Crisis phenomena in economy increasingly bring forward the matter of more detailed elaboration of potential risks associated with construction contracts applied in Kazakhstan. Conventional construction contracts are replaced by internationally used contracts adjusted to Kazakhstan standards.
1. EPC Contracts – Overview
EPC (Engineering, Procurement, Construction) combines three primary construction stages (engineering, procurement, and construction itself). EPC is the general name for construction contracts applied for implementation of complex construction projects in the international construction industry.
EPC contracts are conventionally viewed as a risk management instrument in the course of construction projects, and as an instrument ensuring balance of interests of the parties to the construction project.
A distinctive feature of EPC contracts is the so-called “complex approach”, which integrates efforts of all participants in the construction project. The approach includes coordination of efforts of all project participants by a single party – an engineer, supervisor, or project manager, whose role is further described in more details.
For a number of reasons described below, such form of EPC contracts as FIDIC contracts is more popular in Kazakhstan. Just as initially designed, such contracts are by default intended to be universal and efficient within the legal system of virtually any country. Moreover, such contracts are widely used in international practice, especially in the countries of Western Europe, being the primary contracts used for implementation of large-scale projects with complex jurisdictions.
2. Forms of FIDIC Construction Contracts: Origins, Types, Structure
FIDIC stands for Federation International des Ingenieurs-Conseils – International Federation of Consulting Engineers. Established in 1913 in France as an association of construction engineers, this organization is currently involved in development of standard contractual terms to regulate relations between the parties to construction projects.
The first standard FIDIC contract was developed in 1947 upon request of the World Bank. Nowadays, the following standard forms of FIDIC construction contracts issued in 1999 are widely used:
- Conditions of Contract for Construction (“The Red Book”);
- Conditions of Contract for Plant and Design Build (“The Yellow Book”);
- Conditions of Contract for EPC/Turnkey Projects (“The Silver Book”);
- Short Form of Contract (“The Green Book”);
In 2008, a new standard form of FIDIC contract named “Conditions of Contract for Design, Build and Operate Projects”, formerly known as “DBO form” was issued.
Apart from the primary standard forms, FIDIC also issues standard contract forms pertaining to various construction-related fields, such as financing, various types of services, etc.
The main feature of standard FIDIC forms is such party as an engineer. In these forms (basically, in the Red Book, the Yellow Book, and DBO form), an engineer is a representative of the Customer responsible for coordination of construction project implementation and relations between the Customer and the Contractor. It shall be admitted that Engineer (in other versions - the “Supervisor”, “Contract Administrator”, etc.) is a critical link in the chain of interactions among participants in any construction project. Therefore, the provisions on Engineer are contained in other standard forms of construction contracts (apart from FIDIC) that will be described further.
Differences between certain standard FIDIC forms are usually lie in the position of Engineer, in presence or absence of other participants in the construction project, as well as in allocation of duties between Customer and Contractor throughout the main stages of construction project, namely:
- Supply of equipment, engineering, and design;
- Commissioning and operation;
For the avoidance of doubt, note that the foregoing are the basic stages of construction project and may be implemented simultaneously and do not include multiple intermediary sages. Such stages are described in this section solely for the purpose of demonstration of basic differences between primary FIDIC forms.
Conditions of Contract for Construction (“The Red Book”):
In accordance with this form, design is carried out mostly by the Customer (as a rule, not by the Customer itself, but by consultants and designers holding relevant licenses engaged by the Customer). The Engineer acts as a representative of the Customer and coordinates interaction between the Customer and the Contractor, and ensures compliance of construction process with project requirements. At the same time, in certain cases, depending on the circumstances and Customer’s will, the Contractor may be responsible for design of particular elements of construction works, i.e. mechanical works, electric works, etc. Role of the Engineer in this case is particularly important for evaluation and measurement of performance because in accordance with the Red Book, payment is made on the basis of actually completed works approved by the Engineer.
Conditions of Contract for Plant and Design Build (“The Yellow Book”):
In accordance with this form, the Contractor, acting in compliance with Customer’s requirements, designs and performs construction works under the project that may include any combinations of mechanic, electric, and any other construction works. The Engineer ensures project management (while reconciling its actions with the Customer) and approves invoices issued by the Contractor to be in line with the cost of works that, as expected, should not exceed the amount initially agreed by the parties to the Contract, regardless of scope and types of works that should be completed by the Contractor to fulfill its obligations. 777
Conditions of Contract for EPC/Turnkey Projects (“The Silver Book”):
This form is recommended for use when one party (the Contractor) assumes responsibility for design and subsequent implementation of construction project, including required engineering, procurement, supply of equipment, any additional design etc., i.e. carries out construction on a “turnkey” basis. This form does not imply presence of an Engineer because the primary function of an Engineer is a coordination of activity among various participants in the construction project, and in this case all activities are coordinated by the Contractor that presents the end results to the Customer. Usually, the cost of such projects is fixed, even though the parties may make required adjustments to the cost during the project. In accordance with this contract form, potential risks are borne by the Contractor.
