Projects revolving around EPC contracts have a natural tendency to be complex due to the their nature, the number of parties involved and the costs associated with these projects. These complexities often result in contentious discourses arising between the parties, potentially leading to multiple disputes.
For the unfamiliar reader, EPC contracts are engineering, procurement and construction contracts which explains the method of procurement of the engineered works. EPC contracts are colloquially termed “turnkey” for the reason that the Contractor has “single point responsibility” for designing, constructing, completing and then handing over an operational facility, for use by the Owner.
In this article, the term “facility” is a general term for the product being procured by the Owner (i.e. the power plant, process plant, wind farm, factory etc.) and the “Owner” and “Contractor” are referred to as the parties to an EPC contract.
Aim of the article
In principle, the formation of disputes is against the natural interests of the parties to an EPC contract. This article provides an insight into the types of disputes which may arise during the lifecycle of an EPC project with practical guidance for both the Contractor and Owner on minimising disputes during the various stages of a project.
Before considering the means of minimising disputes in a project, it is worth noting the key factors which give rise to disputes under EPC contracts.
For any EPC project, the most highly coveted position, which presumably each party to an EPC contract wishes to attain, is striking the optimum balance between the key factors of time, cost and quality, to achieve the “golden triangle”. Successfully balancing these factors is a difficult challenge, requiring skill, experience and some luck! Theory suggests that enhancing or reducing any one factor has a direct impact on the other two factors - practice suggests that most disputes are in some way connected with these factors.
No doubt, the parties involved in any EPC project will have differing views as to the order of priority of these factors. For example, an Owner would likely want its facility to be constructed for the lowest cost, to a high standard and within the shortest possible timeframe. A lender would want to ensure that the facility is constructed within budget and within the shortest possible time so that the facility can begin to generate income allowing for the debt to be serviced. The Contractor would want to ensure that it generates the most profit from the project and also maintains the integrity of its pricing and programme.
Disputes can arise at any stage of an EPC project. Typically, an EPC project will have the following stages:
- Conceptual phase – this is the phase the Owner develops its concept of the facility and its objective, the initial design calculations are drafted, the financial input required is evaluated and the regulatory requirements to be fulfilled are acknowledged.
- Basic design phase – this is the phase where the preliminary designs (the plans and drawings) for the construction of the facility are developed, the approval of the provision of finance by the financiers is procured and the draft EPC contract is developed by the Owner with the contracts package being prepared ready for tender.
- Contracting phase – this is the stage where potential contractors have been identified as suitable bidders, they would submit their tenders and the successful tenderer shall negotiate the EPC contract with the Owner.
- Execution phase – this phase is where the Contractor undertakes the detailed engineering, procurement and construction, testing, pre-commissioning and completes the initial operational activities of the facility.
- Final phase – this phase includes the commissioning and initial operational tests of the facility.
- Operation phase – this is where possession of the facility has reverted from the Contractor to the Owner who is then responsible for operating the facility.
Disputes mostly arise during the execution phase or the operation phase. However, the implementing of dispute management and minimisation mechanisms ought properly to begin from the conceptual phase, as explained in the next section.
Preventing or addressing disputes before formal dispute resolution
The ideal position in any EPC project is for there to be no disputes between the parties. As this is unlikely, the next best thing is to minimise disputes occurring between the parties and, should they occur, provide a means of quickly resolving them in a manner which is the least detrimental to the outcome of the project.
Contractual misnomers are the origin of many disputes, i.e. where one party favours a particular interpretation benefiting its interest against another party’s interpretation.
The contract is the single most important document determining the relationship between the parties and their conduct. It can be the document which encourages a harmonious working relationship or it can be the root of division and conflict between the parties. It is the document that ought to clearly record the rights, obligations, duties and risks which each party has agreed to.
In order to minimise disputes occurring as a result of incomplete, ambiguous and unclear contracts, parties should consider the following actions during the various phases of the EPC project:
1. Conceptual phase
The Owner should consider what terms and obligations could be added to the future EPC contract to evidence the objective of constructing the facility.
2. Basic design phase
The Owner should be liaising with its technical team responsible for preparing the preliminary designs and developing the contracts package.
