How to make EPC contracts effective

EPC contracts allow the employer to have a single point of responsibility with one entity [frequently a consortium or joint venture] agreeing to engineer, procure and construct a project. EPC contracts better enable performance on a fast-track basis and may be more appealing to lenders than other types of arrangements. A few issues that may assume particular importance in the context of EPC contracts follow.

Payment guarantees

Generally, a contractor does not have a direct relationship with the lenders financing the project. Aditionally, the employer is frequently a special purpose vehicle with the project itself, and the rights [leasehold or freehold] to the land upon which the project is to be constructed, its only assets. Both factors may raise a concern about whether the contractor will be paid. Ways to address this concern include negotiating a provision requiring the employer to demonstrate that it has adequate financing, obtaining payment guarantees from the parent organisation of the employer, seeking a letter of credit from the employer and requiring pre-payment of a portion of the contract price. EPC contracts may also include "step-in" rights, giving the project's lender the right to contract directly with the contractor in the event that the employer defaults on its payment obligations.

Most EPC contracts allow the employer to deduct liquidated damages if the works are delayed. While the contractor may argue for a cap on the damages to be deducted, it is not uncommon for the cap to be the contract price. Consequential losses are typically excluded. However, loss of profit may be viewed by a court or tribunal as a direct loss on a financed project and therefore may not be caught by a consequential loss exclusion.

Defects liability

Most EPC contracts require the contractor to retain responsibility for remedying defects for a certain period of time. This defects liability period is often one year. The clock usually starts to run on the defect liability period after the employer takes over the works. An important consideration in defects liability clauses is the standard of care adopted. Most contractors prefer the standard to be that of reasonable skill and care, whereas employers often prefer to add the more onerous fitness for purpose standard. The defects liability period may be extended in respect of items that need to be repaired or replaced.

Variations

Clearly defining the scope of works is key to ensuring certainty on what will considered to be a variation. Given the delaying effect of certain variations – particularly variations relating to the design of the works – it may be advisable to negotiate a design freeze date, following which no further design changes may be requested. Contractors may also want changes to applicable laws or standards to give rise to a variation, thereby allowing the contractor to have an extension for completion or payment for the costs occasioned by such changes.

Force majeure clauses

There are several issues to consider when drafting force majeure clauses for EPC contracts. First, it must be determined whether the clause will be open or closed. In a closed clause, there is a list of events which will constitute force majeure. If the event affecting the project is not on the list, then the force majeure clause may not be relied upon. In an open clause, in addition to a list, there is a "catch all" that accounts for circumstances beyond the reasonable control of the parties.

The location of the project may require consideration of the territorial limits in the force majeure clause. For example, if the project is located in a landlocked country, war or weather catastrophe in a neighboring country may have a significant effect on the contractor's ability to secure the supplies required for the project. If the force majeure clause is limited to events occurring in the country where the project is located, the contractor would not be able to assert a claim for force majeure.


- The writer is an associate at Fulbright & Jaworski. The views expressed are her own

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