Short Form of Contract (“The Green Book”):
This form is designed for low-cost projects or simple types of works completed within a short period of time (e.g. earthworks). This form does not imply presence of an Engineer because implementation of such simple project does not require complex structure and coordination thereof.
Conditions of Contract for Design, Build, and Operate Projects (DBO form):
This form is the most recent and currently the most complex of all FIDIC forms. No significant practices have been developed regarding the application of this form as of yet, especially in Kazakhstan, and this makes application of this form even more interesting.
The concept of this form implies its application for the most critical construction projects, including design, construction, and long-term operation and maintaining the proper state of constructed facility. In most cases, all of the foregoing types of activity are entrusted with a single Contractor that often represents an association of companies acting on the basis of joint operating agreement. At the same time, while completing the works in “standard” areas of responsibility, the Contractor is not responsible for project financing at the stage of construction; neither is the Contractor responsible for financial success of the project upon its completion. This is because the goods manufactured at the constructed facility (e.g. electric power, in case of construction of electric power plant) will be owned by the Customer that will dispose such goods at its own. This is the difference between the DBO form and concession agreements.
A contract divided into the following two independent stages is used to implement this concept of interaction:
- Design and construction stage upon completion of which the corresponding facility will be transferred to the Customer’s ownership;
- Operation stage throughout which the Contractor will maintain the proper state of the facility and fulfill the requirements regarding the quantity and quality of manufactured goods (e.g. certain amount of kilowatt-hours of electric power) established in advance. DBO form is recommended for application with respect to the projects with the period of operation stage of at least 20 years, even though the period of such stage may be reduced upon agreement of the parties.
Traditionally, the structure of most FIDIC contracts implies two components. Most contracts are divided into two parts: the first part (general) contains general provisions, and the second part (particular) contains specific features typical of the given project. Besides, each FIDIC contract may include a significant number of schedules that define particular aspects of interaction between the parties to the Contract.
The general part provides for detailed and consistent procedure for interaction between all parties to the Contract throughout the period of construction project implementation. As a result of application of such detailed regulation, the parties to the Contract have a clear procedure for interaction, completion of works, and allocation of risks. Also, detailed breakdown has one more advantage: application of such form implies important elaboration of construction project itself and understanding of its distinctive features. Thus, any form of FIDIC contract is a particular guideline for negotiations with the counterparty. Maximum detailed breakdown means that by the time of contract conclusion, all problems have been clarified and discussed by the parties, and the parties have reached an agreement with regard thereto.
However, the general part contains only the general contract provisions. It is implied that the critical provisions (in Kazakhstani law – material provisions) of any contract are contained in the particular conditions thereof. The particular conditions modify and supplements the provisions of the general part.
Even though the entire contract structure may seem somewhat bulky, it is in fact rather simple for application and ensures detailed elaboration of all matters associated with potential risks.
3. Peculiarities of FIDIC Contracts Application in Kazakhstan
Application of FIDIC contracts in Kazakhstan has a number of particularities and specific features that should be taken into consideration to ensure favorable effect of application thereof. Some of these specific features are related to the features of operation of Kazakhstani laws, while others, on the contrary, are related to the lack of relevant practices and regulatory basis in Kazakhstan.
Below are described several practical matters that should be taken into consideration for application of EPC forms in Kazakhstan. It should be understood, however, that the variety of such matters is much wider in practical setting.
4.1. Concepts of Reasonableness, Acceptability, and Sufficiency. Boilerplate clauses.
FIDIC contracts contain numerous references to such terms as “reasonableness”, “sufficiency”, and “acceptability.” When analyzing such contracts, one can often see the provisions stating that the Contractor shall act “as a reasonable Contractor taking into account the best interests of the Customer.” Similarly, the Customer shall “demonstrate reasonable behavior.”
Presence of such norms can be explained by the combination of business practices attributable to any standard contract form. Therefore, the norms of “reasonable behavior” that may seem to be a mere declaration in Kazakhstan, have a quite specific content in most European countries. Unlike European countries, in Kazakhstan the parties to a contract will incorporate in such norms the meaning that often differs both from one another, and from the meaning incorporated therein by a competent court.
