ENGINEERING, PROCUREMENT, CONSTRUCTION CONTRACT: TOOL [footnoteRef:1]OF PROJECT FINANCE [1: Shalini Wunnava, LL.M. (Banking and Finance), National Law University, Jodhpur. ]

Table of ContentsTable of Contents2INTRODUCTION1Allocation Of Construction Risk: The Turnkey (Or Engineering, Procurement, And Construction [EPC]) Agreement3ENGINEERING, PROCUREMENT & CONSTRUCTION CONTRACT5Each Contract Has Stand Alone With Boiler-Plate Provision5Engineering Contract5Procurement Contract6Construction Contract6Precedence Of Clauses7Scope Of Contract For Off-Shore Constructions8Commencement Of The Works Notice To Proceed Clause9Contract Price, Payments, And Variations10TYPES OF TURNKEY CONTRACTS12Lump-Sum Turnkey Projects12Engineering Procurement And Construction Management Projects (EPCM)12FIDIC AND TURNKEY CONTRACTS15Balancing Of Risk Between Employer And Contractor15Employers View16Contractors View17EPC and PPP17Athens Generating Co. v. Bechtel Power Corp.19Background19The Ruling19Conclusion21Indiantown Cogeneration Facility22McDermott International Inc. v. Burn Standard Co. Ltd23Background23The Ruling23Conclusion24CONCLUSION26

INTRODUCTION Project financing may be defined as the raising of funds on a limited-recourse or nonrecourse basis to finance an economically separable capital investment project in which the providers of the funds look primarily to the cash flow from the project as the source of funds to service their loans and provide the return of and a return on their equity invested in the project.[footnoteRef:2] Project financings typically include the following basic features [2: John D. Finnerty, Project Financing: Asset-Based Financial Engineering, 1 (John Wiley & Sons, 2007).]

1. An agreement by financially responsible parties to complete the project and, toward that end, to make available to the project all funds necessary to achieve completion.2. An agreement by financially responsible parties (typically taking the form of a contract for the purchase of project output) that, when project completion occurs and operations commence, the project will have available sufficient cash to enable it to meet all its operating expenses and debt service requirements, even if the project fails to perform on account of force majeure or for any other reason.3. Assurances by financially responsible parties that, in the event a disruption in operation occurs and funds are required to restore the project to operating condition, the necessary funds will be made available through insurance recoveries, advances against future deliveries, or some other means.A project financing requires careful financial engineering to allocate the risks and rewards among the involved parties in a manner that is mutually acceptable.[footnoteRef:3] The business of project financing is founded upon the identification, assessment, allocation, negotiation, and management of the risks associated with a particular project. Indeed, as project finance lenders look to the revenues generated by the operation of the financed project for the source of funds from which that financing will be repaid, the whole basis for project financing revolves around an understanding of the future project revenues and the impact of various risks upon them. Risk is a crucial factor in project finance since it is responsible for unexpected changes in the ability of the project to repay costs, debt service, and dividends to shareholders. Risks must be identified in order to ascertain the impact they have on a projects cash flows; risks must be allocated, instead, to create an efficient incentivizing tool for the parties involved. Cash flows can be affected by risk, and if the risk has not been anticipated and properly hedged it can generate a cash shortfall. If cash is not sufficient to pay creditors, the project is technically in default. If a project participant takes on a risk that may affect performance adversely in terms of revenues or financing, this player will work to prevent the risk from occurring.[footnoteRef:4] From this perspective, project finance can be seen as a system for distributing risk among the parties involved in a venture. In other words, effectively identifying and allocating risks lead to minimizing the volatility of cash inflows and outflows generated by the project. This is advantageous to all participants in the venture, who earn returns on their investments from the flows of the project company. [3: World Bank, ] [4: I.N.D. Wallace, Construction Contracts: Principles and Policies in Tort and Contract, 401 (Sweet & Maxwell, London, 1986). ]

Most of the time allocated to designing the deal before it is financed is, in fact, dedicated to analysing (or mapping) all the possible risks the project could suffer from during its life. Above all, focus is on identifying all the solutions that can be used to limit the impact of each risk or to eliminate it. Risk allocation is also essential for another reason. This process is a vital prerequisite to the success of the initiative. In fact, the security package (contracts and guarantees, in the strict sense) is set up in order to obtain financing, and it is built to the exclusive benefit of original lenders.[footnoteRef:5] Therefore, it is impossible to imagine that additional guarantees could be given to new investors if this were to prove necessary once the project was under way. [5: John Dewar, International Project Finance, 314 (Oxford University Press, 2011).]

The process of risk management is crucial in project finance, for the success of any venture and is based on four closely related steps[footnoteRef:6] 1) risk identification, 2) risk analysis, 3) risk transfer and allocation of risks to the actors best suited to ensure coverage against these risks, and 4) residual risk management. The agreements embodying the risk allocation should be assessed as a whole, with a view to: (a) providing that significant risks are allocated to those parties that are best able and most motivated to assume them; and (b) reducing the residual risks in the project to a level that the sponsors and lenders can prudently manage. [6: Supra n. 1, at 124.]

An essential aspect of the project finance lawyers role in helping the parties reach a bankability assessment involves reviewing the project, and in particular its underlying documentation, in order to identify its potential and fundamental risks and to determine if, and how appropriately, those risks have been allocated among the parties.[footnoteRef:7] Because the ability of the project company to produce revenue from project operation is the foundation of a project financing, the contracts constitute the framework for project viability and control the allocation of risks. Contracts that represent the cost of fuel and other inputs to the project company are of particular importance because these contracts affect cash flow. [7: Supra n. 4, at 315-16.]

