Engineering, Procurement and Construction contract, also known as EPC contract is a contract which is popular in the construction industry, more particularly in big projects like bridges, stadiums, airport, etc. The contract is in the nature of a turn-key project where the contractor designs the project, procures the logistics, and constructs the assigned work. The typical scope of an EPC contract would include the following things; engineering – preparation of engineering designs, plans and technical specifications of equipment, preparation of performance standard maintenance and training manuals, procurement – provision of equipments, procurement from third parties, delivery to the site, provision of spare parts; construction – construction, erection and completion of the work, rectification of defects.

The contractor may either execute the whole project himself, or through sub-contractors. EPC contract gives much leverage to the project owner in terms of single point contract and responsibility, payment of a fixed lump sum amount, minimum legal risks and obligation and a known time-period for construction which in turn increases the bankability of the project.

Infrastructural development in India is growing at a rapid pace, with the Government increasing its investment on infrastructure sector from ` 20.5 trillion during the Eleventh Five Year Plan to Rs 40.9 trillion during the Twelfth Five Year Plan. EPC contracts highly depend upon the infrastructural investments. Increase in investment in the infrastructural sector by the Government would correspondingly increase the number of EPC contracts in forthcoming days.

However, these contracts are not free from risks which the project owner might overlook while negotiating a contract. The risks might be in nature of default of the contractors, political unrest, weather condition, community and local unrest, disruption due to unfavourable weather. This module would guide both the contractors and the project owners how to incorporate certain clauses to minimise the risks.

I. Scope

This is the fundamental clause on which the success of the whole contract depends. Any kind of ambiguity or uncertainty in the clauses might lead to conflicts and confusion in the future. The clause should be drafted with utmost precision, having clarity and delineate the scope of the work. In terms of content, the clause should define what works are expressly covered under the agreement, what works are expressly excluded, what works are dependent or responsibility of the third party. If, it is not possible to describe the work to be executed in details, such work might be described in details in the schedule annexed to the agreement. Having clarity regarding the scope will also help in formulating the pricing, rights and liabilities of the parties in a better way to suit the nature of the contract.

II. Consideration and Payment

The second most concerned area in an outsourcing agreement is related to the consideration to be paid to the contractor for executing the work. While drafting such a contract, it is essential to identify the mechanism in which the payment should be made. It is also essential that the total lump-sum consideration that would be paid must be negotiated taken into consideration foreseeable probable escalation, project delays, increase the currency exchange rates. If it involves offshore parties, it is essential to mention the currency in which the payment would be made. While drafting the contract, the clauses should expressly provide the payment milestones in a separate schedule or annexure to remove ambiguities regarding the timeframe in which the payments would be released. This will not only motivate the contractor to work on a scheduled timeframe to get his payment released, but will also help the owner and financer to arrange for the payments in a systematic manner. The provision should also explicitly mention who is responsibility for payment of the project taxes, including any current and future tax imposed by the concerned government upon the sale, purchase or use by contractor of materials, supplies, equipment or services or labour.

As often large infrastructural projects gets delayed and project cost increases due to increase in prices of raw materials, labour costs, etc, it is essential to incorporate a “Price escalation clause” to identify the party who will be responsible for the increased costs. The clause may include provision to modify the price of the contract due to an unforeseeable event or increase in prices of raw material to reduce the burden on the contractor. The clause should identify certain essential raw materials like cement, steel which might be subjected to price fluctuation, and the payment for such materials may be made based on the changed price. Provision should also contain that the rate for such materials may be changed on a fixed periodical manner to reduce the risk on one of the parties.

III. Exclusion and Limitation of Liability

An agreement always has the chance of facing some risks associated with transactions. No contract can be free of risks; however it is essential that risk is either excluded, shared, limited or pre-emptive steps taken.

However, there can be provisions related to exclusion of liabilities in form of non-covering of consequential damages (like loss of profits), personal injury, property damage, third party contracts, acts & omissions by employees and by subcontractors, negligence, misconduct, employment and termination related issues, etc, acts of nature.

