EPC Contracts - Oil & Gas Sector

G O I N G B E Y O N D

August 2004

Introduction 3

Basic features of an oil and gas project 4The contractual structure 4Bankability 6

Basic features of an EPC contract 7

Split EPC contracts 11

Key oil and gas specific clauses 14in oil and gas EPC contractsGeneral interface issues 14Feedstock and product storage 14Interfacing of commissioning 15and testing regimesFeed stock specification issues 16Interface issues between a supply 17or offtaker and the EPC contractor

Key performance clauses in oil 18and gas EPC contractsRationale for imposing liquidated damages 18The law of liquidated damages 18Drafting of liquidated damages clauses 19Drafting of the performance guarantee regime 19

Key general clauses in EPC contracts 23Delay and extensions of time 23Exclusive remedies and fail safe clauses 26Force majeure 28Operation and maintenance 31Spare parts 31

Dispute resolution 33

Appendix 1 - Example clausePart I Performance testing and guarantee regimePart II Extension of time regime

Contents

Introduction

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IntroductionEngineering, Procurement and Construction (EPC)Contracts are a common form of contract used toundertake construction works by the private sectoron large scale and complex oil and gas projects.1

Under an EPC Contract a contractor is obliged todeliver a complete facility to a developer who needonly 'turn a key' to start operating the facility, henceEPC Contracts are sometimes called turnkeyconstruction contracts. In addition to delivering acomplete facility, the contractor must deliver thatfacility for a guaranteed price by a guaranteed dateand it must perform to the specified level. Failure tocomply with any requirements will usually result inthe contractor incurring monetary liabilities.

It is timely to examine EPC Contracts and their useon oil and gas projects given the bad publicity theyhave received, particularly in contracting circles. Anumber of contractors have suffered heavy lossesand, as a result, a number of contractors now refuseto enter into EPC Contracts in certain jurisdictions.This problem has been exacerbated by a substantialtightening in the insurance market. Constructioninsurance has become more expensive due both tosignificant losses suffered on many projects and theimpact of September 11 on the insurance market.Further, some project proponents believe that theproject delivery methods such as EPCM give themgreater flexibility and that they have the expertiseand experience required to control costs in an EPCM contract.

However, because of their flexibility, the value andthe certainty sponsors and lenders derive from EPCContracts the authors believe EPC Contracts willcontinue to be a pre-eminent form of constructioncontract used on large scale oil and gas projects inmost jurisdictions.2

This paper will only focus on the use of EPCContracts in the oil and gas sector. However, themajority of the issues raised are applicable to EPCContracts used in all sectors.

Prior to examining power project EPC Contracts indetail, it useful explore the basic features of an oiland gas project.

Footnotes1 By this we mean oil, gas and derivatives of the same such as

methanol, fertiliser etc. See also Roe, D., "LNG Trade: A Review

of Markets, Projects and Issues in the Changing World of LNG",

SMI Publishing Ltd, London on at page 119.2 Some jurisdictions, such as the USA, use alternative structures

which separate the work into various components.

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The detailed contractual structure will vary fromproject to project. However, most projects will havethe basic structure illustrated above.4 As can be seenfrom the diagram, the operating company willusually enter into agreements which cover thefollowing elements:

� An operating agreement with the Joint VentureParticipants (JV) which gives the operatingcompany the right to construct and operate the

oil and gas facility. Usually, each JV participant willsell its own share of the product. This is even thecase if participants jointly market the product.Traditionally the operating agreement is a JointOperating Agreement (JOA) between the JVparticipants whereby one of the participantsoperates the facility.

There is a significant advantage in this structure as it means that one body is responsible for the

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Basic features of an oil and gas project

The contractual structureThe diagram below illustrates the basic contractual structure of a simple project financed oil and gas project using an EPC Contract.3

O&M Contractor Oil or Gas SupplierOfftaker

Possibly one or more of the JV participants

Financing and Security

Agreements

Tripartite Agreements

Operating

Agreement

EPC

Contract

O&M

Contract

Offtake

Agreement

Equity Support

Agreement

LendersProject Company / Oil and Gas Field Operator

Joint venture

EPC Contractor

delivery of projects, relationships with Government,customers and contractors. The JOA governs howliability is spread amongst participants with respectto any liabilities or obligations incurred by theOperator. Generally, the participants have severalliability and the Operator makes cash calls on themin proportion to their respective JV shares to fundcapital expenditure. As special purpose vehicle canalso be created to fulfil this role but usually thecontrol of this vehicle will be in the hands of oneof the JV participants.

� Many oil and gas companies are large companiesand many projects are financed from the balancesheet without finance. However, this is not alwaysthe case. There are a number of small companieslooking to develop assets that are regarded asstranded or too small for large companies tooperate profitably. These companies need financeto carry out these developments. In these casesthe EPC Contractor is required to be a large,experienced participant in the industry who thesponsors and lenders are confident can successfullydeliver the project and is large enough to copewith losses if it does not. Further, companies witha successful track record means that insurance forthe project is easier to obtain. The larger Ownerswill still use an EPC Contract or Design andConstruct Contract for parts of large projects evenif self management, EPCM or Project Managementare used for the greater project.

� There are a number of contractual approaches thatcan be taken to construct an oil and gas facility.An EPC Contract is one approach. Another optionis to have a supply contract, a design agreementand construction contract with or without a projectmanagement agreement. The projectmanagement can be, and often is, carried out bythe proponent itself. Alternatively, an EPCM orproject management contract can be used for themanagement. The choice of contracting approachwill depend on a number of factors including thetime available, the lender�s requirements, thesophistication of the proponent and the identity of the contractor(s). The major advantage of theEPC Contract over the other possible approaches is that it provides for a single point of responsibility.This is discussed in more detail below.

Interestingly, on large project financed derivativeprojects the contractor is increasingly becomingone of the sponsors ie: an equity participant in theproject company. This is not the case in traditionaloil and gas projects. Contractors will ordinarily selldown their interest after financial close because,generally speaking, contractors will not wish to tie up their capital in operating projects. In addition,once construction is complete the rationale forhaving the contractor included in the ownershipconsortium often no longer exists. Similarly, onceconstruction is complete a project will normally be reviewed as lower risk than a project inconstruction, therefore, all other things beingequal, the contractor should achieve a good return on its investments.

� Large over arching Operating and MaintenanceAgreements ("O&M Agreement") are uncommonin the oil and gas industry. Industry participantsare generally in the business of managing thesefacilities. However, components of the operationsare usually contracted out.

� Off take agreements govern the sale of the productof the project. For gas projects and hydrocarbonderivative projects these agreements are crucial tothe development proceeding. Financiers will not lendthe funds and boards will not approve the project ifthere are no customers locked in to take the product.The impact of the offtake agreement is on practicalcompletion. If there are take or pay agreements it isvital that the project is ready to deliver product frominception date of the off-take agreement or it willface penalties. It may even have to buy product onthe open market to meet its obligations. As thesemarkets are usually thinly traded these can be acostly exercise. Oil projects can be under pinned bylong term contracts but it is not the norm.

� Financing and security agreements with the lendersto finance the development of the project.

Accordingly, the construction contract is only one of a suite of documents on an oil and gas project.Importantly, the promoter or the JV participants ofthe project operate and earn revenues undercontracts other than the construction contract.Therefore, the construction contract must, wherepractical, be tailored so as to be consistent with the

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requirements of the other project documents. As a result, it is vital to properly manage the interfacesbetween the various types of agreements. Theseinterface issues are discussed in more detail later in this paper.

BankabilityA bankable contract is a contract with a riskallocation between the contractor and the projectcompany that satisfies the lenders. Lenders focus on the ability (or more particularly the lack thereof)of the contractor to claim additional costs and/orextensions of time as well as the security provided by the contractor for its performance. The lesscomfortable the lenders are with these provisions thegreater amount of equity support the sponsors willhave to provide. In addition, lenders will have to besatisfied as to the technical risk. Obviously price isalso a consideration but that is usually consideredseparately to the bankability of the contract becausethe contract price (or more accurately the capital costof the project facility) goes more directly to theeconomic bankability of the project as a whole.

Before examining the requirements for bankability itis worth briefly considering the appropriate financingstructures and lending institutions. Historically, themost common form of financing for oil and gasprojects is project financing. Project financing is ageneric term that refers to financing secured only by the assets of the project itself. Therefore, therevenue generated by the project must be sufficientto support the financing. Project financing is alsooften referred to as either "non-recourse" financingor "limited recourse" financing.

The terms "non-recourse" and "limited recourse" are often used interchangeably, however, they meandifferent things. "Non-recourse" means there is norecourse to the project sponsors at all and "limitedrecourse" means, as the name suggests, there islimited recourse to the sponsors. The recourse islimited both in terms of when it can occur and howmuch the sponsors are forced to contribute. Inpractice, true non-recourse financing is rare. In mostprojects the sponsors will be obliged to contributeadditional equity in certain defined situations.

Traditionally project financing was provided bycommercial lenders. However, as projects became

more complex and financial markets moresophisticated project finance also developed. In addition, as well as bank borrowings sponsors are also using more sophisticated products like creditwrapped bonds, securitisation of future cash flowsand political, technical and completion risk insuranceto provide a portion of the necessary finance.

In assessing bankability lenders will look at a range offactors and assess a contract as a whole. Therefore,in isolation it is difficult to state whether oneapproach is or is not bankable. However, generallyspeaking the lenders will require the following:

� a fixed completion date;

� a fixed completion price;

� no or limited technology risk;

� output guarantees;

� liquidated damages for both delay and performance;

� security from the contractor and/or its parent;

� large caps on liability (ideally, there would be nocaps on liability, however, given the nature of EPCcontracting and the risks to the contractors involvedthere are almost always caps on liability); and

� restrictions on the ability of the contractor to claimextensions of time and additional costs.

An EPC Contract delivers all of the requirementslisted above in one integrated package. This is oneof the major reasons why they are the predominantform of construction contract used on large scaleproject financed infrastructure projects and why theycan be effective on a variety of oil and gas projects.

Footnotes3 An LNG Project would also usually involve a shipping deal and/or

pipeline aspects.4 Even if the project is developed by a large conglomerate there are

usually contracts between the various entities. For example, where

the proponent will also be the supplier there will often be a supply

agreement put in place so that the new project is properly defeasible

and business property accountable?.

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The key clauses in any construction contract arethose which impact on:

� time; � cost; and� quality.

The same is true of EPC Contracts. However, EPCContracts tend to deal with issues with greatersophistication than other types of constructioncontracts. This is because, as mentioned above, an EPC Contract is designed to satisfy the lenders'requirements for bankability.

EPC Contracts provide for:� A single point of responsibility. The contractor

is responsible for all design, engineering,procurement, construction, commissioning andtesting activities. Therefore, if any problems occurthe project company need only look to one party - the contractor - to fix the problem and providecompensation. As a result, if the contractor is aconsortium comprising several entities the EPCContract must state that those entities are jointlyand severally liable to the project company.

� A fixed contract price. Risk of cost overruns and the benefit of any cost savings are to thecontractor's account. The contractor usually has a limited ability to claim additional money which is limited to circumstances where the projectcompany has delayed the contractor or has ordered variations to the works.

� A fixed completion date. EPC Contracts include aguaranteed completion date that is either a fixeddate or a fixed period after the commencement ofthe EPC Contract. If this date is not met thecontractor is liable for delay liquidated damages("DLDs"). DLDs are designed to compensate theproject company for loss and damage suffered as a result of late completion of the facility. To be enforceable in common law jurisdictions,5 DLDsmust be a genuine pre-estimate of the loss ordamage that the project company will suffer if the facility is not completed by the target completiondate. The genuine pre-estimate is determined byreference to the time the contract was entered into.

DLDs are usually expressed as a rate per day whichrepresents the estimated extra costs incurred (such as extra insurance, supervision fees and financingcharges) and losses suffered (revenue forgone) foreach day of delay.

In addition, the EPC Contract must provide for the contractor to be granted an extension of timewhen it is delayed by the acts or omissions of theproject company. The extension of timemechanism and reasons why it must be includedare discussed on page 38.