3. Contracting phase
This is one of the most important phases of an EPC project as, during it, the Owner seeks tenders for the project, selects its preferred Contractor and then documents the commercial agreement and risk allocation arrived at. During this phase, the Owner should seek to ensure the following:
- that a group of suitable potential contractors for the project is identified, to whom the project is presented;
- that, once tenders are received, they are carefully evaluated and suitably interrogated to resolve as many ambiguities and discrepancies as practicable and thereby arrive at the selection of a preferred Contractor and commercial terms;
- that the parties’ intention is documented in the best way to minimise disputes through to completion of the project;
- that all parties to the EPC contract understand the terms of the contract;
- that the accuracy of key information is checked thoroughly including completion dates, performance levels, performance tests, handover dates, scope of the works, level of delay damages, defects rectification period; and
- that a multi-tiered dispute resolution clause is included to provide a mechanism for resolving disputes outside of formal dispute resolution.
4. Execution phase
The parties at this stage should seek to:
- administer the contract as per the contractual requirements;
- look to resolve any dispute outside of formal dispute resolution methods;
- final phase / Operation phase.
The parties should ensure that all post-handover performance testing and defects rectification are completed in compliance with the contract as agreed between the parties.
Thoroughly and effectively drafting, negotiating and administering an EPC contract are arguably the best means of minimising future disputes under an EPC project.
The EPC procurement method being “turnkey” in nature suggests that the Contractor is to have complete control (with the exception of supervision) over the design and construction of the project. It is intended therefore for an Owner to have limited rights of intervention during the construction of the facility. In reality, however, this is simply not the case and some disputes arise from the Owner’s intervention during the construction of the facility.
In order to minimise the potential for these types of disputes to arise, the parties in practice may choose one of the following options:
- include a mechanism or policy in the contract which entitles the Owner to be involved at particular stages of the construction (i.e. including an approval mechanism of the detailed design and the Contractor being obliged to consider the Owner’s representations);
- the Owner limits its interference and relies on the tender process of selecting a competent Contractor who is able to complete the works to the Owner’s specification; and/or
- the Owner notifies and seeks agreement with the Contractor during the execution or final phase before it would like to “interfere” or be involved with the construction and the scope of such involvement.
The aim of providing for interventions in EPC contracts is to draw attention to the possibility of such interventions occurring and for the Owner and Contractor to discuss these without creating a dispute. Open communication and dealing with the interventions can be a successful means of dispute resolution.
Effective monitoring & management of a project is crucial
The effective monitoring and management of a project can be one of the best means of minimising disputes. This includes efficient contract administration and the timely implementation of necessary actions.
Typically in an EPC project, an Engineer would be appointed by the Owner to administer the contract – whose role would normally include administering and issuing instructions, evaluating claims, issuing payment certificates, witnessing testing and certifying completion under the contract.
Although a degree of responsibility sits with the Engineer, it is also important for the parties to effectively and efficiently manage their respective obligations under the EPC contract – including timely payment of invoices, completing activities in line with the programme and serving notices in a timely manner.
Generally, EPC contracts have tight programmes. It is important for parties to deal with any matters that may delay the project in a timely manner as they arise (rather than store them up for a fight at a later date, when the lost time might not be recoverable).
When it becomes known that there is an issue the party who takes action ahead of the other puts itself in the best position. Such a party would usually collate and record the evidence relating the issue – whether this be set out in minutes, email or letters – and with a chronology of events. Armed with all the relevant information, that party is in a better position to negotiate a resolution of the problem with the other side.
Once an issue becomes known, the contract should be considered as soon as possible to determine whether it deals with the particular issue. If so, then the parties would need to make sure that they carry out the actions pursuant to the contract, including issuing any notices within the timeframes set by the contract. Failure to do so can impact on the party’s recovery and the basis of its claim at a later date.
As EPC contracts are regularly used for complex and high value projects, they can be subject to a multitude of issues, problems and disputes (both complex and simple).
For the benefit of all parties to an EPC project, the ideal position is for there to be no formal disputes, so that there are no wasted costs and time expenditure in administering the disputes. However, as a result of the competing interests of the parties involved, this idealistic outcome is rarely achieved.
The parties to an EPC contract can seek to minimise the opportunity for formal disputes to occur through having properly developed contractual agreements, fostering good (and early) communication, suitably managing interventions by the Owner and ensuring effective project management.