Owners and lenders are becoming increasingly receptive to the idea of offering engineering, procurement, and construction management (EPCM) contracts, as opposed to EPC contracts, for the advantages it offers, writes JONATHAN BRUFAL*.
The majority of mega construction projects are procured using fixed-price, and date-certain engineering procurement and construction (EPC) contracts. Such contracts provide owners and lenders of limited-recourse projects with cost and time certainty and provide a single point of responsibility for the design, construction and procurement of the works.
However, as the size and complexity of projects increases, and as EPC contractors’ bargaining position improves, there is a growing trend, particularly in the mining industry, for procurement to go down the engineering, procurement and construction management (EPCM) route. Under the EPCM contract, the contractor is not responsible for construction, but is instead responsible for design and manages the construction process on behalf of the owner – which in effect is a professional services contract.
Role of the EPCM contractor
One of the primary roles of the EPCM contractor involves with the engineering and design responsibilities of the project. The design of major projects is often split into two phases. The first phase is the front end engineering and design (FEED) stage where engineers set the design parameters and define the scope of the works that will allow the owner to tender. The second phase comprises the detailed design development of the FEED. Both phases can be procured under both methods of procurement, accordingly the design responsibilities are largely the same.
The procurement role of an EPCM contractor is very different to that of an EPC contractor. The EPC contractor has full responsibility for procurement and all sub-contracts will be put in place directly by it. As such, the EPC contractor will take on the performance, time and cost risk of its sub-contractors.
The EPCM contractor, however, will simply advise the owner on the best strategy for the construction and procurement of materials and equipment and contracts awarded will be direct contracts between the trade contractors and the owner – the EPCM contractor will not be party to these agreements. It is therefore crucial for the owner that these contracts are appropriate and protect the owner’s interests as any problems that arise under these contracts such as interface issues, delays, damages to property and defects of the works will ultimately be a problem for the owner, not the EPCM contractor.
EPCM contractors are required to supervise the construction and overall management of the project to ensure work is carried out by the various contractors in accordance with the design criteria and to the required standards. This will include supervising safety management on site, obtaining evidence of faulty work and establishing facts in relation to any defaults or defective work to ensure the owner is protected from any claims. The EPCM contractor will not, however, be responsible for any defects in the works unless such defects have arisen as a result of its negligence in carrying out its construction management services.
The EPCM contractor is usually paid on an actual costs basis at pre-agreed rates as well as a project fee (representing its profit) divided monthly across the construction phase.
The key difference to an EPC contract is that owners and lenders are not given the protection of cost certainty and so will want to ensure there is some protection built into the contract to control outturn costs. To incentivise the EPCM contractor, target prices for outturn costs should be set and an appropriate pain/gain mechanism should be introduced whereby the EPCM contractor shares in any cost savings or overruns. However, given current market conditions and the strong bargaining position of contractors, it is difficult to get contractors to agree to take any responsibility for cost overruns and where cost risk is accepted, liability will often be capped as a percentage of the contractor’s fee.
Under an EPC contract, the contractor will be responsible for completing the project by the fixed completion/milestone dates and will pay delay liquidated damages if it fails to achieve those dates. This is very different to an EPCM contract where the EPCM contractor will generally only have responsibility for carrying out certain programming services such as preparing the project schedule and managing and co-ordinating the other contractors.
It is common for EPCM contractors to be entitled to early completion bonuses in order to incentivise them to achieve timely completion. However, as with cost overruns, EPCM contractors will try to resist taking any responsibility for delays in construction but given that the EPCM contractor is responsible for managing the procurement process, owners should push for the EPCM contractor to take some risk of late completion. As with cost overruns, any liability for delay will generally be capped as a percentage of the contractor’s fee.
Unlike under an EPC contract where there is single-point responsibility, there is a risk under an EPCM structure that the owner can be put in a position where it will have to take action against the EPCM contractor and the direct contractors in circumstances where each party is blaming the others. It is therefore essential that adequate joinder provisions are incorporated into each contract to ensure that all the potential defaulting parties can be joined into the dispute.
Although owners and lenders will generally prefer the EPC contract route for major construction projects, to provide them with the comfort of price and time certainty, the EPCM route is becoming more common. In the current market, fewer EPC contractors are willing to undertake major projects, on a lump sum basis resulting in increased prices which threaten the affordability of projects. Rather than pay inflated prices or risk awarding the contract to an EPC contractor with little experience both owners and lenders are becoming more receptive to alternatives such as the EPCM contract, and in certain industry sectors, such as mining and, it has proved to be both popular and successful.
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