In certain cases, total exclusion of all the liabilities of a party may to not be an ideal solution. In such cases, a limitation clause may be incorporated, wherein a cap on the risk may be fixed. Apart from increase in cost of raw materials, one must take into account the following events which can increase cost of the project which might include, changes in local laws, increase in security arrangements, changes in sub-contractors/suppliers, interferences from other contractors, delay in getting review comments from the owner, interferences from local communities and labour costs. While negotiating for a contract, provisions may be incorporated to explicitly share the increased cost between the parties in a particular ratio or put a cap on the risk. The contract should also ideally contain a time-limitation clause, wherein the contractor will be liable for any defects arising out of the project within a particular time period. One might fix different time-limitation for different aspect of the project.

In case, there is no limitation clause, the burden on the contractor might be huge. The owner may insist for a mandatory insurance policy to be taken by the contractor to protect against such loss. This will not only ensure that the owner gets paid for the damage, but the Contractor is also protected against financial losses. However, incorporation of a limitation clause will reduce the insurance premium amount and will reduce the project price.

Wrap up clause – Alternatively, the owner can take a wrap up insurance or owner controlled insurance policy in which all the contractors and sub-contractors are bundled into one insurance policy. This policy generally covers workers’ compensation, employer’s liability, commercial general liability and excess liability and additional coverage like professional or environmental insurance liability. This policy gives better control to the owner, in terms of the increased coverage amount, reduced cost due to bundling and removes the bidding amount that the contractor quote inclusive of the insurance amount.

IV. Warranties of Work

Warranties of Work clause in an EPC contract makes the contractor liable for any kind of defect arising due to design, engineering, workmanship materials and operations not made according to the specification in the contract. Moreover, the contractor may be liable if the equipments are not installed according to the specified quality, make, etc.

 

The contractor may however limit its liability to the defects or deficiencies to the extent resulting from repairs or alternation and operation by owner’s personnel in a manner inconsistent with or contrary to instructions contained in the operation and maintenance manuals or in case of  normal wear and tear. The warranty clause should specifically mention the time period during which such warranty will be in force. The provision should also mention the period for which the sub-contractors are liable to provide the warranty. The clause also generally specifies whether the contractor is liable for fixing the defect detected during the warranty period and the manner in which the defect would be rectified and who would bear the cost of such rectifications.

Another major concern can come from the latent defects.  Latent defects are defects which are not visible upon ordinary inspection, but become visible after a certain point of time after execution of the project. The warranty clause should mention the time-period of warranty for latent defects by the contractor.

Performance guarantee

This clause can be incorporated in an EPC contract, in which a financial institution like bank or insurance company guarantees that in case the project is not completed by the contractor, that financial institution will make good the owner of the loss arising from the non-completion.

V. Termination

The term clause should specifically mention the term of the contract, conditions for extension of the contract and might provide for provision for mutual termination of the contract.

Termination can be made in two ways – “termination at will or for convenience” or “termination for cause”. Termination for convenience clause is generally included giving the owner the right to terminate the contract for a reason other than default of the contractor. Such reason may include situations where continuation with the project is not financially viable for the owner due to changed situation, or failed to secure financing for the whole project. In case such a provision is not included, the owner may be liable to pay the contractor for the loss of profits for the project. However, the reason for using the clause must be reasonable, and generally does not cover termination on the ground of bad bargain on the price.

The termination for cause provision should expressly lay down the events which might lead to termination of the service, by either party or one of the parties. Termination rights of the contractor may include – Non payment of contract price, material breach by the owner, request for suspension of the work by the owner for a time exceeding a predetermined time. Termination rights of the owner may include – unreasonable delay in execution of the project, underperformance in terms of quality or quantity of work. Other general termination grounds can be insolvency and force majeure.

To make a smooth transition, the termination clause should include remedies clause which includes, return of all the project related documents, return of equipments of the owner, removal of contractor’s equipment from the site at his cost, step-in rights with respect to subcontractor, specific right to continue with the construction, release of liability of sub-contractors, and obligation to co-ordinate and co-operate with the new contractor for a particular time-period.

