Construction Alert. The ABC of EPC and EPCM Contracting. 22 December In brief

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1 Construction Alert 22 December 2011 The ABC of EPC and EPCM Contracting In brief Despite the similarity in their names, "EPC" and "EPCM" contracting are remarkably different creatures. Notwithstanding their popularity in the development of major energy and resources projects, confusion persists in relation to what these contracting methods entail and the typical risk allocation under each model. This article seeks to address this confusion by identifying some of the key characteristics of and differences between an EPC contract and an EPCM contract. Engineering, Procurement and Construction (EPC) EPC stands for Engineering, Procurement and Construction. Under an EPC delivery model, an EPC contractor will generally be responsible for the design, construction and commissioning of a facility. An EPC contract is similar to a design and construct contract in that, under both contracting methods, the contractor delivers a completed project from design. However, the EPC contracting model is typically associated with developing an operating facility (eg a mine processing plant, power station or wind farm) as opposed to a building (which is not usually constructed for the purpose of providing some form of output or operative process). Therefore, an EPC contract will normally contain a performance specification which outlines performance standards that the completed facility is required to achieve. An EPC contract will typically function as a "turnkey" contract where the EPC contractor is responsible for commissioning of the facility. That is, upon completion, the owner will (ideally) only need to "turn the key" to commence operation of the facility. Alternatively, an EPC contractor may only be required to complete the facility (at mechanical completion) without being responsible for commissioning. The diagram below shows a basic structure for an EPC delivery model. It should be noted that even where an EPC contractor has in-house engineering experience, it may still need to subcontract out design works where, for example, the facility requires specialist process engineering by a third party engineer (this comment applies equally to an EPCM contractor) _1 1

2 Engineering, Procurement and Construction Management (EPCM) EPCM stands for Engineering, Procurement and Construction Management. An EPCM contract is, at its core, a professional services contract. Broadly speaking, an EPCM contractor is not contractually obliged to provide the owner with a completed project on time and on budget, nor does it take responsibility for the construction or quality of the facility. Rather, an EPCM contractor: 1. takes responsibility for the provision of engineering and design services (the "E"); 2. generally procures contracts with suppliers and contractors as agent of the owner (the "P"); and 3. manages the construction phase of the project that is, manages, supervises and coordinates all of the suppliers, construction contractors and other contractors as the owner s representative (the "CM"). The diagram below shows the basic structure for an EPCM delivery model (where the EPCM contractor has in-house engineering capability). Key characteristics and differences Some of the key characteristics of and differences between EPC and EPCM contracts are as follows: 1. Single point of responsibility v multiple points of responsibility An EPC contract provides for a single point of responsibility. An EPC contractor is generally responsible to the owner for all design, engineering, procurement, construction and commissioning of the facility. That is, an EPC contractor generally assumes time, cost and quality risk for the project _1 2