� Performance guarantees. The projectcompany's revenue will be earned by operating the facility. Therefore, it is vital that the facilityperforms as required in terms of output, efficiencyand reliability. Therefore, EPC Contracts containperformance guarantees backed by performanceliquidated damages ("PLDs") payable by thecontractor if it fails to meet the performanceguarantees.

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Basic features of an EPC contract

PLDs must also be a genuine pre-estimate of the lossand damage that the project company will sufferover the life of the project if the facility does notachieve the specified performance guarantees. Aswith DLDs, the genuine pre-estimate is determinedby reference to the time the contract was signed.

It is possible to have a separate contract that sets out the performance requirements, testing regimeand remedies. However, this can create problemswhere the EPC and the performance guarantees do not match. In our view, the preferred option is to have the performance guarantees in the EPCcontract itself.

PLDs and the performance guarantee regime andits interface with the DLDs and the delay regime is discussed in more detail in the section on keyperformance clauses.

� Caps on liability. As mentioned above most EPCcontractors will not, as a matter of company policy,enter into contracts with unlimited liability.Therefore, EPC Contracts for oil and gas projectscap the contractor's liability at a percentage of thecontract price. This varies from project to project,however, a cap of 100% of the contract price iscommon. In addition, there are normally sub-capson the contractor's liquidated damages liability.For example, DLDs and PLDs might each be cappedat 20% of the contract price with an overall capon both types of liquidated damages of 30% ofthe contract price.

There will also likely be a prohibition on theclaiming of consequential damages. Put simplyconsequential damages are those damages whichdo not flow directly from a breach of contract butwhich were in the reasonable contemplation of theparties at the time the contract was entered into.This used to mean heads of damage like loss ofprofit. However, loss of profit is now usuallyrecognised as a direct loss on project financedprojects and, therefore, would be recoverableunder a contract containing a standard exclusion of consequential loss clause. Nonetheless, careshould be taken to state explicitly that liquidateddamages can include elements of consequentialdamages. Given the rate of liquidated damages is pre-agreed most contractors will not object tothis exception.

In relation to both caps on liability and exclusion of liability it is common for there to be someexceptions. The exceptions may apply to either or both the cap on liability and the prohibition on claiming consequential losses. The exceptionsthemselves are often project specific, however,some common examples include in cases of fraudor wilful misconduct, in situations where theminimum performance guarantees have not beenmet and the cap on delay liquidated damages hasbeen reached and breaches of the intellectualproperty warranties.

� Security. It is standard for the contractor toprovide performance security to protect the projectcompany if the contractor does not comply with itsobligations under the EPC Contract. The securitytakes a number of forms including:

� a bank guarantee or bond for a percentage,normally in the range of 5-15%, of the contractprice. The actual percentage will depend on anumber of factors including the other securityavailable to the project company, the paymentschedule (because the greater the percentageof the contract price unpaid by the projectcompany at the time it is most likely to draw onsecurity ie: to satisfy DLD and PLD obligationsthe smaller the bank guarantee can be), theidentity of the contractor and the risk of it notproperly performing its obligations, the price of the bank guarantee and the extent of thetechnology risk;

� retention ie: withholding a percentage (usually5%-10%) of each payment. Provision is oftenmade to replace retention monies with a bankguarantee (sometimes referred to as a retentionguarantee (bond));

� advance payment guarantee, if an advancepayment is made; and

� a parent company guarantee - this is aguarantee from the ultimate parent (or othersuitable related entity) of the contractor whichprovides that it will perform the contractor'sobligations if, for whatever reason, thecontractor does not perform.

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� Variations. The project company has the right toorder variations and agree to variations suggestedby the contractor. If the project company wantsthe right to omit works either in their entirety or tobe able to engage a different contractor this mustbe stated specifically. In addition, a properlydrafted variations clause should make provision forhow the price of a variation is to be determined.In the event the parties do not reach agreement on the price of a variation the project company orits representative should be able to determine theprice. This determination is subject to the disputeresolution provisions. In addition, the variationsclause should detail how the impact, if any, on theperformance guarantees is to be treated. For somelarger variations the project company may alsowish to receive additional security. If so, this mustalso be dealt with in the variations clause.

� Defects liability. The contractor is usually obligedto repair defects that occur in the 12 to 24 monthsfollowing completion of the performance testing.Defects liability clauses can be tiered. That is theclause can provide for one period for the entirefacility and a second, extended period, for morecritical items.

� Intellectual property. The contractor warrantsthat it has rights to all the intellectual propertyused in the execution of the works and indemnifiesthe project company if any third parties' intellectualproperty rights are infringed.

� Force majeure. The parties are excused fromperforming their obligations if a force majeureevent occurs. This is discussed in more detail on page 28.

� Suspension. The project company usually has the right to suspend the works.

� Termination. This sets out the contractualtermination rights of both parties. The contractorusually has very limited contractual terminationrights. These rights are limited to the right toterminate for non-payment or for prolongedsuspension or prolonged force majeure and will befurther limited by the tripartite or direct agreementbetween the project company, the lenders and thecontractor. The project company will have more

extensive contractual termination rights. They willusually include the ability to terminate immediatelyfor certain major breaches or where the contractorbecomes insolvent and the right to terminate aftera cure period for other breaches. In addition, theproject company may have a right to terminate forconvenience. It is likely the project company'sability to exercise its termination rights will also belimited by the terms of the financing agreements.

� Performance specification. Unlike a traditionalconstruction contract, an EPC Contract usuallycontains a performance specification. Theperformance specification details the performancecriteria that the contractor must meet, but doesnot dictate how they must be met. This is left tothe contractor to determine. A delicate balancemust be maintained. The specification must bedetailed enough to ensure the project companyknows what it is contracting to receive but not sodetailed that if problems arise the contractor canargue they are not its responsibility.

Whilst there are, as described above, numerousadvantages to using an EPC Contract, there are somedisadvantages. These include the fact that it canresult in a higher contract price than alternativecontractual structures. This higher price is a result of a number for factors not least of which is theallocation of almost all the construction risk to thecontractor. This has a number of consequences, one of which is that the contractor will have to factorinto its price the cost of absorbing those risks. Thiswill result in the contractor building contingenciesinto the contract price for events that areunforeseeable and/or unlikely to occur. If thosecontingencies were not included the contract pricewould be lower. However, the project companywould bear more of the risk of those unlikely orunforeseeable events. Sponsors have to determine,in the context of their particular project, whether the increased price is worth paying.

As a result, sponsors and their advisers must criticallyexamine the risk allocation on every project. Riskallocation should not be an automatic process.Instead, the project company should allocate risk in a sophisticated way that delivers the most efficientresult. For example, if a project is being undertakenin an area with unknown geology and without the

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time to undertake a proper geotechnical survey, theproject company may be best served by bearing thesite condition risk itself as it will mean the contractordoes not have to price a contingency it has no wayof quantifying. This approach can lower the riskpremium paid by the project company. Alternatively,the opposite may be true. The project company maywish to pay for the contingency in return for passingon the risk which quantifies and caps its exposure.This type of analysis must be undertaken on all majorrisks prior to going out to tender.

Another consequence of the risk allocation is the fact that there are relatively few engineering andconstruction companies that can and are willing to enter into EPC Contracts. As mentioned in theIntroduction some bad publicity and a tighteninginsurance market have further reduced the pool of potential EPC Contractors. The scarcity of EPC Contractors can also result in relatively highcontract prices.

Another major disadvantage of an EPC Contractbecomes evident when problems occur duringconstruction. In return for receiving a guaranteedprice and a guaranteed completion date, the projectcompany cedes most of the day-to-day control overthe construction. Therefore, project companies havelimited ability to intervene when problems occurduring construction. The more a project companyinterferes during the construction, the greater thelikelihood of the contractor claiming additional timeand costs. In addition, interference by the projectcompany will make it substantially easier forcontractors to defeat claims for liquidated damagesand defective works.

Obviously, ensuring the project is completedsatisfactorily is usually more important thanprotecting the integrity of the contractual structure.However, if a project company interferes with theexecution of the works they will, in mostcircumstances, have the worst of both worlds. They will have a contract that exposes them toliability for time and costs incurred as a result of theirinterference without any corresponding ability tohold the contractor liable for delays in completion or defective performance. The same problems occureven where the EPC Contract is drafted to give theproject company the ability to intervene. In many

circumstances, regardless of the actual drafting, if the project company becomes involved indetermining how the contractor executes the worksthen the contractor will be able to argue that it is notliable for either delayed or defective performance.

As a result, it is vitally important that great care istaken in selecting the contractor and in ensuring thecontractor has sufficient knowledge and expertise toexecute the works. Given the significant monetaryvalue of EPC Contracts, and the potential adverseconsequences if problems occur during construction,the lowest price should not be the only factor usedwhen selecting contractors.

Footnotes5 For the purposes of this paper, we have assumed the EPC contract

will be governed by the law of a common law jurisdiction. Where

there are differences between jurisdictions we have adopted the

English law approach. Therefore, if an EPC Contract is governed by

a law other than English law you will need to seek advice from local

counsel to ensure the contract is enforceable in the relevant

jurisdiction. For example, in both the PRC and Malaysia liquidated

damages amounts specified in a contract may be subsequently altered

by a court. If a party can show that the liquidated damages amounts

will either under or in some cases over compensate a party the court

can adjust the damages payable so they more accurately reflect the

actual damage suffered by a party.

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There are two main reasons for using a split contract.The first is because it can result in a lower contractprice as it allows the contractor to make savings inrelation to onshore taxes; in particular on indirect andcorporate taxes in the onshore jurisdiction. Thesecond is because it may reduce the cost ofcomplying with local licensing regulations by havingmore of the works, particularly the design works,

undertaken offshore.7 In addition, in some countrieswhich impose restrictions on who can carry outcertain activities like engineering and design services,splitting the EPC Contract can also be advantageousbecause it can make it easier to repatriate profits.Below is a diagram illustrating a more complex splitEPC structure we have used previously that dealtwith both tax and licensing issues.

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Split EPC contracts

One common variation, particularly in Asia, on the basic EPC structure illustrated above is a split EPC Contract.Under a split EPC Contract, the EPC Contract is, as the name implies, split into two or more separate contracts.

The basic split structure (illustrated below) involves splitting the EPC Contract into an Onshore ConstructionContract and an Offshore Supply Contract.6

Example simple split EPC structure

OffshoreContractor

OnshoreContractor

Wrap-AroundGuarantee

Project Company

GUARANTOR

OnshoreContract

OffshoreContract

Example split EPC structure

Whilst a split EPC Contract can result in cost savings,there are risks to the project company in using such a structure. This mainly arises because of thederogation from the principle of single point responsibility.

Unlike a standard EPC Contract, the project companycannot look only to a single contractor to satisfy allthe contractual obligations (in particular, design,construction and performance). Under a splitstructure, there are at least two entities with thoseobligations. Therefore, a third agreement, a wrap-around guarantee,8 is used to deliver a singlepoint of responsibility despite the split.

Under a wrap-around guarantee, an entity, usuallyeither the offshore supplier or the parent company of the contracting entities, guarantees the obligationsof both contractors. This delivers a single point ofresponsibility to the project company and the lenders.The contracting entities will then enter into aseparate agreement to determine how, as betweenthemselves, liability is to be apportioned. However,that agreement is not relevant for the purposes ofthis paper.

In addition, the wrap-around guarantee will, ifproperly drafted, prevent the various contractorsfrom relying on the defaults of the other parties

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GuaranteeAgreement

Wrap-AroundGuarantee

GuaranteeAgreement

GUARANTOR

Offshore Guarantor PROJECT COMPANY B(only onshore entity) Onshore Guarantor

Project ManagementAgreement

ConstructionContract

Design ReviewContract

D(an offshore entity)

E(an offshore entity)

F(an offshore entity)

DesignAgreement

EquipmentSupply Contract

C(an offshore entity)

C(an offshore entity)

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to avoid performing their contractual obligations - a tactic known as a "horizontal defence". Thewrap-around guarantee should also prevent acontractor from relying on the project company'sdefault where the project company's default was a result, either directly or indirectly, of the nonperformance, under performance or delay inperformance of any of the other contractors undertheir respective contracts.