Allocation Of Construction Risk: The Turnkey (Or Engineering, Procurement, And Construction [EPC]) AgreementA turnkey agreement also known as EPC (engineering, procurement, and construction) is a construction contract by which the SPV transfers construction risk of the structure to the contractor. In exchange for a set fee, the contractor guarantees the SPV the following[footnoteRef:8]: [8: Stefano Gatti, Project Finance in Theory and Practice: Designing, Structuring, and Financing Private and Public Projects, 49 (London: Elsevier, 2013).]

I. The completion dateII. The cost of the worksIII. Plant performanceIV. A warranty period (usually between 12 and 24 months) after the plant has been accepted by the SPV, where plant maintenance and replacement of parts are granted for free by the contractor.As far as guarantees on completion dates, when the pre-established construction time is up, one of two possible situations can occur[footnoteRef:9] [9: Id. at 121]

1. The plant meets minimum performance standards.2. The plant does not meet minimum performance standards.In addition to these guarantees, there may be coverage against technological risk.[footnoteRef:10] Transferring this type of risk to third parties is always quite complex, in particular if the projects base license is extremely innovative. In concrete terms, the options available are the following[footnoteRef:11] [10: Dennis Campbell et. al., International Project Finance, 5 (New York: Transnational Publication, 2010).] [11: Id. at 78.]

1. To ask independent technical advisors their opinion on the effectiveness of the technology2. To oblige the technology supplier to pay penalties either in one lump sum or proportional to the patent value of the technology3. To oblige the contractor to provide performance guarantees on the technology that are incorporated in the construction contract (wrapping or wraparound responsibility)Wrapping (or wraparound responsibility) is what provides lenders with a real guarantee. [footnoteRef:12] With this type of contract, the contractor is required to ensure that the plant corresponds exactly to design and technical specifications listed in the license agreement for use of know-how with the SPV. Of course, when contractors give this guarantee, presumably they are familiar with the technology to be developed, and as a result the SPV will clearly face higher construction costs. When the technology in question is absolutely new, there is no wrapping. No contractor, however reliable, would be able to offer an SPV such a broad guarantee. In these cases, the venture can be financed only if the sponsors guarantee total recourse to lenders during the construction phase. Such recourse is eliminated only if the plant proves functional once construction is complete. [12: Supra n. 7, 58-59.]

Of course, the judgments of technical consultants do not constitute legally binding guarantees. Nonetheless, if a panel of experts unanimously supports the validity of the technology with initial due diligence of technological features, the project stands a greater chance of success than if the response is general skepticism. Penalties paid by suppliers, whether lump sum or proportional, have a greater impact on the SPVs cash flows. However, it should be said that the amount of these penalties is always less than the overall value of the project. Therefore, lenders should not rely too heavily on these figures to recover their investments in case of setbacks.

ENGINEERING, PROCUREMENT & CONSTRUCTION CONTRACTEngineering, procurement and construction, together with testing and start-up, are the four broad, general phases of project construction. It is not surprising therefore that the types of construction-related contracts are generally structured to cover these phases.[footnoteRef:13] There are three general types of constructionrelated contracts used in a typical project financing: engineering, procurement, and construction. A fourth, called commonly an EPC is one contract that covers all three phases engineering, procurement and construction. The latter type is often called a fast track construction contract. [13: Supra n. 1, at 513. ]