Nevertheless, it is not recommended that such norms be eliminated or adjusted without proof for application in Kazakhstan. Application of such norms depends on the degree of jurisdiction under which contractual disputes will be settled. In case if a relevant FIDIC contract is concluded between the Customer and the Contractor that are registered in different countries and, therefore, prefer to submit a relevant dispute for resolution to an international court of arbitration, one can make an assumption (and in certain cases, determine) whether the relevant court has appropriate jurisdiction. Admittedly, this matter is of lesser importance in case of ad hoc arbitration; however, the arbitrators appointed by the parties may have a specific opinion on particular contractual matters.
Generally speaking, it should be noted that according to Kazakhstani practices, during preparation of commercial contracts (not only in sphere of construction) a number of matters are taken into account. Usually, these are the matters that from commercial perspective have no fundamental importance at the time of contract conclusion. Often, such matters include the following:
- as mentioned above, determination of the governing law and the court to settle contractual disputes;
- force majeure clause;
- interpretation and definitions;
- contract entirety clause (the provision stipulating that the contract represents full and entire agreement between the parties);
- assignment clause etc.
In English law, these clauses are called boilerplate clauses. Literally speaking, this means “standard clauses.” The name itself suggests that such provisions are used throughout the contract in accordance with a certain boilerplate known to either party and that no particular attention should be attributed to formulation thereof in each particular case.
We believe that such approach is not justified. Even though “boilerplate clauses” have no significant commercial importance at the time of contract conclusion, such clauses serve as regulating provisions that are applied in case if any issues arise throughout execution of such contract. Qualitative legal analysis of such clauses, rather than “material” provisions elaborated in details at the time of contract conclusion, conducted in each individual case is a way to protect the parties to the contract from any risks that become commercial immediately upon occurrence and may lead to significant losses. This is demonstrated in our arbitration example.
4.2. Design and Approval
The matters of design in the course of construction project are of high importance. The process of construction project approval in Kazakhstan is a complex, multi-stage, and time-consuming procedure that certainly should be reflected in a relevant contract.
As a rule, FIDIC forms attribute design matters either entirely to the competence of the Customer, or entirely to the competence of the Contractor. Such forms also stipulate a number of obligations of the parties on delivering project documentation or materials required for development thereof to each other. Besides, FIDIC forms specify obligations of either party on obtaining required permits associated with construction process. However, the matter of project documentation approval is rarely stipulated by FIDIC forms.
We recommend that the matters of project documentation approval in course of FIDIC forms application in Kazakhstan be considered. This can help to avoid such problems, as inaccurate evaluation by the Contractor of timeframes required for project completion in case if approval is the responsibility of the Contractor. In case if approval is the responsibility of the Customer, it is important to determine what documents should be provided by the Contractor to obtain the consent and in what periods of time such documents should be provided.
4.3. Contract Structure and Value
The main question pertaining to the contract structure if applying FIDIC forms in Kazakhstan is whether the complex two-component structure of the contract is worth applying here.
There are no reasons why such structure could not be used in Kazakhstan. In practical setting, many companies prefer combining general and special parts through transposing provisions from special part into general part and inserting them in relevant articles to simplify the contract. However, as in the case of any modification of initial form of FIDIC contracts, one should apply discretion to determine the court for consideration of contractual disputes, should such disputes arise (see clause 4.1 above).
Nevertheless, in our opinion, the practice of determining contractual terms by binding them with the terms of tender documentation in relation to FIDIC contracts is not applicable in Kazakhstan. First of all, in case of application of FIDIC contracts in Kazakhstan, no tender may be conducted in any particular case. Moreover, in accordance with the provisions of the RoK Civil Code, material terms of construction contract include the period of works completion, and, in our opinion, such period should be disclosed in the contract without references to tender documentation that constitutes a separate document or a package of documents.
International forms of construction contracts reviewed in this article serve as highly efficient instrument of interaction between the parties to a construction project. We believe that the number of companies applying such forms will increase as much as the anticipated development of construction market. This, to our mind, will be supported by increasing integration of Kazakhstan in the world economy.
This article analyzes general issues addressing application of FIDIC forms in Kazakhstan. In general, the process of adjustment of each form to local requirements involves serious and complex work.
Application of international forms of construction contracts in Kazakhstan is, certainly, is limited by a number of conditions as described herein. But regardless of any potential challenges related to application, it is obvious that along with overall expansion of construction market the transition from conventional to alternative contract forms is inevitable.
The article was published in KazService Magazine in the issue dedicated for Mangistau Oblast, #3 (3), March-April 2013