In addition to horizontal defences, the wrap-aroundguarantee should deal with the following matters:

� Guarantees and indemnities - the guarantor mustguarantee the performance of the totality of theworks and the ability of the separate parts to work seamlessly.

� Liquidated damages - this is linked to the issue of horizontal defences discussed above. The wrap-around guarantee must ensure thatliquidated damages are paid regardless of whichcontractor is late and which contractor fails toperform. Similarly, the aggregate cap of liability in the wrap-around guarantee must override anycaps on liability in the split contracts themselves.

� Provision of a performance bond by the guarantoror its parent. It is usually prudent to have theguarantor provide security for their obligationsunder the wrap-around guarantee. This may be in addition to or in replacement of the securityprovided under the EPC Contracts themselves. It will depend on the particular requirements of each project.

� Liability (and limitation of liability) of the guarantor- the guarantor's liability should be equal to theaggregate liability of the contracting entities underthe split EPC Contracts.

� Duration of the wrap-around guarantee - thewrap-around guarantee should remain in force foras long as possible to offer the project companyadditional protection in the event latent defectsoccur. In any event, it should remain in force untilthe expiry of the defects liability period or theresolution of any dispute arising out of or inconnection with the construction of the facility,whichever is the later.

� Dispute resolution - the procedures should beidentical to those in the project documents andallow the project company to consolidate claims.

� Termination - termination of an EPC Contractshould automatically terminate the other EPCContract(s) and the Wrap-Around Guarantee(except in respect of accrued liability).

� Tax indemnity - ideally the contractor(s) shouldindemnify the project company for any taxes orpenalties payable as a result of the split.

In addition, the wrap-around guarantee shouldcontain provisions dealing with the practicalconsequences of splitting the contract and how thecontracts and the project should be administered.For example, there should also be clauses dealingwith more mundane issues like notices. Noticesissued under one contract should be deemed to be notices under the other contracts.

Whenever an EPC Contract is split the primary driverboth of the general structure of the split and theparticular drafting approach must be achieving a tax effective structure. Therefore, tax advice fromexperts in the relevant jurisdiction must be obtainedand those experts must review the split contracts and the wrap-around guarantee.

Footnotes6 We have prepared a paper that deals with the variations and

complications in split EPC Contracts. You should consult that paper

if you want more information on this topic. 7 Modularisation is now a common form of construction and is an

example where a split EPC contract may be particularly appropriate.8 This is also called a Co-ordination Agreement, an Administration

Agreement or an Umbrella Deed.

General interface issuesAs noted in the previous section, an EPC Contract isone of a suite of agreements necessary to develop anoil and gas project. Therefore, it is vital that the EPCContract properly interfaces with those otheragreements. In particular, care should be taken to ensure the following issues interface properly:

� commencement and completion dates;

� liquidated damages amounts and trigger points;

� caps on liability;

� indemnities;

� entitlements to extensions of time;

� insurance;

� force majeure; and

� intellectual property.

Obviously, not all theses issues will be relevant for allagreements. In addition to these general interfaceissues that apply to most types of projects, there arealso oil and gas project issues that must beconsidered. These issues are many and varied anddepend largely on the nature of the project. Forexample, on a methanol project the facility must be ready and able to accept feed stock, process it to meet rigorous occupational health, safety andenvironmental guidelines and export methanol tomeet supplier and customer demands and

contractual obligations. An oil project handling a light sweet crude is usually more simple. They are discussed in more detail below.

Some major oil and gas specific interface issues are:

� Access for the contractor to the feed stock and to a receiving vessel9 to allow timely completion of construction, commissioning and testing.

� Consistency of commissioning and testing regimes.

� Feed stock, product and by-product (such asgreenhouse emissions) specification requirements.

� Interface issues between the relevant governmentagencies and system operator and the contractor.In particular, whilst the project company mustmaintain a long term/comfortable relationship with either the Government or the system operatorthe contractor does not.

Feedstock and product storageUsually, EPC Contracts will not provide for thehandover of the facility to the project company untilall commissioning and reliability trialling has beensuccessfully completed.10 This raises the importantissue of the supply of feed stock and otherconsumables (such as water) and receipt of productduring testing and commissioning and the need forthe EPC Contract to clearly define the obligations ofthe project company in providing feed stock andsufficient storage or product demand to fully andproperly commission and test the facility.

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Key oil and gas specific clauses in oil and gas EPC contracts

Lenders need to be able to avoid the situation wherethe project company's obligation to ensure feedstock and storage (or demand) is uncertain. This willresult in protracted disputes with the contractorconcerning the contractor's ability to commission andtest the facility at design conditions and to obtainextensions of time in situations where delay has beencaused as a result of the failure or otherwise of theproject company to provide sufficient (or sufficientquality) feed stock or storage.

With respect to the obligation to ensure theavailability of sufficient feed stock, the projectcompany is the most appropriate party to bear thisrisk vis-à-vis the contractor, since the projectcompany usually either builds the infrastructure itselfor has it provided through the relevant SupplyAgreement. Issues that must be considered include:

(a) where is the feed stock from, an existing facilityor a new facility?

(b) if it is a new facility, what is the timing forcompletion of that facility - will it fit in with thetiming under the EPC Contract? What are therisks, and what can be done if it is not finished?

(c) what happens if insufficient feed stock is availableor not available at all? Contractors will usuallywant the test to be deemed complete in thesecircumstances.

(d) what happens if the feed stock does not meetthe specification? The Contract should providean adjustment mechanism to cope with this.

With respect to the contractor's ability to exportproduct, the EPC Contract must adequately deal with this risk and satisfactorily answer the followingquestions to ensure the smooth testing,commissioning and achieving commercial operation:

(a) what is the extent of the product exportobligation? It will usually be an obligation toprovide storage or demand for the product for a fixed period of time.

(b) what is the timing for the commencement of thisobligation? Does the obligation cease at therelevant target date of completion? If not, doesits nature change after the date has passed?

(c) what is the obligation of the project company toprovide demand or storage in cases where theContractor's commissioning / plant is unreliable - is it merely a reasonableness obligation?

(d) what happens if the project company fails toprovide sufficient storage or demand?Contractors will usually seek to have the testdeemed complete.

Many EPC Contracts are silent on these matters orraise far more questions than they actually answer.Given that the project company's failure will stemfrom restrictions imposed on it under its supply orofftake agreements, the best answer is to back toback the project company's obligations under theEPC Contract (usually to provide an extension of time and / or costs) with its supply and off-takeagreements. This approach will not eliminate the risk associated with commissioning and testing issuesbut will make it more manageable.

Our experience in a variety of projects has taught us that the issue of availability and quality of feedstock and availability of storage or demand is amatter which must be resolved at the contractformation stage.

Interfacing of commissioning and testing regimesIt is also important to ensure the commissioning and testing regimes in the EPC Contract mirror therequirements of any supply and offtake agreements.Mismatches only result in delays, lost revenue andliability for damages under the EPC Contract, supplyor off-take agreements, all of which have thepotential to cause disputes. This is even moreimportant where the EPC Contract is part of a largerdevelopment, say a methanol plant on the back of a new gas processing plant. For example, the gasprocessing plant might need the methanol plant totake its product as much as the methanol plantneeds its product. If the interface is not carefullythought through and agreed in the contracts thenthis interface becomes a ripe area for disputes.

Testing/trialling requirements under any relatedcontracts must provide the necessary projectcompany satisfaction under the EPC Contract andthe off take and supply contracts. Relevant testingissues which must be considered include:

15

� Will any related facilities be required for the tests/trialling?

� Is there consistency between obtaining handoverfrom the Contractor under the EPC Contract andcommercial operation. It is imperative to ensurethat there is a sufficient window for the EPCContract facility and any related facilities to betested. Contractors will usually want anagreement that where the testings/trials cannot beundertaken, through no fault of its own, in areasonable time frame the test/trials are deemed tobe completed. It must not be forgotten thatvarious certifications will be required at the lenderlevel. The last thing the lenders will want is theprocess to be held up by their own requirementsfor certification. To avoid delays and disruption it isimportant that the lenders' engineer is acquaintedwith the details of the project and, in particular,any potential difficulties with the testing regime.Therefore, any potential problems can be identifiedearly and resolved without impacting on thecommercial operation of the facility.

� Is the basis of the testing to be undertakenmirrored under both the EPC Contract and relatedfacility? Using the methanol example above, is thegas processing plant required to produce the samequality gas that the methanol plant is to be tested/trialled, and ultimately operated on?11

� On what basis are various environmental tests to be undertaken?

� What measurement methodology is being used?Are the correction factors to be applied under therelevant documents uniform? Are references tointernational standards or guidelines to a particularedition or version?

� Are all tests necessary for the contractor tocomplete under the EPC Contract able to beperformed as a matter of practice?

Significantly, if the relevant specifications are linkedto guidelines such as the international environmentalguidelines, consideration must be given to changeswhich may occur in these guidelines. The EPCContract reflects a snapshot of the standards existingat a time when that contract was signed. It may bea number of years post that date in which the actual

construction of the project is undertaken thusallowing for possible mismatches should thelegislative/guidelines have changed as regardsenvironmental concerns. It is important that there is certainty as to which standard applies. Is it thestandard at the time of entering the EPC Contract or is it the standard which applies at the time of testing?

Consideration must therefore be given to theappropriate mechanism to deal with potentialmismatches between the ongoing obligation ofcomplying with laws, and the contractor's obligationto build to a specification agreed at a previous time.Consideration must be given to requiring satisfactionof guidelines "as amended from time to time".12

The breadth of any change of law provision will be at the forefront of any review.

The above issues raise the importance of the testingschedules to the EPC Contract. The size andimportance of the various projects to be undertakenmust mean that the days where schedules areattached at the last minute without being subject to review are gone they are part and parcel of theEPC Contract.

Discrepancies between the relevant testing andcommissioning requirements will only serve to delayand distract all parties from the successfulcompletion of testing and reliability trials.

These are all areas where lawyers can add value tothe successful completion of projects by being alertto and dealing with such issues at the contractformation stage.

Feed stock specification issuesThe nature of the feed stock to be supplied to thecontractor under the EPC Contract is also anotherimportant issue. Where there is a supply agreement13

it is vitally important that adequate review is done atthe EPC Contract level to ensure that the feed stockbeing provided under the supply agreement meetsthe requirements of the EPC Contract. Similarconsideration will need to be given to any projectcompany where it will be supplying the feed stockitself. This is a common area of dispute where thefacility fails to meet the specification in test/trials.

16

Differing feed stock specification requirements canonly result in delay, cost claims and extension of time claims at the EPC Contract level. Feed stockspecification issues will be hidden away in theschedules. Again, watch out for those schedules.

In addition, where certain tests require specific typesor quality of feed stock the review should check thatthere are arrangements in place for that type ofquality of feed stock to be provided. If thespecification calls for a wide range of feed stock and provision is made for it to be tested as such, itwill be meaningless if the test cannot be undertaken.For example, the production plan might show anincrease in a certain contaminant over the life of theproject so a test on the lower quality feedstock maybe appropriate, but only if it is possible to do so.

Interface issues between a supply or offtakerand the EPC contractor At a fundamental level, it is imperative that theappropriate party corresponds with the relevantsupplier or offtaker/system operator duringconstruction on issues such as the provision of off-take facilities / feedstock requirements/testingrequirements and timing.

The project company must ensure the EPC Contractstates clearly that it is the appropriate party tocorrespond with the supplier or offtaker and thesystem operator. Any uncertainty in the EPCContract may unfortunately see the EPC contractordealing with the supplier or offtaker and/or thesystem operator thus possibly risking the relationshipof the project company with its customer.Significantly, it is the project company which mustdevelop and nurture an ongoing and long termrelationship with the offtaker. On the other hand, it is the contractor's prime objective to complete the project on time or earlier at a cost which providesit with significant profit. The clash of theseconflicting objectives in many cases does not allowfor such a smooth process. Again, the resolution of these issues at the EPC Contract formation stageis imperative.