There is no accepted definition for each of these terms in the construction field. The term turnkey tends to mean the most extreme form of placing design and construction responsibility on the contractor, such that after completion the employer need only turn the key to commence operation of the constructed facility. Notwithstanding this, the term turnkey will be used here to describe the more general global arrangement of placing all design, procurement and construction responsibilities on one contractor.Each Contract Has Stand Alone With Boiler-Plate ProvisionEngineering Contract The engineering contract provides a project company with professional assistance in project design, bidding and review and administration of the work. Specifically, it provides for boiler plate provisions such as thei) the preparation of preliminary and general project designs; ii) preparation of specifications; iii) preparation of initial cost estimates; iv) preparation, solicitation and analysis of bids for work and supplies; v) preparation of detailed drawings for bidding purposes; vi) review of detailed drawings produced by suppliers; vii) scheduling of work; viii) inspection and testing; and ix) during the construction phase, administration of the construction contract for the project company. This is primarily because all project construction work, including engineering work, is included in a broad, turnkey construction contract in which the contractor is a single point of responsibility for all construction phases. Procurement Contract The procurement contract provides for the orderly procurement of work and supplies for a project. The contract specifically needs to includes provisions such as the i) require the architect/ engineer to establish bidding procedures for machinery, equipment, material and supplies; ii) to perform an economic analysis of the bids; iii) to coordinate export licenses and other governmental authorizations necessary for the export or import of materials, supplies, machinery and equipment to the project site; iv) schedule and monitor delivery dates; v) make transportation arrangements for delivery of materials, supplies, machinery and equipment to the project site; and vi) coordinate financial matters, such as scheduling cash needs, reviewing invoices and administration of accounting records. A separate procurement contract is not used often in a project financing, for the same reasons that a separate engineering contract is not used. That is, all procurement work is included under the scope of the turnkey construction contract, and funds are typically not available for procurement work until a financial closing occurs.Construction Contract The construction contract is the contract that governs the complete construction of the project. As such, the contractor agrees in the construction contract to provide all constructionrelated services, including i) construction supervision, ii) labour and management, iii) construction facilities, iv) tools and supplies,v) site investigation, and vi) field engineering. In the conventional contracting procedure for a major project, the project developer, or a Contracting Authority uses an architect and/or consulting engineer to draw up the design for the project, with detailed drawings, bill of quantities, etc., based on which a bid for the construction is invited; any specific equipment required is procured separately. But even if the Sponsors or Contracting Authority have the experience to arrange the work under separate contracts and coordinate different responsibilities between different parties, this is not usually acceptable to lenders in project finance who want there to be one-stop responsibility for completing the project satisfactorily, since they do not want the Project Company to be caught in the middle of disputes as to who is responsible for a failure to the do the job correctly. Therefore the Construction Contract in a project-financed project is usually in the form of a contract to design/engineer the project, procure or manufacture any plant or equipment required, and construct the project, so creating a turnkey responsibility to deliver a complete project fully equipped and ready for operation that is a D&B (Design and Building) or EPC (Engineering, Procurement, Construction) Contract.Precedence Of ClausesAnother approach to contracting for major projects is to appoint a contracting or engineering company as construction manager, with the responsibility of handling all aspects of the construction of the project, against payment of a management fee. The fee may vary according to the final outcome of the construction costs. Although this may be an economically efficient way of handling major projects, a variable construction cost is not acceptable to lenders because of the risk of a cost overrun for which there may not be sufficient funding, or which adds so much to the costs that the project cannot operate economically. The Construction Contract therefore also provides for the work to be done by the Construction Contractor at a fixed price. Finally Project Completion has to match the requirements of the Project Agreement for the project to be complete by a fixed date. So the Construction Contract also provides for a Fixed Project Completion date. Such a turnkey, fixed-price, date-certain Construction Contract transfers a significant amount of responsibility (and thus risk) to the Construction Contractor. Moreover the Construction Contractor has to wrap (i.e., guarantee) the performance of its own sub-contractors, and is taking extra risk in this respect. These extra risks are clearly likely to cause the Construction Contractor to build more contingencies into the contract costings, and hence a higher contract price than the price if the work were done on a cost-plus basis. Typically the extra cost of such a Construction Contract adds 20% to the estimated cost of a contract which is not on a turnkey, fixed-price, date-certain basis, but the outturn cost of the latter kind of contract may easily increase by 20%, hence producing the same result.[footnoteRef:14] [14: Frdric Blanc-Brude, Hugh Goldsmith & Timo Vlil, Ex Ante Construction Costs in the European Road Sector: A Comparison of Public-Private Partnerships and Traditional Public Procurement, Economic and Financial Report, 46 (EIB, Luxemburg, 2006).]

Fixed-price, date-certain Construction Contracts are standard in most process plant and infrastructure projects. Sponsors who want to adopt a different approach normally have to give lenders a Project Completion guarantee, thus diluting the non-recourse nature of the transaction. Certain types of projects do not or cannot usually use such contractsfor example mining and oil and gas extraction projects, as well as projects involving a gradual investment in a network, influenced by changing demand, such as in telecommunications projects.An exception to the turnkey responsibility of the Construction Contractor arises where the project is being constructed using technology licensed by a third party, which is commonly the case in refinery or petrochemical plant projects. The Construction Contractor does not take responsibility for the performance of the plant insofar as this depends on such a third-party license. It should be noted that standard forms of Construction Contracts, such as those produced by the International Federation of Consulting Engineers (FIDIC) are generally not suitable for project finance, first because they tend to be too contractor friendly, and second because there are some differences of structure compared to project finance requirements.[footnoteRef:15] [15: John Dewar, International Project Finance Law and Practice, 85, 417 (Oxford University Press, 2011).]

Scope Of Contract For Off-Shore ConstructionsThe Construction Contract sets out the design, technical specifications, and performance criteria for the project, and may offer a fast-track route to construction of the project, since the contract can be signed and construction can begin before all the detailed design work is complete.[footnoteRef:16] Nonetheless the Construction Contractor remains responsible for constructing a project that is capable of performing as specified, even if something has been omitted from the detailed description. The Project Company may also have the right to object to detailed designs as these are produced by the Construction Contractor. Its position here is different to that of an Off-taker/Contracting Authority. [16: Joseph A. Huse, Understanding and Negotiating Turnkey Contracts, 277 (Sweet & Maxwell: London, 2009).]

The Construction Contractor is responsible for employing (and paying) its own subcontractors or equipment suppliers, although the Project Company may have a right of prior approval over major subcontractors or equipment suppliers, to ensure that appropriately qualified subcontractors or suppliers with relevant technology are being used.[footnoteRef:17] Construction insurance should normally be excluded from the scope of the Construction Contract price. For tax reasons Construction Contracts with international contractors are sometimes broken into separate parallel contracts, for example for provision of services (such as design) and equipment, or into an offshore contract for work outside the country of the project, and an onshore contract for the rest (which would probably be mainly carried out by a local construction company as sub-contractor to the Construction Contractor). This is acceptable provided the contracts are clearly linked together and effectively form one whole. [17: C.G. Hammond, Dealing with Defects: Defective Owner Provided Preliminary Design in Design-Build Contracting, 15 I.C.L.R. 193 (1998), 196.]

