Engineering, procurement, and construction agreements, commonly known as “EPC agreements,” are used for the construction of facilities intended to carry out a process, with the potential process being anything from manufacturing a product to generating electricity to treating wastewater. An EPC agreement is similar to a design-build contract where the owner engages one entity to design and construct the desired facility, except an EPC agreement goes one step further in that the contractor must not only design and build the desired facility but also must design and build the facility so that it produces some guaranteed level of output.
Using a refinery example to compare the different contract types:
- Under a traditional design-bid-build contract the owner would first engage a design firm to design the refinery. Once the designer completed the plans, the project would be put out to bid. The selected contractor would then construct the refinery per the plans.
- Under a design-build contract, the owner would engage one entity that would handle all of the design and construction work. Under the design-build contract as well as under a design-bid-build contract, the owner may insist on or the designer may specify that certain equipment be installed, but typically there would be no guarantee as to the refinery’s performance.
- Under an EPC contract, the owner would specify not only that it wanted a refinery but also that the facility must meet certain performance requirements. The owner would engage one entity who would design and construct the refinery, procure the necessary equipment, and guarantee that upon completion the facility will meet the performance requirements. Typically, under an EPC contract a failure to provide a facility meeting the performance requirements results in liquidated damages against the EPC contractor.
Like other construction contracts, the cost of an EPC project can be set up as:
- A turnkey contract with a guaranteed maximum price (“GMP”) where the contractor performs all of the work and provides all of the materials for a lump sum price;
- A cost plus contract where the contractor is paid the actual costs of the labor and materials for the work plus a percentage of that cost as the contractor’s fee; and
- A unit price contract where the contractor is paid a set amount for each unit of work completed.
The structure of the typical EPC agreement provides for three milestones—mechanical completion, substantial completion, and final completion—with the contractor paying delay liquidated damages for failing to timely achieve the milestones. Also, the performance of the facility is typically tested at substantial completion, and the contractor pays performance liquidated damages for failing to achieve the guaranteed level of performance. Mechanical completion is generally the stage at which all of the equipment has been installed and is functional, and substantial completion is when the equipment functions as specified in the agreement and all that remains is punchlist items. Final completion occurs when all of the punchlist items are complete and no work remains to be done.
Strong EPC agreement provisions are not only crucial to owners and EPC contractors, but because EPC agreements are often part of the equation in getting a lender to finance a project, the terms are also important to lenders. Lenders must be satisfied with contract terms before agreeing to finance a project. Often projects are funded through project finance where the project itself is the sole or main asset securing the loan and the revenues generated by the project are to repay the loan, and in that scenario, the EPC agreement’s provisions take on heightened importance to the lender. Generally, lenders are most concerned with EPC agreement provisions related to: the results of the contractor’s failure to meet performance requirements, the guarantees that the contractor will complete performance, and the contractor’s ability to increase price or extend the schedule through change orders or claims. The lender’s assessment of these provisions determines whether the EPC agreement is “bankable” or “financeable.”
For the key provisions, the major considerations include:
- Contractor performance
- What method or combination of methods, if any, to use to secure the contractor’s performance: performance bond, parent guaranty, or letter of credit?
- Schedule and delay
- What liquidated damages to provide as result of contractor’s failure to timely complete milestones?
- What limits to place on the contractor’s ability to obtain additional time?
- Performance requirements
- What performance tests and requirements apply?
- When is testing for satisfaction of those requirements to occur and is any testing to occur post-completion to ensure continued satisfaction of those requirements?
- What liquidated damages apply for failure to achieve the requirements?
- Can the contractor “buy-down” a failure to achieve the requirements and if so, is there some minimum level of performance below which the contractor cannot buy-down?
- Warranties and liabilities
- What warranties will contractor provide and for how long?
- Are there any limitations on contractor’s liability, whether a dollar amount cap on liability or exclusion of certain forms of liability such as consequential damages?
- Subcontractor obligations and liens
- Whether to require a payment bond to ensure subcontractors are timely paid?
- What lien waivers are required to ensure facility completed with clean title and no liens?