Footnotes9 Or a sufficient source of demand.10 Some owners will, however, carry out the commissioning themselves.11 This sounds basic but it has been a relatively common error. The

same issue arises if the testing, using this example, was contingent

on another related facility being able to accept some or all of

the product.12 It is often the case that if amendments to the design are required

as a result the Contractor will be entitled to extensions of time

and/or variations.13 As opposed to the situations of the operator of the new plant also

supplying the feed stock, which presents its own problems.

17

Rationale for imposing liquidated damages Almost every construction contract will imposeliquidated damages for delay and impose standardsin relation to the quality of construction. Most,however, do not impose PLDs. EPC Contracts imposePLDs because the achievement of the performanceguarantees has a significant impact on the ultimatesuccess of a project. Similarly, it is important that thefacility commences operation on time because of theimpact on the success of the project and because ofthe liability the project company will have underother agreements, This is why DLDs are imposed.DLDs and PLDs are both 'sticks' used to motivate the contractor to fulfil its contractual obligations.

The law of liquidated damagesAs discussed above, liquidated damages must be a genuine pre-estimate of the project company's loss. If liquidated damages are more then a genuinepre-estimate they will be a penalty andunenforceable. There is no legal sanction for settinga liquidated damages rate below that of a genuinepre-estimate, however, there are the obvious financial consequences.

In addition to being unenforceable as a penalty,liquidated damages can also be void for uncertaintyor unenforceable because they breach the preventionprinciple. Void for uncertainty means, as the termsuggests, that it is not possible to determine how theliquidated provisions work. In those circumstances, a court will void the liquidated damages provisions.

The prevention principle was developed by the courtsto prevent employers ie: project companies fromdelaying contractors and then claiming DLDs. It is

discussed in more detail below in the context ofextensions of time.

Prior to discussing the correct drafting of liquidateddamages clauses to ensure they are not void orunenforceable it is worth considering theconsequences of an invalid liquidated damagesregime. If the EPC Contract contains an exclusiveremedies clause the result is simple - the contractorwill have escaped liability unless the contract containsan explicit right to claim damages at law if theliquidated damages regime fails. This is discussed in more detail on page 26.

If, however, the EPC Contract does not contain anexclusive remedies clause the non-challenging partyshould be able to claim at law for damages they have suffered as a result of the challenging party'snon or defective performance. What then is theimpact of the caps in the now invalidated liquidateddamages clauses?

Unfortunately, the position is unclear in common law jurisdictions, and a definitive answer cannot beprovided based upon the current state of authority.It appears the answer varies depending uponwhether the clause is invalidated due to its characteras a penalty, or because of uncertainty orunenforceability. Our view of the current position is set out below. We note that whilst the legalposition is not settled the position presented belowdoes appear logical.

� Clause invalidated as a penaltyWhen liquidated damages are invalidated becausethey are a penalty (ie: they do not represent a

18

Key performance clauses in oil and gasEPC contracts

genuine pre-estimate of loss), the cap on liquidateddamages will not act as a cap on damages claimsat general law. We note that it is rare for a courtto find liquidated damages are penalties incontracts between two sophisticated, well advised parties.

� Clause invalidated due to acts of prevention by the principal A liquidated damages clause will cap thecontractor's liability where a liquidated damagesregime breaches the prevention principle becausethis gives effect to the commercial bargain struckby the parties.

� Clause void for uncertainty A liquidated damages clause which is uncertain issevered from the EPC Contract in its entirety, andwill not act as a cap on the damages recoverableby the principal from the contractor. Uponseverance, the clause is, for the purposes ofcontractual interpretation, ignored.

However, it should be noted that the threshold testfor rendering a clause void for uncertainty is high,and courts are reluctant to hold that the terms of acontract, in particular a commercial contract whereperformance is well advanced, are uncertain.

Drafting of liquidated damages clausesGiven the role liquidated damages play in ensuringEPC Contracts are bankable, and the consequencesdetailed above of the regime not being effective, it isvital to ensure they are properly drafted to ensurecontractors cannot avoid their liquidated damagesliability on a legal technicality.

Therefore, it is important, from a legal perspective, toensure DLDs and PLDs are dealt with separately. If acombined liquidated damages amount is levied forlate completion of the works, it risks being struck outas a penalty because it will overcompensate theproject company. However, a combined liquidateddamages amount levied for underperformance mayunder compensate the project company.

Our experience shows that there is a greaterlikelihood of delayed completion than there is ofpermanent underperformance. One of the reasonswhy projects are not completed on time is

contractors are often faced with remedyingperformance problems. This means, from a legalperspective, if there is a combination of DLDs andPLDs, the liquidated damages rate should includemore of the characteristics of DLDs to protect againstthe risk of the liquidated damages being found to be a penalty.

If a combined liquidated damages amount includes a NPV or performance element the contractor will be able to argue that the liquidated damages are not a genuine pre-estimate of loss when liquidateddamages are levied for late completion only.However, if the combined liquidated damagescalculation takes on more of the characteristics of DLDs the project company will not be properlycompensated if there is permanentunderperformance.

It is also important to differentiate between thedifferent types of PLDs to protect the projectcompany against arguments by the contractor thatthe PLDs constitute a penalty. For example, if asingle PLDs rate is only focused on output and notefficiency, problems and uncertainties will arise if theoutput guarantee is met but one or more of theefficiency guarantees are not. In thesecircumstances, the contractor will argue that thePLDs constitute a penalty because the loss the projectcompany suffers if the efficiency guarantees are notmet are usually smaller than if the output guaranteesare not met.

Drafting of the performance guarantee regimeNow that it is clear that DLDs and PLDs must be dealtwith separately it is worth considering, in moredetail, how the performance guarantee regimeshould operate. A properly drafted performancetesting and guarantee regime is important becausethe success or failure of the project depends, allother things being equal, on the performance of theoil and gas facility.

The major elements of the performance regime are:

� testing;� guarantees; and � liquidated damages.

19

Liquidated damages were discussed above. Testingand guarantees are discussed below.

TestingPerformance tests may cover a range of areas. Three of the most common are:

Functional tests - these test the functionality ofcertain parts of the facility. For example, pumps,valves, pressure vessels etc. They are usually discretetests which do not test the facility as a whole.Liquidated damages do not normally attach to thesetests. Instead, they are absolute obligations thatmust be complied with. If not, the facility will notreach the next stage of completion (for example,mechanical completion or provisional acceptance).

Emissions tests - these test compliance againstenvironmental requirements. Again, these arenormally absolute obligations because theconsequences of failure can be as severe as beingforced to shut down the facility. These tests shouldensure the most stringent obligations imposed on theproject company, whether by government regulationsor by lenders, are met. Emissions tests occur atvarious times, including during and after guaranteetests. Liquidated damages are sometimes levied ifthe contractor fails the emissions tests. However,given emissions tests are usually related toenvironmental approvals, it is likely that the facilitywill not be able to operate if the emissions tests arefailed. Therefore, passing the emissions tests isusually an absolute obligation not linked toliquidated damages.

Guarantee tests - these test the ability of the facilityto meet the performance criteria specified in thecontract. There are often minimum and guaranteedlevels of performance specified and, as discussedabove, providing the minimum levels are met theconsequence of failure is normally the payment ofPLDs. Satisfaction of the minimum performanceguarantees14 is normally an absolute obligation. Theminimum performance guarantees should be set at alevel of performance at which it is economic toaccept the Facility. Lender's input will be vital indetermining what is this level. However, it must beremembered that lenders have different interests tothe sponsors. Lenders will, generally speaking, beprepared to accept a facility that provides sufficient

income to service the debt. However, in addition tocovering the debt service obligations, sponsors willalso want to receive a return on their equityinvestment. If that will not be provided via the saleof product because the contractor has not met theperformance guarantees, the sponsors will have torely on the PLDs to earn their return. In someprojects, the guarantee tests occur after hand over of the facility to the project company. This meansthe contractor no longer has any liability for DLDsduring performance testing.

In our view, it is preferable, especially in projectfinanced projects, for handover to occur aftercompletion of performance testing. This means thecontractor continues to be liable for DLDs until eitherthe facility operates at the guaranteed level or thecontractor pays PLDs where the facility does notoperate at the guaranteed level.15 Obviously, DLDswill be capped (usually at 20% of the Contract Price)therefore, the EPC Contract should give the projectcompany the right to call for the payment of thePLDs and accept the facility. If the project companydoes not have this right the problem mentionedabove will arise, namely, the project company will nothave received its facility and will not be receiving anyDLDs as compensation.

It is common for the contractor to be given anopportunity to modify the facility if it does not meetthe performance guarantees on the first attempt.This is because the PLD amounts are normally verylarge and most contractors would prefer to spendthe time and the money necessary to remedyperformance instead of paying PLDs. Not givingcontractors this opportunity will likely lead to anincreased contract price both because contractors willover engineer the facility and will build a contingencyfor paying PLDs into the contract price. The secondreason is because in most circumstances the projectcompany will prefer to receive a facility that operatesat 100% capacity and efficiency. The right to modifyand retest is another reason why DLDs should bepayable up to the time the performance guaranteesare satisfied.

If the contractor is to be given an opportunity tomodify and retest the EPC Contract must deal withwho bears the costs of the additional feed stock and

20

consumables required to undertake the retesting.The cost of the feed stock in particular can besignificant and should, in normal circumstances, be to the contractor's account because the retestingonly occurs if the performance guarantees are notmet at the first attempt.

Technical issuesIdeally, the technical testing procedures should be setout in the EPC Contract. However, for a number ofreasons, including the fact that it is often notpossible to fully scope the testing program until thedetailed design is complete, the testing proceduresare usually left to be agreed during construction bythe contractor, the project company's representativeor engineer and, if relevant, the lenders' engineer.However, a properly drafted EPC Contract shouldinclude the guidelines for testing.

The complete testing procedures must, as aminimum, set out details of:

� Testing methodology - reference is often made to standard methodologies, for example, theAmerican Society of Mechanical Engineersmethodology.

� Testing equipment - who is to provide it, where it is to be located, how sensitive must it be.

� Tolerances - what is the margin of error.

� Ambient conditions - what atmosphericconditions are assumed to be the base case (testing results will need to be adjusted to take into account any variance from these ambientconditions).

� Steady State testing - using ordinary parameters to avoid running the plant at unsustainable shortterm rates.

Provision of consumables and feed stockThe responsibility for the provision of consumablesand feed stock required to carry out the performancetests must be clearly set out in the EPC Contract. Ingeneral, the project company will be responsible forthe provision of both consumables and feed stock.

As the proper interpretation of the project company'sobligation to supply consumables is often a matter ofdispute between the project company and contractor,it is important for the EPC Contract to preciselyidentify the quality and quantity of consumables tobe provided as well as the time for provision of thoseconsumables (which should be linked to the progressof the works rather than a specific date). Theresponsibility for the cost of providing consumablesand feed stock must also be clearly identified. This is discussed in more detail in the section on feedstock specification issues.

An example of the performance testing andguarantee regime we have used on a number of projects is included in Appendix 1 of this paper.

These example clauses are only extracts from acomplete contract and ideally should be read as partof that entire contract and, in particular, with theclauses that deal with DLDs, PLDs, liability, the scopeof the Contractor's obligations, including any fitnessfor purpose warranties and termination.Nonetheless, they do provide an example of the way a performance testing and liquidated damagesregime can operate.

The process is best illustrated diagrammatically. Referto the flowchart below to see how the various partsof the performance testing regime should interface.

Footnotes14 This can be in the form of steady state testing.15 It can be term that handover will not occur until the performance

guarantees are met there will be a regime by which this may waived.

21

Performance guarantees and testing

22

The Plant has or is deemed to have reached Mechanical Completion.

Contractor commences Functional Tests, Emission Testsand Performance Tests.

Has any ofthe Functional Tests, Emission

Tests or Performance Tests beeninterrupted or terminated for

any reason?

Particular Functional Tests, Emission Testsor Performance Tests must be restarted.Yes

Did Owner'sRepresentative or Contractor

order cessation of functional Tests, EmissionTests or Performance Tests due to damage to

the Works, other property or personal injury being likely to result

from continuation?