Commencement Of The Works Notice To Proceed Clause There may be a gap between the time the Construction Contract is signed and the point at which Financial Close has been reached, and usually the Construction Contractor does not begin work until the latter date, when there is assurance that the financing is available. The Construction Contract therefore often provides for a Notice to Proceed (NTP), i.e., a formal notice to begin the works, which can be issued by the Project Company at Financial Close. In such cases the required Project Completion date is calculated as a date that is a period of time after the NTP is issued, rather than a fixed date.A delay in reaching Financial Close may affect the Construction Contract pricethere is likely to be a final date for NTP, after which the Construction Contractor may increase the price (or there is an automatic increase based on an inflation index) or is no longer bound to undertake the works. Similarly, a delay in starting the work will lead to a delay in Project Completion, which could jeopardize the project as a whole. In such cases, the Sponsors may be willing to take the risk of asking the Construction Contractor to begin work under their guarantee, based on the assumption that Financial Close will catch up with events, enabling the guarantee to be cancelled at that point. For this purpose, an optional procedure for pre-NTP works may be included in the Construction Contract: this work may cover just the (relatively low cost) preliminary design work, or allow the Construction Contractor to place orders for (high-cost) long lead-time equipment.[footnoteRef:18] [18: J. Davidson Frame, Project Finance: Tools and Practice, 68 (University of Management and Technology, 2003).]

The Project Company should have the right to terminate the Construction Contract if at any time a decision is taken not to proceed further with the project (this is known as a termination for convenience), against an agreed formula for paying compensation to the Construction Contractor.Contract Price, Payments, And VariationsPayment of the contract price is normally made in stages: after an initial deposit, payments are made against the Construction Contractor reaching pre-agreed milestones, relating to items such as completing a major stage of the works or delivery of a major piece of equipment, or alternatively against the overall value of the work performed as a proportion of the total contract value.[footnoteRef:19] Payments may be made directly by the lenders to the Construction Contractor, rather than passing the funds through the Project Companys bank account.[footnoteRef:20] [19: Huse Kirkland, Shumway, The Use of the Target Concept for Tunnelling Projects in Light of the Eurotunnel Experience, Options for Tunnelling Conference of the International Tunnelling Association, Amsterdam, the Netherlands (Apr. 19-22, 1993) at 6.] [20: M.L. McAlpine, Construction Law: Will DesignBuild Contracting Really Solve All of the Problems? (1997) 76 MI Bar Jnl. 522, at 533.]

If export credits or other tied funding are being used, the Construction Contractor cannot change the arrangements for sourcing of equipment or services (as otherwise the Project Company may not have enough finance available).Although in principle the Construction Contract price is fixed, there are some exceptions to this that usually allow the Construction Contractor to increase the price, e.g. : if the Project Company changes the required design or performance of the plant, or adds other new elements to the contract; if Owners Risks cause additional costs, including the cost of delays to the construction program; if changes in law require the design or construction of the project to be changed.The Construction Contractor normally remains responsible for any problems with the geology of the site that cause extra costs, although the Construction Contractor may not accept liability for problems with projects being built in locations where mining has taken place and underground site conditions are uncertain. The way in which the Construction Contract price is made up has in principle nothing to do with the Project Company, which is just paying a lump-sum price; however, it is sometimes necessary for the price to be broken up by the Construction Contractor for the Project Companys tax purposes.

TYPES OF TURNKEY CONTRACTSIn a number of projects, completion risk is allocated to a contractor through a turnkey construction contract. In such an agreement, the contractor undertakes to build a fully operational facility for a fixed (subject to limited exceptions) price by a specified date certain. Where the market for construction work is competitive, with enormous costs and great attention to bidding detail, when tenders are called for projects, a pre-committed project financing package will often be required by the relevant procuring authority. In many sectors a turnkey construction contract by itself will be accepted by banks for known sponsors, familiar equipment and systems, and safe locations without further sponsor support for delay or cost overruns.[footnoteRef:21] These structures are commonly seen in the context of independent power projects (IPPs) and a number of public private partnerships (PPPs). [21: I.N.D. Wallace, Design-and-Build: a No-No for Owners, (1999) 4 Const. & Eng. L. 7 at 8.]

Lump-Sum Turnkey ProjectsIn this type of project, which is also called an engineering procurement and construction contract (EPC) contract, the owner develops a conceptual design specification and issues requests for proposal and engages an engineering company as the contractor. The contractor is required to deliver the project on a particular date for a fixed price, hence the term lump sum. The contractor also needs to guarantee the performance, quality and efficiency of the operations, hence the name turnkey, which suggests that all the owner has to do is turn the key for operations to commence without any problem.[footnoteRef:22] In the building and construction industry, this form of contract is known as design-build contract. The contractor provides architectural design, engineering, and construction to the owner for an agreed price. [22: G. Westring, Turnkey Heavy Plant Contracts from the Owners Point of View, (1990) 7 I.C.L.R. 234, at 235.]