VI. Liquidated Damages

Liquidated damages are basically pre-quantified amount of damages that need to be paid by the defaulting party to the other party for a particular breach. Incorporation of a liquidated damage clause helps in calculation of the loss where it is difficult to identify the damage, for example in case of underperformance or delay. The non-defaulting party need not prove the actual damage, it is sufficient if the non-defaulting party proves that he has suffered some loss. However, the liquidated damages clauses should have a cap on the maximum liability to minimise the risk on one of the party. It should be kept in mind that the liquidated damage clause should not be in form a penalty or should not be unreasonable.

Liquidated damages can be in form of Delay Liquidated damages or Performance liquidated damages.  Delay liquidated damages are paid where the contractor has not adhered to the agreed timeline for completion, it is generally on the basis of rate per day calculated on the basis of foregone revenue and/or estimated extra cost actually incurred for the delay. Whereas, performance liquidated damages are paid where the contractor has failed to adhere to the agreed quality or quantity which may in turn affect the output of the whole project, for example reduced power generation from a power plant due to under quality work.

However, to minimise the risk of the Contractor, the contract should exclude a delay caused by the failure of the owner, or a liability sharing clause where the delay occurred due to concurrent delays by the owner and the contractor. The owner should be cautious whether the contract has an Exclusive remedy clause. An exclusive remedy clause will limit the liability of the Contractor to the Liquidated damages for the specific event, and not for any other damages.

VII. Jurisdiction and Dispute Resolution

In most cases, the clauses related to jurisdiction and dispute resolution are overlooked. An EPC Agreement, especially if it involves parties living in different jurisdictions, it is essential to be clear about the jurisdiction where in case of any dispute related to the agreement can be conducted and the governing law to be applicable. Having an Alternative dispute resolution clause which is clear and define predictive rules can help in reducing litigation or might be helpful in settling the dispute in the best interest of the parties without involving huge costs and within a short span of time.

Under a jurisdiction clause, the parties may select the venue and the Court where the dispute can be resolved. While selecting such venues, it is better to be specific about the particular Court, and not just the Country. Jurisdiction clauses can be exclusive, i.e., the disputes can only be brought in the Court agreed by the parties, or non exclusive, where the parties are free to select the Court, subjected to applicable jurisdictional laws on the Contract. In case, the agreement has provisions for separate agreements or annexure regulating specific areas, the clause should be drafted in a manner so that any dispute arising out of or related to the contract are to be referred to the same Courts and follow the same dispute resolution mechanism.

A Governing law clause will not only decide on which country’s law is applicable, but also determines how the provisions of the Agreement are to be interpreted, and the validity of exclusions or liability clauses. In case, there is no provision or the clause is silent, the conflict of law rules of the jurisdiction in which the action was brought (lex fori) will determine the governing law.

However, having an alternative mechanism in case of a conflict, like mediation through experts or involvement of the top-tier management of both the parties to negotiate can be considered before considering for legal avenues.

VIII. Force majeure

A force majeure clause is incorporated in the contract to avoid any liability by the parties in case of an event which cannot be anticipated or reasonably foreseeable. For the contractor it is essential that the clause is drafted in such a way that most of the probable events are expressly stated in the clause. However, the owner may insist to expressly state such events which may be excluded. However, one should keep in mind that not all unforeseeable events are covered, unless it is specifically mentioned in the contract. Some of such examples include; events which escalates the cost of the project, bad weather condition which are usual in the particular area, changes in law which makes the execution difficult but not impossible, delay by a supplier who is struck by a force majeure unless it is proved there is no other way the material may be  sourced.

The clause should generally state that the obligation of the parties is suspended during the period of the force majeure andthe contractor may resume his obligations once such event ceases. In case of a prolonged event, the contract may be terminated after expiry of a predetermined period of suspension. The contractor may insist for including a price escalation clause to cover force majeure clause to reduce liability. The owner should include a clause making the contractor liable to take measures to mitigate or minimise the risk. The contractor must check for such provision, and insist on limiting the liability to “commercially viable measures”.

 

Photo credits: Rudolph.A.furtado (on Wikimedia Commons)