Has the Plantfailed to pass any of the

Functional Tests, Emission Tests orPerformance Tests or have any

such Tests been stoppedbefore its completion?

Contractor must repeat particular Functional Tests, EmissionTests or Performance Tests, subject to 24 hours prior notice

from Contractor to Owner's Representative.

All appropriate adjustments and modifications to be made by Contractor with all reasonable speed and at its own expense prior to repetition of any Functional Tests,

Emission Tests or Performance Tests.Contractor must produce and present written report of results

of the Functional Tests, Emission Tests and PerformanceTests within 7 days of completion of the Functional Tests,

Emission Tests or Performance Tests.

No

Yes

No

Yes

No

Contractor to pay appropriatePerformance Liquidated Damages.

Has the MinimumRated Output Performance

Guarantee and the Minimum NetHeat Rate Performance Guarantee

been met duringPerformance Tests?

Has the Ownerissued a Substantial

Completion Certificate eventhough all of the requirements

have not been met?

No

Have the MinimumPerformance Guarantees beenmet before reaching the cap on

Delay Liquidated Damages.

Contractor to payfull Delay Liquidated

Damages (cap value).

Has the Rated OutputPerformance Guarantee been met

during the Performance Tests?

Has the Contractorelected to pay Performance

Liquidated Damages before theexpiry of the Extended Testing

Period?

Has the Ownerrequired the

Contractor to pay PerformanceLiquidated Damages before the

expiry of the ExtendedTesting Period?

Has the MaximumRated Output Performance

Guarantees been met beforethe expiry of the Extended

Testing Period?

Contractor to pay pro rataDelay Liquidated Damages

and appropriatePerformance LiquidatedDamages and Owner to

issue SubstantialCompletion Certificate.

Contractor to pay fullDelay Liquidated

Damages (cap value) andappropriate PerformanceLiquidated Damages and

Owner to issueSubstantial Completion

Certificate.

Contractor to pay prorata Delay LiquidatedDamages and Ownerto issue Substantial

CompletionCertificate.

Completion

No No

No No

AND

No

Yes

Yes

Yes Yes No

Yes

Yes

Owner's Representative must evaluate and approve resultswith no allowances for measurement tolerances over and

above the ISO test standard.

Delay and extensions of time

The prevention principleAs noted previously, one of the advantages of an EPC Contract is that it provides the project companywith a fixed completion date. If the contractor failsto compete the works by the required date they areliable for DLDs. However, in some circumstances thecontractor is entitled to an extension of the date forcompletion. Failure to grant that extension can voidthe liquidated damages regime and 'set time atlarge'. This means the contractor is only obliged to complete the works within a reasonable time.

This is the situation under common law governedcontracts16 due to the prevention principle. Theprevention principle was developed by the courts to prevent employers ie: project companies fromdelaying contractors and then claiming DLDs.

The legal basis of the prevention principle is unclearand it is uncertain whether you can contract out ofthe prevention principle. Logically, given mostcommentators believe the prevention principle is an equitable principle, explicit words in a contractshould be able to override the principle. However,the courts have tended to apply the preventionprinciple even in circumstances where it would not,on the face of it, appear to apply. Therefore, there isa certain amount of risk involved in trying to contractout of the prevention principle. The more prudentand common approach is to accept the existence of the prevention principle and provide for it the EPC Contract.

The contractor's entitlement to an extension of timeis not absolute. It is possible to limit the contractor'srights and impose pre-conditions on the ability of thecontractor to claim an extension of time. A relativelystandard extension of time (EOT) clause would entitlethe contractor to an EOT for:

� an act, omission, breach or default of the projectcompany;

� suspension of the works by the project company(except where the suspension is due to an act oromission of the contractor);

� a variation (except where the variation is due to an act or omission of the contractor); and

� force majeure,

which cause a delay on the critical path17 and aboutwhich the contractor has given notice within theperiod specified in the contract. It is permissible (and advisable) to make both the necessity for thedelay to impact the critical path and the obligation to given notice of a claim for an extension of timeconditions precedent to the contractor's entitlementto receive an EOT. In addition, it is usually goodpractice to include a general right for the projectcompany to grant an EOT at any time. However, this type of provision must be carefully draftedbecause some judges have held (especially when theproject company's representative is an independentthird party) the inclusion of this clause imposes amandatory obligation on the project company to

23

Key general clauses in EPC contracts

grant an extension of time whenever it is fair andreasonable to do so, regardless of the strictcontractual requirements. It must be made clear that the project company has complete andabsolute discretion to grant an EOT, and that it is not required to exercise its discretion for the benefitof the Contractor.

Similarly, following some recent common lawdecisions, the contractor should warrant that it willcomply with the notice provisions that are conditionsprecedent to its right to be granted an EOT.

We recommend using the clause in Part II ofAppendix 1.

Concurrent delayYou will note that in the suggested EOT clause, oneof the subclauses refers to concurrent delays. This isrelatively unusual because most EPC Contracts aresilent on this issue. For the reasons explained belowwe do not agree with that approach.

A concurrent delay occurs when two or more causesof delay overlap. It is important to note that it is theoverlapping of the causes of the delays not theoverlapping of the delays themselves. In ourexperience, this distinction is often not made. Thisleads to confusion and sometimes disputes. Moreproblematic is when the contract is silent on theissue of concurrent delay and the parties assume the silence operates to their benefit. As a result ofconflicting case law it is difficult to determine who,in a particular fact scenario, is correct. This can alsolead to protracted disputes and outcomes contrary to the intention of the parties.

There are a number of different causes of delaywhich may overlap with delay caused by thecontractor. The most obvious causes are the acts or omissions of a project company.

A project company may have obligations to providecertain materials or infrastructure to enable thecontractor to complete the works. The timing forthe provision of that material or infrastructure (andthe consequences for failing to provide it) can beaffected by a concurrent delay.

For example, the project company may be obliged, asbetween the project company and the contractor, toprovide a pipeline or vessel to connect to the facilityby the time the contractor is ready to commission thefacility. Given the construction of the pipeline or thechartering of a vessel can be expensive, the projectcompany is likely to want to incur that expense asclose as possible to the date commissioning is due tocommence. For this reason, if the contractor is indelay the project company is likely to further delayincurring the expense of building the pipeline orchartering the vessel. In the absence of a concurrentdelay clause, this action by the project company, inresponse to the contractor's delay, could entitle thecontractor to an extension of time.

Concurrent delay is dealt with differently in thevarious international standard forms of contract.Accordingly, it is not possible to argue that oneapproach is definitely right and one is definitelywrong. In fact, the 'right' approach will depend on which side of the table you are sitting.

In general, there are three main approaches for dealing with the issue of concurrent delay. These are:

� Option one - the contractor has no entitlement toan extension of time if a concurrent delay occurs.

� Option two - the contractor has an entitlement toan extension of time if a concurrent delay occurs.

� Option three - the causes of delay areapportioned between the parties and thecontractor receives an extension of time equal to the apportionment. For example, if the causesof a 10 day delay are apportioned 60:40 projectcompany : contractor, the contractor would receivea 6 day extension of time.

Each of these approaches is discussed in more detail below.

Option One: Contractor not entitled to an extensionof time for concurrent delays A common, project company friendly, concurrentdelay clause for this option one is:

24

"If more than one event causes concurrent delaysand the cause of at least one of those events, butnot all of them, is a cause of delay which would notentitle the Contractor to an extension of time under[EOT Clause], then to the extent of theconcurrency, the Contractor will not be entitled to an extension of time."

The most relevant words are bolded.

Nothing in the clause prevents the contractor fromclaiming an extension of time under the generalextension of time clause. What the clause does do is to remove the contractor's entitlement to anextension of time when there are two or more causesof delay and at lease one of those causes would notentitle the contractor to an extension of time underthe general extension of time clause.

For example, if the contractor's personnel were onstrike and during that strike the project companyfailed to approve drawings, in accordance with thecontractual procedures, the contractor would not be entitled to an extension of time for the delaycaused by the project company's failure to approvethe drawings.

The operation of this clause is best illustrateddiagrammatically.

Example 1: Contractor not entitled to an extensionof time for project company caused delay

In this example, the contractor would not be entitledto any extension of time because the ContractorDelay 2 overlap entirely the Project Company Delay.Therefore, using the example clause above, thecontractor is not entitled to an extension of time tothe extent of the concurrency. As a result, at the endof the Contractor Delay 2 the contractor would be in8 weeks delay (assuming the contractor has not, atits own cost and expense accelerated the Works).

Example 2: Contractor entitled to an extension oftime for project company caused delay

In this example, there is no overlap between thecontractor and Project Company Delay Events thecontractor would be entitled to a two weekextension of time for the project company delay.Therefore, at the end of the Project Company Delay the contractor will remain in six weeks delay,assuming no acceleration.

Example 3: Contractor entitled to an extension of time for a portion of the project company caused delay

In this example, the contractor would be entitled to a one week extension of time because the delaysoverlap for one week. Therefore, the contractor isentitled to an extension of time for the period whenthey do not overlap ie: when the extent of theconcurrency is zero. As a result, after receiving theone week extension of time, the contractor would be in seven weeks delay, assuming no acceleration.

From a project company's perspective, we believe,this option is both logical and fair. For example, if, inExample 2 the Project Company Delay was a delay inthe approval of drawings and the Contractor Delaywas the entire workforce being on strike, what logicis there in the contractor receiving an extension oftime? The delay in approving drawings does notactually delay the works because the contractorcould not have used the drawings given its workforcewas on strike. In this example, the contractor would

25

Contractor Delay 1Contractor Delay 2

Project Company Delay

6 weeks 2 weeks1 week

Contractor DelayEvent

6 weeks 2 weeks

Project Company DelayEvent

Delay

Contractor Delay 1Contractor Delay 2

Project Company Delay

6 weeks2 weeks

2 weeks

suffer no detriment from not receiving an extensionof time. However, if the contractor did receive anextension of time it would effectively receive awindfall gain.

The greater number of obligations the projectcompany has the more reluctant the contractor willlikely be to accept option one. Therefore, it may notbe appropriate for all projects.

Option Two: Contractor entitled to an extension of time for concurrent delaysOption two is the opposite of option one and is theposition in many of the contractor friendly standardforms of contract. These contracts also commonlyinclude extension of time provisions to the effect that the contractor is entitled to an extension of time for any cause beyond its reasonable controlwhich, in effect, means there is no need for aconcurrent delay clause.

The suitability of this option will obviously depend onwhich side of the table you are sitting. This option isless common than option one but is nonethelesssometimes adopted. It is especially common whenthe contractor has a superior bargaining position.

Option Three: Responsibility for concurrent delays is apportioned between the partiesOption three is a middle ground position that hasbeen adopted in some of the standard formcontracts. For example, the Australian Standardsconstruction contract AS4000 adopts theapportionment approach. The AS4000 clause states:

"34.4 Assessment

When both non qualifying and qualifying causesof delay overlap, the Superintendent shallapportion the resulting delay to WUC accordingto the respective causes' contribution.

In assessing each EOT the Superintendent shalldisregard questions of whether:

a) WUC can nevertheless reach practicalcompletion without an EOT; or

b) the Contractor can accelerate, but shall haveregard to what prevention and mitigation of thedelay has not been effected by the Contractor."

We appreciate the intention behind the clause andthe desire for both parities to share responsibility forthe delays they cause. However, we have someconcerns about this clause and the practicality of theapportionment approach in general. It is easiest todemonstrate our concerns with an extreme example.For example, what if the qualifying cause of delaywas the project company's inability to provide accessto the site and the non-qualifying cause of delay wasthe contractor's inability to commence the worksbecause it had been black banned by the unions.How should the causes be apportioned? In thisexample, the two causes are both 100% responsiblefor the delay.

In our view, an example like the above where both parties are at fault has two possible outcomes. Either:

� the delay is split down the middle and thecontractor receives 50% of the delay as anextension of time; or

� the delay is apportioned 100% to the projectcompany and therefore the contractor receives100% of the time claimed.