The risk is mostly transferred from the owner, who responsible for setting only the conceptual specifications, to the EPC contractor, who is responsible for delivering the project for the agreed price. As a result, owners view EPC contracts favourably. The disadvantage is that the project may cost more because the con tractor will include a charge for risk in the price. Governments preclude this type in a bid to ensure the lowest price for infrastructure development. The acceptance of publicprivate partnerships and project finance means that EPC contracts have become more common in the development of public infrastructure.Engineering Procurement And Construction Management Projects (EPCM)In the engineering procurement and construction management (EPCM) contract, the owner of the project appoints a contractor to manage the engineering design, the procurement of the equipment and materials, and the management of the construction phase. Construction contractors and equipment suppliers perform the work required to build the project under supervisory management of the EPCM contractor. The EPCM contractor, who is paid on a cost reimbursable basis, acts on behalf of the owner, who retains responsibility for the project. (An EPCM contract should not be confused with an EPC contract. The EPC contract is to deliver the entire project, generally for a lump-sum price, while the EPCM contract is a design and management function, generally rewarded on a cost reimbursable basis.)A major difference between these contracts is the manner in which the risk is shared between the owner and the contractor. The three main forms of engineering contract share the construction and completion risk between parties differently. The owner retains most of the risk if it decides to manage the project itself or to appoint an EPCM contractor. The contractor accepts most of the risk in an EPC contract.Table 1: Sharing of risks between contractor and owner in a capital project[footnoteRef:23] [23: F.K. Crundwell, Finance for Engineers: Evaluation and Funding of Capital Projects, 533 (Springer Publications, London, 2008).]

Risk sharingTypes of contract

Risks retained by project ownerEngineering, procurement, and construction management (EPCM)Cost reimbursableProject managementFee for service

Risks shared with contractorAlliancePerformance incentiveConstruction management

Risks accepted by contractorLump-sum turnkeyFixed priceGuaranteed maximum priceEngineering, procurement and construction (EPC)

An EPC contractor is unlikely to accept responsibility for the engineering design package that has been prepared by the owner or on behalf of the owner by another contractor. The providers of such front-end engineering services will limit their liability to a percentage of fees.[footnoteRef:24] If it is suspected that there is a fault in the design, it is difficult to determine which of the parties is at fault. As a result, the owner does not divest himself of all risks through a lump-sum turnkey or EPC contract. [24: P.O. Marsh, Contracting for Engineering and Construction Projects, 252 (Institute of Purchasing & Supply, 1988).]

FIDIC AND TURNKEY CONTRACTSBalancing Of Risk Between Employer And ContractorFIDICs Red and Yellow Books (i.e. standard forms of contract for works of civil engineering construction and for electrical and mechanical works) have been in widespread use for several decades, and have been recognised among other things for their principles of balanced risk sharing between the Employer and the Contractor.[footnoteRef:25] These risk sharing principles have been beneficial for both parties, the Employer signing a contract at a lower price and only having further costs when particular unusual risks actually eventuate, and the Contractor avoiding pricing such risks which are not easy to evaluate. The principles of balanced risk sharing are continued in the new Construction and Plant and Design-Build Books. [25: Joseph A. Huse, Jonathan Kay Hoyle, FIDIC Design-Build, Turnkey and EPC Contracts, (1999) I.C.L.R. 27.]

During recent years it has been noticed that much of the construction market requires a form of contract where certainty of final price, and often of completion date, are of extreme importance.[footnoteRef:26] Employers on such turnkey projects are willing to pay more sometimes considerably more for their project if they can be more certain that the agreed final price will not be exceeded. Among such projects can be found many projects financed by private funds, where the lenders require greater certainty about a projects costs to the Employer than is allowed for under the allocation of risks provided for by FIDICs traditional forms of contracts. [26: Christopher Wade, The Silver Book: The Reality, 18 (3) I.C.L.R. 497 (2001).]

Often the construction project (the EPC Contract) is only one part of a complicated commercial venture, and financial or other failure of this construction project will jeopardize the whole venture. For such projects it is necessary for the Contractor to assume responsibility for a wider range of risks than under the traditional Red and Yellow Books.[footnoteRef:27] To obtain increased certainty of the final price, the Contractor is often asked to cover such risks as the occurrence of poor or unexpected ground conditions, and that what is set out in the requirements prepared by the Employer actually will result in the desired objective.[footnoteRef:28] If the Contractor is to carry such risks, the Employer obviously must give him the time and opportunity to obtain and consider all relevant information before the Contractor is asked to sign on a fixed contract price. [27: 1 Atkin Chambers, Hudsons Building And Engineering Contracts, 3.026, 426-428 (Sweet and Maxwell, 11th ed., 1995).] [28: Supra n. 15, at 37. ]

Employers ViewThe Employer must also realize that asking responsible contractors to price such risks will increase the construction cost and result in some projects not being commercially viable. Even under such contracts the Employer does carry certain risks such as the risks of war, terrorism and the like and the other risks of Force Majeure, and it is always possible, and sometimes advisable, for the Parties to discuss other risk sharing arrangements before entering into the Contract.[footnoteRef:29] [29: Supra n. 25, at 500.]

