limiting the offshore epc contractor's risks and liabilities

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Addressing contractual challenges

Offshore Korea Technical Conference 2016

LIMITING THE OFFSHORE CONTRACTORS RISK AND LIABILITES Wednesday 19 October 2016, BEXCO, BUSAN KoreaPresented by: Primila EdwardPrincipal Legal ConsultantStraits Consulting Group

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Common form of contract used to undertake construction works by the private sector on large scale and complex construction projects is the EPC / EPCC / EPCIC model.Under this EPC contract, a contractor is to deliver a complete facility to a developer / owner who need only turn a key to start operating the facility, hence EPC contracts are sometimes called turnkey construction contracts.

2Overview, Legal Framework & Contract Structure & Risk Allocation

The risks of disputes arising and derailing the project is ever present. In a recent survey conducted by Deloitte & Touches Construction and Advisory services showed that there is .2

In addition the EPC contractor must delivering a complete facility, for a guaranteed price, normally a Lump Sum. So these contracts are called Lump Sum Turn Key (LSTK) contract.Contractors must complete the project by the guaranteed date and It must perform to the specified guaranteed level.

3Overview, Legal Framework & Contract Structure & Risk Allocation

The risks of disputes arising and derailing the project is ever present. In a recent survey conducted by Deloitte & Touches Construction and Advisory services showed that there is .3

CONTRACTORS RIKS & LIABILITIES

Contractors needs to manage the risks involved in performing the contracts according to specifications provided by Owner by the guaranteed date, within the agreed lump sum price and meeting the guaranteed levels agreed.Contractors failure to comply with these strict contractual obligations will usually result in the contractor being liable for breach of contract and incurring monetary liabilities in the form of damages.

EPC / EPCIC CONTRACTS GENERALLY

Key elements impact Time, Costs and QualityAssumption of all Project Risk by Contractor leads to 8-15% increase in actual costs of the work . (Fred Lyon, President TriCon Power Group, Florida)Avoid paying a premium by Owner assuming some of the risk and aggressively manage the risk.Not just allocate risk but share risk and ultimately the rewardsPARTIES SHOULD Assumes risks if in a position to control

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EPC & EPCIC Contract Structure

CONTRACT STRUCTURE FOR P3 PROJECTS

EPC CHARACTERISTICSInterface with other project contractsOne integrated packageSingle Point ResponsibilityBankabilityClaims for Additional Costs, EOTSecurity for Performance, Technical RiskOutput guaranteesLD for both output and delay Fixed Completion Date & Fixed PriceNo or limited technology RiskSecurity or Parent guaranteeCaps on liability

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The general characteristic of an EPC contract is 8

EPC CONTRACT CULTUREBlame GameWho is to blame ?EmployerContractorSub-Contractor or Supplierleads toMore DisputesMore ClaimsMore Costs Over runs

Having said this the EPC contract remains the most commonly used contract for major engineering and construction projects in the Oil and Gas, Petrochemical industry mainly due to its selling factor which is the single point of responsibility aspect whereby the Contractor is held responsible for the project. This also what makes it bankable.

As Projects get larger so do EPC contracts and it is not uncommon for EPC contracts to be worth billions of US dollars.

For example it was reported that the EPC contract awarded to CTJV a Chiyoda and Technip Joint venture for the onshore construction of two large scale LNG projects for Qatargas was worth USD 4 billion. Therefore it is no small feat to mange the risks associated with such huge contracts. When there is a problem the EPC contract culture looks to see who is to blame basically promoting the mantra always start by blaming the other side. The EPC contract culture is adversarial and the parties look to protect their own turf. But there is a high price to pay for this. As each party tries to pass the risk to the other, the cost of bearing the risk gets higher. This can lead to undue escalation of price for the Owners.