The delay is unlikely to be apportioned 100% to thecontractor because a judge or arbitrator will likelyfeel that that is 'unfair', especially if there is apotential for significant liquidated damages liability.We appreciate the above is not particularly rigorouslegal reasoning, however, the clause does not lenditself to rigorous analysis.

In addition, option three is only likely to be suitable if the party undertaking the apportionment isindependent from both the project company and the contractor.

Exclusive remedies and fail safe clauses It is common for contractors to request the inclusionof an exclusive remedies clause in an EPC Contract.However, from the perspective of a project company,the danger of an exclusive remedies clause is that itprevents the project company from recovering anytype of damages not specifically provided for in theEPC Contract.

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An EPC Contract is conclusive evidence of theagreement between the parties to that contract. If a party clearly and unambiguously agrees that theironly remedies are those within the EPC Contract,they will be bound by those terms. However, thecourts have been reluctant to come to this conclusionwithout clear evidence of an intention of the partiesto the EPC Contract to contract out of their legalrights. This means if the common law right to suefor breach of EPC Contract is to be contractuallyremoved, it must be done by very clear words.

Contractor's perspectiveThe main reason for a contractor insisting on aproject company being subject to an exclusiveremedies clause is to have certainty about itspotential liabilities. The preferred position for acontractor will be to confine its liabilities to what is specified in the EPC Contract. For example, anagreed rate of liquidated damages for delay and,where relevant, underperformance of the facility. A contractor will also generally require the amount of liquidated damages to be subject to a cap and for the EPC Contract to include an overall cap on its liability.

Project company's perspectiveThe preferred position for a project company is for it not to be subject to an exclusive remedies clause.An exclusive remedies clause limits the projectcompany's right to recover for any failure of thecontractor to fulfill its contractual obligations tothose remedies specified in the EPC Contract. Forthis reason, an exclusive remedies clause is anillogical clause to include in an EPC Contract fromthe perspective of a project company because itmeans that the project company has to draft aremedy or exception for each obligation - thisrepresents an absurd drafting position. For example,take the situation where the EPC Contract does nothave any provision for the recovery of damages otherthan liquidated damages. In this case, if thecontractor has either paid the maximum amount of liquidated damages or delivered the facility in a manner that does not require the payment ofliquidated damages (ie it is delivered on time andperforms to specification) but subsequent to thatdelivery the project company is found to have aclaim, say for defective design which manifests itself

after completion, the project company will have noentitlement to recover any form of damages as anyremedy for latent defects has been excluded.

The problem is exacerbated because most claimsmade by a project company will in some way relateto performance of the facility and PLDs wereexpressed to be the exclusive remedy for any failureof the facility to perform in the required manner. Forexample, any determination as to whether the facilityis fit for purpose will necessarily depend on the leveland standard of the performance of the facility. Inaddition to claims relating to fitness for purpose, aproject company may also wish to make claims for,amongst other things, breach of contract, breach of warranty or negligence. The most significant riskfor a project company in an EPC Contract is wherethere is an exclusive remedies clause and the onlyremedies for delay and underperformance areliquidated damages. If, for whatever reason, theliquidated damages regimes are held to be invalid,the project company would have no recourse againstthe contractor as it would be prevented fromrecovering general damages at law, and thecontractor would escape liability for late delivery and underperformance of the facility.

Fail safe clausesIn contracts containing an exclusive remedies clause,the project company must ensure all necessaryexceptions are expressly included in the EPCContract. In addition, drafting must be included to allow the project company to recover generaldamages at law for delay and underperformance ifthe liquidated damages regimes in the EPC Contractare held to be invalid. To protect the position of aproject company (if liquidated damages are found for any reason to be unenforceable and there is anexclusive remedies clause), we recommend thefollowing clauses be included in the EPC Contract:

"[ ].1 If clause [delay liquidated damages] isfound for any reason to be void, invalid orotherwise inoperative so as to disentitle theProject company from claiming Delay LiquidatedDamages, the Project company is entitled to claimagainst the Contractor damages at law for theContractor's failure to complete the Works by theDate for Practical Completion.

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[ ].2 If [ ].1 applies, the damages claimed by theProject company must not exceed the amountspecified in Item [ ] of Appendix [ ] for any oneday of delay and in aggregate must not exceedthe percentage of the EPC Contract Pricespecified in Item [ ] of Appendix [ ]."

These clauses (which would also apply to PLDs) meanthat if liquidated damages are held to beunenforceable for any reason the project companywill not be prevented from recovering generaldamages at law. However, the amount of damagesrecoverable at law may be limited to the amount ofliquidated damages that would have beenrecoverable by the project company under the EPCContract if the liquidated damages regime had notbeen held to be invalid (see discussion in 6.2 above).For this reason, the suggested drafting should becommercially acceptable to a contractor as its liabilityfor delay and underperformance will be the same asoriginally contemplated by the parties at the time ofentering into the EPC Contract.

In addition, if the EPC Contract excludes the partiesrights to claim their consequential or indirect losses,these clauses should be an exception to thatexclusion. The rationale being that the rates ofliquidated damages are likely to include an elementof consequential or indirect losses.

Force majeure

What is force majeure?Force majeure clauses are almost always included inEPC Contracts. However, they are rarely given muchthought unless and until one or more parties seek torely on them. Generally, the assumption appears to bethat "the risk will not affect us" or "the force majeureclause is a legal necessity and does not impact on ourrisk allocation under the contract". Both of theseassumptions are inherently dangerous, and, particularlyin the second case, incorrect. Therefore, especially inthe current global environment, it is appropriate toexamine their application.

Force majeure is a civil law concept that has no realmeaning under the common law. However, forcemajeure clauses are used in contracts because theonly similar common law concept - the doctrine offrustration - is of limited application. For that

doctrine to apply the performance of a contract mustbe radically different from what was intended by theparties. In addition, even if the doctrine does apply,the consequences are unlikely to be thosecontemplated by the parties. An example of howdifficult it is to show frustration is that many of theleading cases relate to the abdication of King EdwardVIII before his coronation and the impact that had oncontracts entered into in anticipation of thecoronation ceremony.

Given force majeure clauses are creatures of contracttheir interpretation will be governed by the normalrules of contractual construction. Force majeureprovisions will be construed strictly and in the eventof any ambiguity the contra proferentem rule willapply. Contra proferentem literally means "againstthe party putting forward". In this context, it meansthat the clause will be interpreted against theinterests of the party that drafted and is seeking torely on it. The parties may contract out of this rule.

The rule of ejusdem generis which literally means "of the same class" may also be relevant. In otherwords, when general wording follows a specific listof events, the general wording will be interpreted inlight of the specific list of events. In this context itmeans that when a broad 'catch-all' phrase, such as 'anything beyond the reasonable control of theparties', follows a list of more specific force majeureevents the catch all phrase will be limited to eventsanalogous to the listed events. Importantly, partiescannot invoke a force majeure clause if they arerelying on their own acts or omissions.

The underlying test in relation to most force majeureprovisions is whether a particular event was withinthe contemplation of the parties when they madethe contract. The event must also have been outsidethe control of the contracting party. There aregenerally three essential elements to force majeure:

� it can occur with or without human intervention;

� it cannot have reasonably been foreseen by theparties; and

� it was completely beyond the parties' control andthey could not have prevented its consequences.

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Given the relative uncertainty surrounding themeaning of force majeure we favour explicitlydefining what the parties mean. This takes thematter out of the hands of the courts and givescontrol back to the parties. Therefore, it isappropriate to consider how force majeure riskshould be allocated.

Drafting force majeure clausesThe appropriate allocation of risk in projectagreements is fundamental to negotiations betweenthe project company and its contractors. Risksgenerally fall into the following categories:

� risks within the control of the project company;

� risks within the control of the contractor; and

� risks outside the control of both parties.

The negotiation of the allocation of many of the risksbeyond the control of the parties, for example, latentsite conditions and change of law, is usually verydetailed so that it is clear which risks are borne bythe contractor. The same approach should beadopted in relation to the risks arising from events of force majeure.

There are 2 aspects to the operation of force majeure clauses:

� the definition of force majeure events; and

� the operative clause that sets out the effect on theparties' rights and obligations if a force majeureevent occurs.18

The events which trigger the operative clause mustbe clearly defined. As noted above, given thecommon law meaning of the term force majeure is not certain and is open to interpretation of thecourts, it is in the interests of both parties to ensurethat the term force majeure is clearly defined.

The preferred approach for a project company is todefine force majeure events as being any of theevents in an exhaustive list set out in the contract. In this manner, both parties are aware of whichevents are force majeure events and which are not.Clearly, defining force majeure events makes the

administration of the contract and, in particular, themechanism within the contract for dealing with forcemajeure events simpler and more effective.

An example exhaustive definition is:

"An Event of Force Majeure is an event orcircumstance which is beyond the control andwithout the fault or negligence of the partyaffected and which by the exercise of reasonablediligence the party affected was unable toprevent provided that event or circumstance islimited to the following:

(a) riot, war, invasion, act of foreign enemies,hostilities (whether war be declared or not)acts of terrorism, civil war, rebellion,revolution, insurrection of military or usurpedpower, requisition or compulsory acquisitionby any governmental or competent authority;

(b) ionising radiation or contamination, radioactivity from any nuclear fuel or from anynuclear waste from the combustion of nuclearfuel, radio active toxic explosive or otherhazardous properties of any explosiveassembly or nuclear component;

(c) pressure waves caused by aircraft or otheraerial devices travelling at sonic or supersonic speeds;

(d) earthquakes, flood, fire or other physicalnatural disaster, but excluding weatherconditions regardless of severity; and

(e) strikes at national level or industrial disputesat a national level, or strike or industrialdisputes by labour not employed by theaffected party, its subcontractors or itssuppliers and which affect an essential portionof the Works but excluding any industrialdispute which is specific to the performanceof the Works or this Contract."

An operative clause will act as a shield for the partyaffected by the event of force majeure so that a partycan rely on that clause as a defence to a claim that ithas failed to fulfil its obligations under the contract.

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An operative clause should also specifically deal withthe rights and obligations of the parties if a forcemajeure event occurs and affects the project. Thismeans the parties must consider each of the events itintends to include in the definition of force majeureevents and then deal with what the parties will do if one of those events occurs.

An example of an operative clause is:

"[ ].1 Neither party is responsible for any failure to perform its obligations under this Contract, if itis prevented or delayed in performing thoseobligations by an Event of Force Majeure.

[ ].2 Where there is an Event of Force Majeure,the party prevented from or delayed inperforming its obligations under this Contractmust immediately notify the other party givingfull particulars of the Event of Force Majeure andthe reasons for the Event of Force Majeurepreventing that party from, or delaying that partyin performing its obligations under this Contractand that party must use its reasonable efforts to mitigate the effect of the Event of ForceMajeure upon its or their performance of theContract and to fulfil its or their obligationsunder the Contract.

[ ].3 Upon completion of the Event of ForceMajeure the party affected must as soon asreasonably practicable recommence theperformance of its obligations under thisContract. Where the party affected is theContractor, the Contractor must provide a revisedProgram rescheduling the Works to minimise theeffects of the prevention or delay caused by theEvent of Force Majeure.

[ ].4 An Event of Force Majeure does not relievea party from liability for an obligation which arosebefore the occurrence of that event, nor doesthat event affect the obligation to pay money in a timely manner which matured prior to theoccurrence of that event.

[ ].5 The Contractor has no entitlement and theProject Company has no liability for:

(a) any costs, losses, expenses, damages or thepayment of any part of the Contract Priceduring an Event of Force Majeure; and

(b) any delay costs in any way incurred by theContractor due to an Event of Force Majeure."

In addition to the above clause, it is critical toappropriately deal with other issues that will arise if aforce majeure event occurs. For example, as notedabove, it is common practice for a contractor to beentitled to an extension of time if a force majeureevent impacts on its ability to perform the works.Contractors also often request costs if a forcemajeure event occurs. In our view, this should beresisted. Force majeure is a neutral risk in that itcannot be controlled by either party. Therefore, theparties should bear their own costs and neither partyshould be penalised.