In the case of BOT (Build-Operate-Transfer) type projects, which are normally negotiated as a package, the allocation of risk provided for in the turnkey construction Contract negotiated initially between the Sponsors and the EPC Contractor may need to be adjusted in order to take into account the final allocation of all risks between the various contracts forming the total package.[footnoteRef:30] Apart from the more recent and rapid development of privately financed projects demanding contract terms ensuring increased certainty of price, time and performance, it has long been apparent that many employers, particularly in the public sector, in a wide range of countries have demanded similar contract terms, at least for turnkey contracts.[footnoteRef:31] They have often irreverently taken the FIDIC Red or Yellow Books and altered the terms so that risks placed on the Employer in the FIDIC Books have been transferred to the Contractor, thus effectively removing FIDICs traditional principles of balanced risk sharing. This need of many employers has not gone unnoticed, and FIDIC has considered it better for all parties for this need to be openly recognised and regularised. By providing a standard FIDIC form for use in such contracts, the Employer does not have to attempt to alter a standard form intended for another risk arrangement, and the Contractor is fully aware of the increased risks he must bear. Clearly the Contractor will rightly increase his tender price to account for such extra risks. This form for EPC/Turnkey Projects is thus intended to be suitable, not only for EPC Contracts within a BOT or similar type venture, but also for all the many projects, both large and smaller, particularly E & M (Electrical and Mechanical) and other process plant projects, being carried out around the world by all types of employers, often in a civil law environment, where the government departments or private developers wish to implement their project on a fixed-price turnkey basis and with a strictly two party approach. [30: Supra n.24, at 30.] [31: Supra n. 17, at 223.]

Contractors ViewEmployers using this form must realise that the Employers Requirements which they prepare should describe the principle and basic design of the plant on a functional basis. The Tenderer should then be permitted and required to verify all relevant information and data and make any necessary investigations.[footnoteRef:32] The Tenderer shall also carry out any necessary design and detailing of the specific equipment and plant he is offering, allowing him to offer solutions best suited to his equipment and experience.[footnoteRef:33] Therefore, the tendering procedure has to permit discussions between the Tenderer and the Employer about technical matters and commercial conditions. [32: Supra n. 20, 11.] [33: Supra n. 21, 237.]

All such matters, when agreed, shall then form part of the signed Contract. Thereafter the Contractor should be given freedom to carry out the work in his chosen manner, provided the end result meets the performance criteria[footnoteRef:34] specified by the Employer. Consequently, the Employer should only exercise limited control over and should in general not interfere with the Contractors work. Clearly the Employer will wish to know and follow progress of the work and be assured that the time programme is being followed. He will also wish to know that the work quality is as specified, that third parties are not being disturbed, that performance tests are met, and otherwise that the Employers Requirements are being complied with. A feature of this type of contract is that the Contractor has to prove the reliability and performance of his plant and equipment. Therefore special attention is given to the Tests on Completion, which often take place over a considerable time period, and Taking Over shall take place only after successful completion of these tests.[footnoteRef:35] [34: Supra n.15, 38.] [35: Supra n. 25, 503.]

EPC and PPPFIDIC recognizes that privatelyfinanced projects are usually subject to more negotiation than publicly-financed ones and that therefore changes are likely to have to be made in any standard form of contract proposed for projects within a BOT or similar type venture.[footnoteRef:36] Among other things, such form may need to be adapted to take account of the special, if not unique, characteristics of each project, as well as the requirements of lenders and others providing financing. Nevertheless, such changes do not do away with the need for a standard form. [36: n. 7, 273.]

These Conditions of Contract for EPC/Turnkey Projects are not suitable for use in the following circumstances: i. If there is insufficient time or information for tenderers to scrutinise and check the Employers Requirements or for them to carry out their designs, risk assessment studies and estimating (taking particular account of Sub-Clauses 4.12 and 5.1 of the Silver Book).ii. If construction will involve substantial work underground or work in other areas which tenderers cannot inspect. iii. If the Employer intends to supervise closely or control the Contractors work, or to review most of the construction drawings. iv. If the amount of each interim payment is to be determined by an official or other intermediary. FIDIC recommendations are that the Conditions of Contract for Plant and Design-Build be used in the above circumstances for Works designed by (or on behalf of) the Contractor.