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SPLIT EPC CONTRACT -OFFSHORE AVOIDS HOST COUNTRY RESTRICTIONS

10Project Co

Onshore EPCContractorOffshore EPCContractor

Parent CoWrap AroundGuarantor

Offshore ContractOnshoreContract

Interface ObligationsCoordination AgreementAdministrative Agreement/Umbrella Deed4 Party Agreement

SPLIT EPCWRAP AROUND GUARANTEENo Horizontal DefenceTotal Performance/Fit for PurposeObligation to Interface & IntegrateLAD borne for both split contractors regardless of which one is to be blamedPerformance Bond from Parent Co for both split contractors

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IDENTIFYING, ALLOCATING & SHARING OF RISK BASED ON EPCIC Contract Type

Types of Risks - Evaluation and Analysis DESIGN RISKSConstruction Risks PROJECT MANAGEMENT Operating Risks Financial and Economic Risks Legal Risks Political Risks

Contractor RisksRisk Allocation to Contractors - Single Point of Responsibility - Fixed Completion Date - Limited Technology Risks - Performance Guarantees - Liquidated Damages for Both Delay & Performance - Security from Contractor or its Parent- High Limits on Liability of Contractors - Limited Ground for the Contractor to Claim - Extensions of Time and Additional Costs

EPC CONTRACT STRUCTURE

Single Point of ResponsibilityThe preferred option for delivery of a construction project is the contractors the single point responsibility solution will typically means the contractor is fully responsible for the completion of the project on time, within budget to the required standard.This legal principle allow the Owner to hold the Contract only responsible for the delivery of the project irrespective of which party that is a sub-contractor or supplier who may be responsible.This is the turnkey EPC contract module.

LEGAL, TECHNICAL AND COMMERCIAL OF TENDERERS

Any Legal qualifications permitted ? Any structural requirements - potential contracting party? Is ITB binding bid ?Contractor initiate negotiations - potential local partners? Contractor decide on its own legal structure at this time? Should a consortium model be considered? Is there a reference to a certain jurisdiction? Does ITB include standard contractual documents? Tax and import issues in the relevant country? Local presence required?

BEST PRACTICES IN TENDER EVALUATIONS AND SELECTION OF TENDERERCompanies should encourage innovation and alternative solutions by using performance based specifications where appropriate, leading to: Increased efficiency in design, tendering, project management and financial management; Speedy resolution of complex design and production problems; Less rework and a lower cost finished product; and Improved delivery of projects in terms of higher quality outcomes, timely delivery and environmentally responsible buildings or infrastructure.

INNOVATION AND TIME FOR TENDERSPrincipals should also encourage innovation by; Allowing sufficient time for tender response having regard to project complexity and the past experience of tenderers; andConsidering alternative approaches to delivery of projects.

INNOVATIVE DELIVERY SYSTEMSInnovative approaches and delivery systems, such as joint ventures, alliance contracting, partnering,strategic alliances and the like, These delivery systems should be consistent with the standards of behaviour required by the Company. It should be pursued by the parties where measurable benefits are to be obtained. This objective should form a necessary component in the evaluation of tenders.

NEGOTIATING EPC CONTRACTSPositional BargainingPositional bargaining is a negotiation strategy that involves holding onto a fixed idea, or position, of what you want and arguing for it and it alone, regardless of any underlying interests. Each side starts with an extreme position, which in this case is a monetary value, and proceeds from there to negotiate and make concessions. Eventually a compromise may be reached.19

DIFFERENCE IN BARGAINING POSITIONSInterest-based bargaining This is a method of negotiating that focuses on meeting the underlying concerns, needs or interests of the parties involved in the negotiation. The parties are encouraged to communicate what is important about an issue rather than arguing for a specific position or solution. This type of bargaining allows the parties to understand where the other party is coming from and is cooperative.20

LETTER OF INTENT & LETTER OF AWARDA true 'letter of intent' will be simply a letter expressing an intention to agree something in the future i.e. it doesn't form a contract. Letters of Award or Acceptance are more likely to confirm an agreement, although again the detail of the letters must be read to appreciate the obligations placed on each party.In broad terms the difference contractually between a letter of intent, a letter of acceptance and a letter of award will depend upon the particular details contained within each 'letter'; you cannot rely on the title of the letter to tell you its true nature. 21

LETTER OF INTENTCommitment from operator enable contractor to start placing orders to meet the time schedule. Cancellation fees should be covered. Contractor should avoid any kind of reservoir risk.Bank guarantees and/or corporate guarantees required. Projects where several partners are developing the field,, cancellation fess can end up worthless if backed by a single purpose company who is formal contract party (minor partner ) Include regulation covering the possibility extension o