Another key clause that relates to force majeure typeevents is the contractor's responsibility for care of theworks and the obligation to reinstate any damage tothe works prior to completion. A common exampleclause is:

"[ ].1 The Contractor is responsible for the careof the Site and the Works from when the ProjectCompany makes the Site available to theContractor until 5.00pm on the Date ofCommercial Operation.

[ ].2 The Contractor must promptly make goodloss from, or damage to, any part of the Site andthe Works while it is responsible for their care.

[ ].3 If the loss or damage is caused by an Eventof Force Majeure, the Project Company may directthe Contractor to reinstate the Works or changethe Works. The cost of the reinstatement work orany change to the Works arising from a directionby the Project Company under this clause will bedealt with as a Variation except to the extent thatthe loss or damage has been caused orexacerbated by the failure of the Contractor tofulfil its obligations under this Contract.

[ ].4 Except as contemplated in clause [ ].3, thecost of all reinstatement Works will be borne bythe Contractor."

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This clause is useful because it enables the projectcompany to, at its option, have the damaged sectionof the project rebuilt as a variation to the existingEPC Contract. This will usually be cheaper thanrecontracting for construction of the damagedsections of the works.

Operation and maintenance

Operating and maintenance manualsThe contractor is usually required to prepare a detailedOperating and Maintenance Manual. The EPCContract should require the contractor to prepare adraft of the O&M Manual within a reasonable time toenable the project company, the operator and possiblythe lenders to provide comments, which can beincorporated into a final draft at least 6 months beforethe start of commissioning.

The draft should include all information which maybe required for start-up, all modes of operationduring normal and emergency conditions andmaintenance of all systems of the facility.

Operating and maintenance personnelIt is common for the contractor to partake in thetraining the operations and maintenance staffsupplied by the project company. The cost of thistraining will be built into the contract price. It isimportant to ensure the training is sufficient toenable such staff to be able to efficiently, prudently,safely and professionally operate the facility uponcommercial operation. Therefore, the framework forthe training should be described in the appendixdealing with the scope of work (in as much detail as possible). This should include the standards oftraining and the timing for training.

The project company's personnel trained by thecontractor will also usually assist in thecommissioning and testing of the facility. They willdo this under the direction and supervision of thecontractor. Therefore, absent specific drafting to thecontrary, if problems arise during commissioningand/or testing the contractor can argue they areentitled to an extension of time etc. We recommendinserting the following clause:

"[ ].1The Project Company must provide asufficient number of competent and qualifiedoperating and maintenance personnel to assistthe Contractor to properly carry outCommissioning and the Commercial OperationPerformance Tests.

[ ].2 Prior to the Date of Commercial Operation,any act or omission of any personnel provided bythe Project Company pursuant to GC [ ].1 is,provided those personnel are acting inaccordance with the Contractor's instructions,directions, procedures or manuals, deemed to be an act or omission of the Contractor and theContractor is not relieved of its obligations underthis Contract or have any claim against the ProjectCompany by reason of any act or omission."

Spare partsThe contractor is usually required to provide, as partof its scope of works, a full complement of spareparts (usually specified in the appendices (the scopeof work or the specification)) to be available as at the commencement of commercial operation.

Further, the contractor should be required to replaceany spare parts used in rectifying defects during thedefects liability period, at its sole cost. There shouldalso be a time limit imposed on when these spareparts must be back in the store. It is normallyunreasonable to require the spare parts to have beenreplaced by the expiry of the defects liability periodbecause that may, for some long lead time items,lead to a extension of the defects liability period.

The project company also may wish to have theoption to purchase spares parts from the contractoron favourable terms and conditions (including price)during the remainder of the concession period. Inthat case it would be prudent to include a termwhich deals with the situation where the contractoris unable to continue to manufacture or procure thenecessary spare parts. This provision should coverthe following points:

� written notification from the contractor to theproject company of the relevant facts, with sufficienttime to enable the project company to order a finalbatch of spare parts from the contractor;

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� the contractor should deliver to, or procure for theproject company (at no charge to the projectcompany), all drawings, patterns and other technicalinformation relating to the spare parts; and

� the contractor must sell to the project company (at the project company's request) at cost price(less a reasonable allowance for depreciation) all tools, equipment and moulds used inmanufacturing the spare parts, to extent they areavailable to the contractor provided it has used itsreasonable endeavours to procure them.

The contractor should warrant that the spare partsare fit for their intended purpose, and that they areof merchantable quality. At worst, this warrantyshould expire on the later of:

� the manufacturer's warranty period on theapplicable spare part; and

� the expiry of the defects liability period.

Footnotes16 It can arise in civil law countries as well, it will depend on the relevant

provisions of the code in those countries. For example, the PRC

Contract Law contains articles that entitle a contractor to an extension

of time for employer caused delays.17 The critical path is the path on the construction program that shows

the dates when certain activities must be completed by in order to

achieve completion by the specified date.18 A common failing of force majeure in some negotiations is to focus

on the definitional issues rather than the consequences. Both issues

are important.

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Dispute resolution provisions for EPC Contracts couldfill another entire paper. There are numerousapproaches that can be adopted depending on thenature and location of the project and the particularpreferences of the parties involved.

However, there are some general principles whichshould be adopted. They include:

� having a staged dispute resolution process thatprovides for internal discussions and meetingsaimed at resolving the dispute prior tocommencing action (either litigation or arbitration);

� obliging the contractor to continue to execute theworks pending resolution of the dispute;

� not permitting commencement of litigation orarbitration, as the case may be, until aftercommercial operation of the facility. This provisionmust make provision for the parties to seek urgentinterlocutory relief ie: injunctions and to commenceproceedings prior to the expiry of any limitationsperiod. If the provision does not include theseexceptions it risks being unenforceable; and

� providing for consolidation of any dispute withother disputes which arise out of or in relation to the construction of the facility. The power toconsolidate should be at the project company'sdiscretion.

We have prepared a paper which details thepreferred approach to be taken in respect of disputeresolution regimes in various Asian jurisdictionsincluding the PRC, Philippines, Thailand, Vietnam andTaiwan. You should consult this paper if you wantmore information on this topic.

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Dispute resolution

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Commissioning tests and mechanical completion1.1 After the Contractor has provided the Owner's

Representative with the marked up As-BuiltContract Documents [defined in the Contract]the Contractor must carry out theCommissioning Tests for the relevant System.

1.2 The Commissioning Tests:(a) for each System must:

(i) be performed on a System by System basis;and

(ii) include the inspection and checking ofequipment and supporting sub systems, trialoperation of supporting equipment, initialoperation of the System, operation of theSystem to obtain data, perform systemcalibration and corrective works, andshutdown inspection and correction ofdefects and non-conforming Works identifiedduring the Commissioning Tests; and

(b) must demonstrate:(i) the capability of major sections of the Works

to operate in all modes of start-up, steadystate, transients, plant changeovers,shutdowns, trips and the like; and

(ii) the technical suitability of the Works and itscontrol equipment and the capability of theoperational procedures recommended by the Contractor.

[Clause 1.2 is optional. The Commissioning Testingregime can be included in the general testing regimein clause 1.3. The reference to a "System" is areference to a discrete part of the Works thatcontains several elements but which can be testedindependently of the entire Works. Examples includethe fire safety system, distributed control system andcompressors etc.]

1.3 In carrying out any Test which requires theContractor to export product the Contractormust:

(a) issue a notice to the Owner's Representative atleast 24 hours prior to the time at which itwishes to so supply, detailing the testing orcommissioning and including the Contractor'sbest estimate of the total period and quantityof Product that will be supplied during the Test;

(b) promptly notify the Owner's Representative if there is any change in the informationcontained in such notice; and

(c) do all things necessary to assist the Owner(including but not limited to co-operating with third parties,

so that the Owner can comply with its obligationswith respect to the Test.

Mechanical completion1.4 As soon as the Facility has, in the opinion of the

Contractor, reached the stage of MechanicalCompletion, the Contractor must give notice tothe Owner's Representative.

Appendix 1 - Example clausePart I - Performance testing and guarantee regime

1.5 The Owner's Representative must, promptly,and no later than 3 days after receipt of theContractor's notice under GC 1.4, either issue a facility Certificate of Mechanical Completionin the form specified in Appendix X stating that the Facility has reached MechanicalCompletion or notify the Contractor of anydefects and/or deficiencies.

1.6 If the Owner's Representative notifies theContractor of any defects and/or deficiencies,the Contractor must then correct such defectsand/or deficiencies and must repeat theprocedure described in GC 1.4.

1.7 If the Owner's Representative is satisfied thatthe Facility has reached Mechanical Completion,the Owner's Representative must promptly, and no later than 3 days after receipt of theContractor's repeated notice, issue a Certificateof Mechanical Completion stating that theFacility has reached Mechanical Completion as at the date stated in that certificate.

1.8 If the Owner's Representative is not so satisfied,then it must notify the Contractor of anydefects and/or deficiencies within 3 days afterreceipt of the Contractor's repeated notice andthe above procedure must be repeated.

1.9 If the Owner's Representative fails to issue theCertificate of Mechanical Completion and failsto inform the Contractor of any defects and/ordeficiencies within 6 days after receipt of theContractor's notice under GC 1.4 or within 3days after receipt of the Contractor's repeatednotice under GC 1.6, then the Facility isdeemed to have reached MechanicalCompletion as at the date of the Contractor'snotice or repeated notice, as the case may be.

Functional tests, emission tests, performancetests and substantial completion

Tests2.1 Upon receipt of the Certificate of Mechanical

Completion, or when the Facility is deemed tohave reached Mechanical Completion underGC 1.9, the Contractor must carry out theFunctional Tests, Emission Tests andPerformance Tests, provided the Contractor

gives at least 48 hours notification to theOwner's Representative prior to commencingsuch tests.

2.2 The Contractor must not commence any of theFunctional Tests, Emission Tests or PerformanceTests prior to Mechanical Completion.

2.3 For the avoidance of doubt, it is a conditionprecedent to the achievement of SubstantialCompletion that the Emission Tests must bepassed.

Procedure2.4

(a) If a Functional Test, Emission Test orPerformance Test is interrupted or terminated,for any reason, such Test must be re-startedfrom the beginning, unless otherwise approvedby the Owner's Representative.

(b) The Owner's Representative or the Contractoris entitled to order the cessation of anyFunctional Test, Emission Test or PerformanceTest if damage to the Works, or other propertyor personal injury are likely to result fromcontinuation.

(c) If the Facility (or part thereof) fails to pass anyof the Functional Tests, Emission Tests orPerformance Tests (or any repetition thereof inthe event of prior failure) or if any FunctionalTest, Emission Test or Performance Test isstopped before its completion, such FunctionalTest, Emission Test or Performance Test must,subject to 48 hours prior notice having beengiven by the Contractor to the Owner'sRepresentative, be repeated as soon aspracticable thereafter. All appropriateadjustments and modifications are to be madeby the Contractor with all reasonable speedand at its own expense before the repetition of any Functional Test, Emission Test orPerformance Test.

(d) The results of the Functional Tests, EmissionTests and Performance Tests must be presentedin a written report produced by the Contractorand delivered to the Owner's Representativewithin 7 days of the completion of theFunctional Tests, Emission Tests or Performance

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Tests. Such results will be evaluated andapproved by the Owner's Representative. In evaluation of such results, no additionalallowance will be made for measurementtolerances over and above those specified in the applicable test standard.

(e) The report provided in accordance with clause2.4(d) above shall be in a form agreed by theParties. If no agreement is reached then thereport is to be in the form as provided by theOwner's representative. If the parties fail toagree on a form and the Owner'sRepresentative fails to provide a form of report then the report shall be in a form thatcomplies with best industry practices andcontains the information required for theOwner to meet all relevant standards.

Substantial completion2.5 As soon as the Facility has, in the opinion of

the Contractor, reached the stage of SubstantialCompletion, the Contractor must give notice to the Owner's Representative.