Athens Generating Co. v. Bechtel Power Corp.A utility company has recovered liquidated damages from a contractor at the stipulated rate of $49,000 per day for each of three gas turbines. Although liquidated damages totalled $26,950,000, the daily rate was a reasonable forecast of the damages the project owner might incur as a result of late substantial completion of the generating units. Lower actual damages, calculated in hindsight, were of no consequence.BackgroundAthens Generating Company LL.P., was awarded a $522 million contract to Bechtel Power Corporation for engineering, procurement and construction (EPC) Contract of a 1080-megawatt merchant power plant in Athens, New York, on the upper Hudson River. The plant included three gas turbines to be manufactured by Siemens Westinghouse Power Corporation. The contract called for substantial completion of the project by no later than August 12, 2003 with liquidated damages of $49,000 per day for late completion of each of the three gas turbines. Bechtel did not achieve substantial completion until March 18, 2004. Athens refused to release the contract balance, assessing liquidated damages at the stipulated daily rate.Bechtel argued that it was not responsible for the late completion. Athens directed a number of product modifications and project betterments. Work was also delayed by a tornado and a regional power outage. And. Athens suspended the use of fuel gas for 35 days because of a spike in price.Bechtel also challenged the enforceability of the liquidated damages clause. The contractor said the daily rate of $49.000 per turbine constituted an impermissible penalty. The actual cost incurred by Athens because of the late completion was far less, so recovery at the stipulated rate would produce a windfall for the project owner. The entire dispute was submitted to arbitration, as called for in the terms of the contract.The RulingThe panel of arbitrators found that the product modifications and project betterments alleged by Bechtel were within the scope of Bechtels contract. The Siemens technology for the gas turbines was considered Immature and not yet proven in extensive commercial use. Bechtel was aware of this and assumed technology risk under the terms of the contract. This technology risk included the time and cost of implementing numerous product modifications during the course of Bechtels performance of its obligations under the EPC contract. To the extent that time delays and costs were caused by the implementation of these product modifications, such cost and time should be borne by Bechtel.The arbitrators addressed Bechtels complaint that sonic of the modifications were not necessary to achieve substantial completion. Yet the contractor was forced to proceed with the modifications, which further delayed completion. These were decisions that Siemens and Bechtel made for their own convenience. There was no directive from the project owner. And in any event, the activities were not on the critical path of the work.Bechtel fared better with its other excusable delay allegations. The tornado affected temporary power. Bechtel was entitled to a one-day extension on two of the three turbines. The regional blackout also shut down temporary power at the site. Bechtel was entitled to a two-day extension on all three turbines. And, the fuel gas suspension ordered by Athens delayed Bechtels work on all three turbines by 35 days. The Panel found that winter weather in 2002 constituted a Force Majeure event, under the EPC contract. However, with regard to Bechtels $9 million weather Force Majeure claim, it rejected the vast majority.Even after accounting for excusable delay, the arbitrators said Bechtel was responsible for 208 days of late completion on unit-1, 179 days on unit-2, and 148 days on unit-3. When the daily rate of $49,000 per turbine was applied, Bechtel was liable for liquidated damages of $26,950,000. The arbitrators discussed in detail Bechtels contention that the liquidated damages clause of the contract was an unenforceable penalty. The arbitrators noted that the contract was negotiated at arms length between two very experienced, sophisticated business entities. These clauses are enforceable if the daily rate represents a reasonable forecast, at the time of contract formation, of the actual damages the project owner might incur as a result of late completions. Bechtel presented an expert witness, Laurie Oppel, who testified regarding the economics of operating the generating plant at the time Bechtel claimed. But Athens disagreed, that the plant was substantially complete. The arbitrators described Oppel as a very qualified and candid witness. But said her opinion addressed the actual damages Athens incurred as a result of late completion rather than the estimate used at the time of contract formation. The fact that the quantum [of stipulated liquidated damages] may with the benefit of hindsight, be higher than the other party actually suffered is of no consequence.In contrast, Athens expert witness, Michael J. King, addressed the estimates used in arriving at the daily rate of $49.000 per turbine. King testified that this had been a reasonable forecast, at the time of contract formation, of the actual damages Athens might incur as a result of late completion. The arbitrators found this testimony credible and ruled that the liquidated damages clause in the contract was enforceable.The arbitrators said the contract balance was $28,303,747. When the liquidated damages of $26,950,000 were deducted, Bechtel was awarded $1,353,747 as force majeure damages from the tornedo. Athens submitted the final arbitration award to the Superior Court for the District of Columbia for confirmation.ConclusionAn authoritative and persuasive expert opinion is not effective if it does not address the necessary elements of recovery. In this case, an element as the reasonableness of the estimated actual damages was beyond the liquidated damages claimed by the owner, but such estimation was seen to be reasonable at the time of contract formation, neither parties can argue the claim of a clauses reasonability after the occurrence of the event.

Indiantown Cogeneration FacilityBechtel Power Corporation was awarded a fixed price turnkey construction contract for the Indiantown Cogeneration facility in Florida. Cogeneration refers to the production of electricity and steam from the same power plant. A fixed price of $438.7 million was agreed on for a guaranteed completion date of January 21, 1996. Three different definitions of completion were defined: (i) mechanical completion meant that all the materials and equipment required for the operation of the facility had been installed and operated safely; (ii) substantial completion meant that the facility met certain environmental requirements and could be operated at 88% of the net electrical output; and (iii) final completion meant that mechanical completion in addition to all performance tests. Substantial completion was to be met by the completion date, and final completion within one year of substantial completion. If final completion was not met by the guaranteed completion date, Bechtel would pay liquidated damages. The liquidated damages were limited to $100 million. The contract limited changes to the scope of the project. Construction was financed from four sources: (i) a bank loan of $202.6 million; (ii) tax-exempt bonds totalling $113 million; (iii) a $139 million loan from GE capital; and (iv) $100,000 of equity capital. The project was refinanced before completion of construction due to cost overruns during construction that called for additional capital. Bonds, called first mortgage bonds, were issued for the amount of $505million. In addition, new tax-exempt bonds amounting to $125million were issued. These funds were used to repay the bank loans, the earlier tax-exempt bonds, and the original loan from GE Capital. GE Capital was committed to funding $140 million of the construction costs. On completion, this loan would effectively be converted to equity, and the other partners would pay GE Capital for their share of the equity. Thus, the total capital on completion of the project would be $630million in debt from the mortgage bonds and the tax-exempt bonds, and $140 million in equity

