There is a swing away from the engineering, procurement, construction and management (EPCM) contracting model in South African construction and mining sectors. Instead, engineering, procurement and construction (EPC) contracts are increasingly being used, according to construction law specialist MDA Attorneys.
There is a difference and the consequences of choosing the wrong type of contract can be severe. While an EPC contract takes the form of a design and construction contract, the EPCM model can be regarded as a professional services contract. The EPCM contractor has a duty to ensure that the engineering and design of the project complies with the project’s technical and functional specifications.
Natalie Reyneke, director at MDA Attorneys, says, “In the mining industry as well as plant design and build or upgrade projects, EPC contracts are being used more frequently due to unprecedented risks and opportunities in the current economic climate, a very competitive market and a shortage of skills among clients (owners of the project).
“Cost and time overruns are common, so clients try to avoid assuming risk, especially when it is unlikely that project savings can be achieved. On the other hand, construction contractors are grateful for work secured and sometimes overlook the risks involved.”
In an EPC contract, the contractor needs to price and schedule for the entire project (design, engineering, procurement and construction services). The EPC contractor provides the tendered price and completion date, so clients are less likely to allow for any adjustments. Clients expect their projects to be completed in the time and within the costs calculated and supplied by the contractor. The client does not expect to take much risk and does not expect to pay any more than what was budgeted.
In contrast, the EPCM contractor provides a cost estimate and estimated duration of the work which are generally subject to contractual provisions, allowing for remeasurement and adjustment.
The client enters into multiple contracts on the advice of the EPCM contractor, so cost management is required on several contracts.
There are fundamental differences in terms of fixed price and remeasurable contracts, yet we are seeing EPC contracts being conflated by the insertion of ‘estimated’ budgets in pricing documents, while the conditions of contract are essentially an EPC lump sum contract. The two simply don’t speak to each other.
The EPC contractor sees no harm in signing a remeasurable subcontract, believing that they can manage the budget. However, the EPC contract usually contains numerous restrictions on their ability to claim additional compensation or time. Adding to the risk, the EPC contractor must ensure that agreements with subcontractors follow suit, as any additional costs incurred by subcontractors cannot be claimed from clients.
What to look out for
Another anomaly that we often see is the insertion into the pricing schedule of a ‘contingency’. While it sounds like a good idea, the conditions of contract do not provide for such a concept. We also regularly come across the phrase ‘fixed and firm’ when talking about pricing. This could mean either that there is no escalation on the prices making up the lump sum, or it’s intended to indicate the price of the project is a fixed lump sum and not subject to remeasurement.
Whose risk is it?
EPC contractors carry the risk of not completing the project on time and for the tendered price, whereas this risk is generally more evenly distributed between the client, the EPCM contractor and the appointed contractors or suppliers in an EPCM contract. It stands to reason that the EPC contractor is bound by the price and timelines it has offered to the client.
It is the contractor who designs and builds the works, so EPC contractors also assume the risk for performance. In addition, EPC contractors must manage the procurement and administration of supplies, professional services and subcontracts.
Skill and care
On the other hand, EPCM contractors do not contract with the construction contractors nor suppliers – the client does, and EPCM contractors only take risks in relation to these contracts if problems have arisen due to a lack of skill and care.
Because EPC contractors include the assumed risk in their pricing, EPC contracts are more costly to execute. In addition, the EPC contractor very often stands to benefit from any cost savings occurring on the project. In this way a well-negotiated, priced and executed EPC contract can result in significant benefits to the EPC contractor.
Expertise requirements differ
Under the EPCM model, clients usually appoint both an EPCM contractor (who provides professional services) and a construction contractor. Under the EPC model, the appointed contractor provides design, engineering, procurement and construction services. In addition, the EPC contractor appoints subcontractors to implement and complete the project.
Due to the nature of EPC contracts and client expectations for contractors to provide turnkey services, there is little involvement from the client and the projects are largely managed by the EPC contractor, who contracts directly with the suppliers and other subcontractors. Cost risk and control are weighted towards the EPC contractor and away from the client.
With in-house skills are in short supply currently, the use of an EPC contract allows the client to limit its involvement in the contract.
While there are several issues for contracting parties to consider when entering into and executing an EPC contract, alleviation of risks can be achieved with a clear understanding of what they are, a well-negotiated contract and a well-qualified tender submission.