3 An EPCM contract, on the other hand, requires the owner to have multiple points of responsibility for delivery of the facility. While an EPCM contractor is responsible for the design component, it is not usually responsible for the construction and procurement components. Rather, the owner must separately contract with contractors and suppliers, and responsibility for those goods and services lies with the relevant contractor or supplier. An EPCM contractor s responsibility is generally limited to the managing of those contractors and suppliers on behalf of the owner. That is, an EPCM contractor generally does not assume time, cost and quality risk for the project. The single point of responsibility makes the EPC contracting model an attractive option for owners. As the allocation of risk is primarily with the EPC contractor, the owner only need look to the EPC contractor to address any defect or dispute that arises. This is compared with an EPCM contract, under which the owner may need to seek recourse from a number of contractors and suppliers, depending on the nature of the defect or dispute. 2. Time An EPC contractor will typically agree to deliver a fully operational facility within a fixed period or by a fixed date (being fixed at the time of entering into the EPC contract and subject to any extension of time and suspension rights set out in the contract). Time certainty of delivery may be important to an owner where, for example, it has future obligations to provide product from the facility by way of offtake arrangements. Also, where a project is debt financed, a financier may consider an EPC contract more bankable if there are contractual mechanisms surrounding timing of delivery. One such mechanism typically found in an EPC contract is a liquidated damages regime for delay in handover of the completed facility. An EPCM contractor will not guarantee that the project will be completed within a fixed period; rather, it will generally only commit to using its best efforts to meet the owner's desired schedule. Consequently, an EPCM contractor may only be liable for delay where that delay is caused by the EPCM contractor's failure to perform (or poor performance of) the professional services under the contract. For this reason, it is unusual to see a liquidated damages regime in an EPCM contract. 3. Contract price An EPC contract is typically performed on a fixed price basis (being fixed at the time of entering into the EPC contract and subject to the terms of the contract, eg right to variation costs and delay costs). As such, an EPC contractor bears the risk of cost overruns and enjoys the benefit of any cost savings. Given the EPC contractor assumes time, cost and quality risk in providing the facility, the contract price under an EPC contract may include a significant risk premium. However, the fixed price nature of an EPC contract provides the owner, and its financier, with some comfort with regard to having "price certainty" in delivering the project. An EPCM contract, on the other hand, is typically performed on a schedule of rates or costreimbursable basis. As an EPCM contractor does not assume time, cost or quality risk in providing the facility, EPCM contracts typically contain significantly lower margins than EPC contracts. 4. Procurement An EPC contractor generally takes responsibility for the procurement of the necessary plant and materials. However, an EPC contractor may purchase equipment as agent of the owner where, for example, the procurement relates to costly and specialised items of equipment, (eg a SAG Mill for a resources processing plant). This is compared to an EPCM contractor, who will generally procure contracts with suppliers and contractors as agent of the owner, and not in its own name. That is, the contractual relationship is between the supplier/contractor and the owner, not the EPCM contractor. 5. Quality / Performance guarantees An EPC contractor will typically guarantee that the completed facility will achieve certain performance standards, usually focusing on the output, efficiency and reliability of the facility. An EPC contract _1 3

4 may also contain a liquidated damages regime to address the EPC contractor s liability for failure to meet the performance guarantees. These performance liquidated damages are in addition to the delay liquidated damages referred to above. An EPCM contractor does not take quality risk and therefore will not provide the owner with performance guarantees similar to those provided by an EPC contractor. Rather, an EPCM contractor will generally only provide warranties relating to the standard to which it will perform its professional services. 6. Owner's involvement Given the risks assumed by an EPC contractor, an EPC contract is usually structured so as to provide an EPC contractor considerable latitude as to the design and the methods and means of construction. If the owner requires greater involvement in, and control over, the design and construction of the facility, procurement of equipment and selection of contractors, an EPCM contract is likely to be more appropriate. EPC contracts may benefit, for example, less well-resourced (whether by way of balance sheet, personnel or other owner resources) or less experienced owners who require an experienced and fully resourced contractor to take control and responsibility for delivery of the project. 7. Defective works / services An EPC contractor is responsible for rectifying any defective work and re-performing any defective services. Under an EPC contract, the risk of any suppliers or subcontractors failing to meet their warranty or contractual obligations lies with the EPC contractor. An EPCM contractor, on the other hand, is only liable to re-perform any defective engineering or design services that it has provided. Otherwise, an EPCM contractor s role is typically limited to assisting the owner in managing the rectification of defects caused by contractors engaged by the owner. Conclusion This article briefly touches on some of the key characteristics of and differences between EPC and EPCM contracting. Determining which contracting method is more appropriate for a project will depend on a number of considerations, including the nature of the project risks involved, the extent to which the owner is willing to accept those risks or pass them on to the contractor and the extent to which the owner is willing to relinquish project delivery control to the contractor. It is important to ensure your clients appreciate the differences between the two contracting methods and the associated risks in using either. Authors Cullen, David Senior Associate david.cullen@blakedawson.com Higgins, Andrew Graduate andrew.higgins@blakedawson.com _1 4

5 This publication is intended only to provide a summary of the subject matter covered. It does not purport to be comprehensive or to render legal advice. No reader should act on the basis of any matter contained in this publication without first obtaining specific professional advice. This article is copyright. For permission to reproduce this article please Katherine Kulakowski: katherine.kulakowski@blakedawson.com Blake Dawson _1 5