McDermott International Inc. v. Burn Standard Co. LtdBackground In this case Burn Standard Company Limited (BSCL) and McDermott International Inc. (MII) entered into various agreements whereof, the latter undertook work in respect of fabrication, transportation and installation of structure, modules, platforms and pipeline components which was to be completed within 24 months. The aforesaid work was sub contracted to MII by BSCL as part of the main contract between BSCL and Oil and Natural Gas Commission (ONGC). BSCL was bound to MII through the terms of the agreements and to the extent that the provisions of the respective main contracts between ONGC and BSCL apply to the relevant sub-contract work of MII. BSCL through these agreements assumed towards MII all the obligations and responsibilities that ONGC, by such main contract, assumes towards BSCL insofar as applicable to the subcontract agreements.There was a delay in performance of the contract on default of BSCL, which led to various disputes and claim for damages by MII. The matter went in for arbitration. In its final award the arbitral panel allowed certain amount of damages along with interests to MII based on the evidences produced by them, which was disputed by the opposite parties, i.e, BSCL. For computation of damages the arbitration panel relied on the Emden Formula as argued by MII. The use of such formula was also disputed by BSCL and the award was challenged before the SC. For the first time the SC, broadly recognized and discussed in detail various formulae that may be used by the parties for computation of damages.The Ruling The SC discussed the following formulae which have been applied internationally for computation of damages in case of EPC contracts: 1. Hudson Formula: In Hudsons Building and Engineering Contracts, Hudson formula is stated in the following terms Contract Head Office overhead & profit x Contract sum x Period of delay100 Contract periodUsing the Emden formula, the head office overhead percentage is arrived at by dividing the total overhead cost and profit of the contractor's organization as a whole by the total turnover. This formula has the advantage of using the contractors actual head office and profit percentage rather than those contained in the contract. This formula has been widely applied and has received judicial support in a number of cases.2. Emden Formula: In Emdens Building Contracts and Practice, the Emden formula is stated in the following terms Head office overhead percentagex contract sum x period of delay100 contract period3. Eichleay Formula: This formula was evolved in America and derives its name from a case heard by the Armed Services Board of Contract Appeals, Eichleay Corporation. It is applied in the following manner Step 1: Original delayed contract price/Total billings for the actual delayed contract period x Indirect expenses for the actual delayed contract period = Indirect expenses allocable to the delayed contractStep 2: Indirect expenses allocable to the delayed contract/Actual days of delayed contract performance = Indirect expenses allocable to the delayed contract per day Step 3: Daily indirect rate x Number of delays = Unabsorbed Indirect expensesThis formula is used where it is not possible to prove loss of opportunity and the claim is based on actual cost. The Eichleay formula is regarded by the Federal Circuit Courts of America as the exclusive means for compensating a contractor for overhead expenses.The Supreme Court of India held that the Indian law does not restrict the use of internationally accepted formulae for computation of damages and the same is consistent with the principle enshrined under the Contract Act. Further, the list of formulae provided for in para 4 of the judgment were held not to be exhaustive and any other formulae can be adopted for computation of damages, depending on the evidences produced by the claimant. Therefore, the Supreme Court upheld the validity and use of Emden Formula by the arbitration panel in the present case for computation of damages which was carried on by experts in the field.ConclusionThe Supreme Court for the first time in McDermotts case above acknowledged the applicability of various internationally accepted formulae for computation of damages. Following this decision, many courts in India have applied the formulae discussed and considered by the Supreme Court above which were most apt as per the facts and circumstances of the case. For example, in Chennai Container Terminal Private Limited v. Board of Trustees[footnoteRef:37] and National Thermal Power Corporation Ltd. v. Wig Brothers Builders and Engineers Ltd.[footnoteRef:38], the courts upheld the applicability of one of the formulae as decided earlier. Mostly these formulae are brought in use at the stage of dispute resolution. As the use of a particular formula can be only ascertained taking in account the facts and circumstances of a particular case, these are not mentioned in the contract itself. The use of these standard formulae minimizes the scope of errors in computation of damages and instils confidence in the contracting parties over the security of their investments due to breach. However, there is a lot of scope for development in this field of law and its high time that proper guidelines are framed, analyzing various facts and circumstances under which a particular formula can be used for computation of damages in an EPC contract. [37: 2009(6) CTC 887.] [38: 2009 (2) Arb.LR 238 (Delhi)]

CONCLUSIONThe key aspects of an EPC Contract from the project-finance point of view are contract scope; commencement of the works ; contract price, payments, and variations ; construction supervision; Owners Risks (Compensation Events); Relief Events; definition of Project Completion; liquidated damages and termination; security; suspension and termination by the Construction Contractor; dispute resolution. There is no single standard form contract or set of contracts that serve as models for international projects. Instead, the parties are best served by identifying the array of relationships which comprise the project in its totality and seek to tailor each agreement to protect the respective parties interests and minimize their risks. For example BOT projects, the FIDIC Orange, Yellow, and Silver Books may all serve as a good starting point for the agreement between the employer and the contractor.A project finance transaction needs predictability, a hybrid construction contract has developed which requires the contractor to provide the complete scope of construction work for a project, for a fixed price, for completion and delivery by a date certain, which performs at agreed-upon levels. All the project company has to do is pay the construction price and turn the key. However, these EPC Contracts become contentious if the boiler-plate clauses are not clear and unambiguous, it would only enhance the financial risk content for the parties to the EPC Contract. Either party may suffer loss in the form of damages, either liquidated or unliquidated, upon breach of the contract, due to the obligation created upon the Contractor or the Employer. A legal advisor has to conduct proper due diligence to avoid or minimise the risk of unliquidated damages and reasonable liquidated damages. Nonetheless, for successful completion of a large scale EPC contract it becomes increasingly important for the contractors to develop their bearings in all aspects of a project like design, procurement, project management competencies, quick mobilization, construction and erection and also to possess new machinery and adopt technological advancements without delay, as it encourages hassle-free single point contracts.1 | Page