2.6 The Owner's Representative must, promptly,and no later than 3 days after receipt of theContractor's notice under GC 2.5, either issue a Substantial Completion Certificate in the form specified in Appendix 13 stating that theFacility has reached Substantial Completion or notify the Contractor of any defects and/or deficiencies.

2.7 If the Owner's Representative notifies theContractor of any defects and/or deficiencies,the Contractor must then correct such defectsand/or deficiencies and must repeat theprocedure described in GC 2.5.

2.8 If the Owner's Representative is satisfied thatthe Facility has reached Substantial Completion,the Owner must, promptly, and no later than 3days after receipt of the Contractor's repeatednotice, issue a Substantial CompletionCertificate stating that the Facility has reachedSubstantial Completion as at the date stated inthat certificate.

2.9 If the Owner's Representative is not so satisfied,then it must notify the Contractor of any

defects and/or deficiencies within 3 days afterreceipt of the Contractor's repeated notice andthe above procedure must be repeated.

2.10 Notwithstanding that all the requirements forthe issuing of a Substantial CompletionCertificate have not been met, the Owner'sRepresentative may at any time, in its absolutediscretion, issue a Substantial CompletionCertificate. The issue of a SubstantialCompletion Certificate in accordance with thisGC 2.10 will not operate as an admission thatall the requirements of Substantial Completionhave been met, and does not prejudice any ofthe Owner's rights, including the right torequire the Contractor to satisfy all of therequirements of the Contract.

Performance guarantees

Output performance guarantees4.1 The Contractor guarantees that, during the

same Performance Tests, the Facility and allparts will meet the [describe output guarantees].

Minimum performance guarantees not met4.2 If, for reasons not attributable to the Owner,

either or both of the Minimum PerformanceGuarantees are not met, the Contractor must at its cost and expense make such changes,modifications and/or additions to the Facility orany part as may be necessary so as to meet atleast the Minimum [describe minimum standardhere]. The Contractor must notify the Ownerupon completion of the necessary changes,modifications and/or additions and must repeat,subject to the Owner's rights under GCs 4.3and 46.2(a)(iii) [Termination], the relevantPerformance Tests until the Minimum [describe]respectively have been met. Nothing in this GC4.2 derogates from the Contractor's obligationto meet the [Output Guarantees].

4.3 Notwithstanding this GC 4 or any otherprovision of this Contract, if for reasons notattributable to the Owner at any time after theContractor has repeated the Performance Teststhe Contractor does not meet either or bothMinimum Performance Guarantees, the Owner

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may require the Contractor to pay:(a) in relation to the Minimum Performance

Guarantee(s) that has/have been metPerformance Liquidated Damages calculated inaccordance with section 2.1(a) or section 2.2(a)of Appendix Y; and/or

(b) if the Minimum [Output Guarantee] has notbeen met:

(i) an amount equal to the amount theContractor would have been liable for if theactual rated output of the facility was equalto 95% of the [Output Guarantee] asspecified in section 2.1(a) of Appendix Y; and

(ii) Performance Liquidated Damages calculatedin accordance with section 2.1(b) ofAppendix Y; and/or

(c) if the Minimum [other Output Guarantee - probably emission] has not been met:

(i) an amount equal to the amount theContractor would have been liable for if theactual net heat rate of the facility was equalto 105% of the [other Output Guarantee] asspecified in section 2.2(a) of Appendix Y; and

(ii) Performance Liquidated Damages calculatedin accordance with section 2.2(b) ofAppendix Y.

4.4 The payment of Performance LiquidatedDamages under GC 4.3 will be in completesatisfaction of the Contractor's guaranteesunder GC 4.1.

Minimum performance guarantees met, but notperformance guarantees4.5 Subject to GC 4.3, 4.6 and 4.7, if, for reasons

not attributable to the Owner, both of the[describe the Guarantees] are not met but boththe Minimum Performance Guarantees are metduring the same Performance Test, theContractor must, prior to the expiration of theExtended Testing Period:

(a) at its cost and expense make such changes,modifications and/or additions to the Facility orany part as may be necessary so as to meet the[describe the Gurantees] respectively;

(b)notify the Owner upon completion of thenecessary changes, modifications and/oradditions; and

(c) repeat the Performance Tests until the [describethe Guarantees] respectively have been metduring the same Performance Test.

4.6 If, during the same Performance Test, theContractor has met both the MinimumPerformance Guarantees, but not both the[describe the Guarantees] by the expiration ofthe Extended Testing Period, the Contractormust pay the respective Performance LiquidatedDamages to the Owner.

4.7(a)Notwithstanding GC 4.5 and 4.6, the

Contractor may at any time during theExtended Testing Period elect to payPerformance Liquidated Damages to the Ownerin respect of the failure to meet either or bothof the [describe the Guarantee] provided theMinimum Performance Guarantees are met.

(b)Notwithstanding GCs 4.5 and 4.6, and subjectto GC 4.3, the Owner may provided that theDate for Commercial Operation has passed,require the Contractor to pay PerformanceLiquidated Damages to the Owner in respect of the failure to meet the [describe the OutputGuarantees].

4.8 The payment of Performance LiquidatedDamages under GC 4.6 or GC 4.7 will be incomplete satisfaction of the Contractor'sguarantees under GC 4.1, provided that theFacility meets both the Minimum [describe theMinimum Guarantees] as at the date ofpayment of such Performance LiquidatedDamages.

Guaranteed availability4.9 The Contractor guarantees that the facility

either in whole or in part will operate at theGuaranteed Availability for a period of 12months from not later than 2 months after theDate of Commercial Operation.

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4.16 If this GC 4 (or any part thereof) is found forany reason to be void, invalid or otherwiseinoperative so as to disentitle the Owner fromclaiming Performance Liquidated Damages, theOwner is entitled to claim against theContractor damages at law for the Contractor'sfailure to meet any or all of the PerformanceGuarantees. Such damages must not exceed:

(a) [set out parameters]

4.17 The Contractor is not entitled to the benefit ofthe exclusion in GC [ ] [prohibition onclaiming consequential loss] in any claim fordamages at law by the Owner against theContractor pursuant to GC 4.16 for theContractor's failure to meet any or all of thePerformance Guarantees."

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4.10 If the actual Availability Period Actual OutputMeasured is less than the GuaranteedAvailability, the Contractor will pay PerformanceLiquidated Damages to the Owner as specifiedin Appendix Y.

4.11 The aggregate liability of the Contractor forPerformance Liquidated Damages under GC4.10 will not exceed the amount calculated inaccordance with Appendix .

General4.12 Performance Liquidated Damages will be

invoiced by the Owner and payment will be due within 21 days of issue of such invoice. At the expiration of 21 days the amountinvoiced is a debt due and payable to theOwner on demand and may be deducted fromany payments otherwise due from the Ownerto the Contractor and the Owner may also have recourse to the security provided underthis Contract.

4.13 The parties agree that the PerformanceLiquidated Damages in Appendix Y are a fairand reasonable pre-estimate of the damageslikely to be sustained by the Owner as a resultof the Contractor's failure to meet thePerformance Guarantees.

4.14 The payment of Performance LiquidatedDamages under this GC 4 is in addition to anyliability of the Contractor for Delay LiquidatedDamages under GC [ ].

4.15 The aggregate liability of the Contractor forDelay Liquidated Damages and PerformanceLiquidated Damages (provided the Contractorhas met both Minimum PerformanceGuarantees) will not exceed the amountcalculated in accordance with section 3 ofAppendix Y. The aggregate liability of theContractor under this GC 4.15 will not apply if the Owner requires the Contractor to payPerformance Liquidated Damages pursuant to GC 4.3.

[ ].1 The Contractor must immediately give notice to the Project Company of all incidents and/orevents of whatsoever nature affecting or likelyto affect the progress of the Works.

[ ].2 Within 15 days after an event has first arisenthe Contractor must give a further notice to the Project Company which must include:

(a) the material circumstances of the eventincluding the cause or causes;

(b)the nature and extent of any delay;

(c) the corrective action already undertaken or to be undertaken;

(d)the affect on the critical path noted on theProgram;

(e) the period, if any, by which in its opinion theDate for Commercial Operation should beextended; and

(f) a statement that it is a notice pursuant to thisGC [ ].2.

[ ].3 Where an event has a continuing effect orwhere the Contractor is unable to determinewhether the effect of an event will actuallycause delay to the progress of the Works sothat it is not practicable for the Contractor togive notice in accordance with GC [ ].2, astatement to that effect with reasons togetherwith interim written particulars (includingdetails of the likely consequences of the eventon progress of the Works and an estimate of

the likelihood or likely extent of the delay) mustbe submitted in place of the notice requiredunder GC [ ].2. The Contractor must thensubmit to the Project Company, at intervals of30 days, further interim written particulars untilthe actual delay caused (if any) is ascertainable,whereupon the Contractor must as soon aspracticable but in any event within 30 days givea final notice to the Project Company includingthe particulars set out in GC [ ].2.

[ ].4 The Project Company must, within 30 days ofreceipt of the notice in GC [ ].2 or the finalnotice in GC [ ].3 (as the case may be), issue anotice notifying the Contractor's Representativeof its determination as to the period, if any, bywhich the Date for Commercial Operation is tobe extended.

[ ].5 Subject to the provisions of this GC [ ], theContractor is entitled to an extension of time tothe Date for Commercial Operation as theProject Company assesses, where a delay to theprogress of the Works is caused by any of thefollowing events, whether occurring before, onor after the Date for Commercial Operation:

(a) any act, omission, breach or default by theProject Company, the Project Company'sRepresentative and their agents, employeesand contractors;

(b) a Variation, except where that Variation iscaused by an act, omission or default of theContractor or its Subcontractors, agents oremployees;

39

Part II - Extension of time regime

(c) a suspension of the Works pursuant to GC [ ],except where that suspension is caused by anact, omission or default of the Contractor or itsSubcontractors, agents or employees;

(d)an Event of Force Majeure; or

(e) a Change of Law.

[ ].6 Despite any other provisions of this GC [ ], theProject Company may at any time make a fairand reasonable extension of the Date forCommercial Operation.

[ ].7 The Contractor must constantly use its bestendeavours to avoid delay in the progress ofthe Works.

[ ].8 If the Contractor fails to submit the noticesrequired under GCs [ ].1, [ ].2 and [ ].3 within the times required then:

(a) the Contractor has no entitlement to anextension of time;

(b)the Contractor must comply with therequirements to perform the Works by the Datefor Commercial Operation; and

(c) any principle of law or equity (including thosewhich might otherwise entitle the Contractor to relief and the "prevention principle") whichmight otherwise render the Date forCommercial Operation immeasurable andliquidated damages unenforceable, will not apply.

[ ].9 It is a further condition precedent of theContractor's entitlement to an extension oftime that the critical path noted on theProgram is affected in a manner which mightreasonably be expected to result in a delay tothe Works reaching Commercial Operation bythe Date for Commercial Operation.

[ ].10 If there are two or more concurrent causes ofdelay and at least one of those delays wouldnot entitle the Contractor to an extension oftime under this GC [ ] then, to the extent ofthat concurrency, the Contractor is not entitledto an extension of time.

[ ].11 The Project Company may direct theContractor's Representative to accelerate theWorks for any reason including as analternative to granting an extension of time to the Date for Commercial Operation.

[ ].12 The Contractor will be entitled to all extracosts necessarily incurred, by the Contractor in complying with an acceleration directionunder GC [ ].11, except where the directionwas issued as a consequence of the failure ofthe Contractor to fulfil its obligations underthis Contract. The Project Company mustassess and decide as soon as reasonablypractical, the extra costs necessarily incurredby the Contractor.

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41

AUTHORS

Damian McNairPartner, MelbourneT +61 3 9643 4111F +61 3 9643 5999damian.mcnair@mallesons.com

Jim Delkousis Partner, PerthT +61 8 9269 7058 F +61 8 9269 7999jim.delkousis@mallesons.com

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CONTACTS

Damian McNairPartner, MelbourneT +61 3 9643 4111F +61 3 9643 5999damian.mcnair@mallesons.com

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Jim DelkousisPartner, PerthT +61 8 9269 7058 F +61 8 9269 7999jim.delkousis@mallesons.com

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