward is nal and binding with limited exceptions.

There are well established international arbitral rules (such as the ICC, LCIA) whichhave dedicated resources to deal with all administrative aspects of the arbitralprocess including but not limited to nomination of arbitrators, advances on costsand recommended model clauses.

Finally the place (or seat) of arbitration needs careful consideration because:

it determines where the award is made (and hence whether it is an awardof a party state for the New York Convention)

the arbitration will be subject to the procedural law of the seat

the courts of the seat will have a supervisory/supportive function in connectionwith the arbitration.

Advice should be sought on a case-by-case basis to ensure that the EPCM contractcontains appropriate dispute resolution provisions which provide clear recourse forthe employer and a high degree of certainty in terms of its ability to enforce any awardmade in its favour.


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ContactsMartin McCannGlobal head of mining,infrastructure and commoditiesNorton Rose Fulbright LLPTel +44 20 7444 [email protected]

Mark BerryPartner, LondonNorton Rose Fulbright LLPTel +44 20 7444 [email protected]

Matthew HardwickSenior associate, London

Norton Rose Fulbright LLPTel +44 20 7444 [email protected]


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