Criterium epc project risks (5.28.13)

Identifying and Managing
Risks in EPC Contracts
Presented By:
Criterium Consulting Group, Inc.
Philip Hamblin, Esq.
Property of Criterium Consulting
May 28, 2013

General Overview
A. Introduction to Criterium Consulting
B. Goals of presentation
C. Agenda
1. General overview of EPC contracts
2. Summary of major project risks and case study
examples
3. Proposed risk mitigation or avoidance
techniques
4. Questions
2

Introduction to Criterium
Criterium Consulting Group, Inc. focuses on litigation support,
alternative dispute resolution services, claims analysis and project
advisory services to the construction, government contracts and
business communities.
Philip Hamblin, Esq. specializes in providing project management
related services including contract review and oversight, schedule
preparation and analysis, risk avoidance, document management, and
change order preparation and negotiation. Mr. Hamblin’s education
includes a Bachelor of Science degree in Construction from Arizona
State University and a Juris Doctorate degree in Law from Rutgers
School of Law, Camden. He is licensed to practice law in the state of
Pennsylvania.
3

Goals of Presentation
To provide a basic understanding of some
of the risks associated with EPC contracts
and the recommended means to mitigate
these risks.
4

“EPC” Contracts Basics
General Overview of EPC Contracts
E – Engineering
P – Procurement
C – Construction
5

General Overview of EPC Contracts
EPC Contracts are one of the most predominant
forms of construction contracts used on large-scale
infrastructure projects
 Basic Features
 Single point of responsibility
 Fixed contract price and completion date
 Performance specification
 Plant performance guarantees
 Contractor performance guarantees (e.g. bank guarantee,
retention withholding, parent company guarantee)
 Other: Force majeure, termination, suspension
provisions, liability caps
6

General Overview of EPC Contracts (Cont.)
Owner has less administrative burden
Potential for multiple disputes is limited
The contractor bears the risk of integrating the
performance of all packages (including subcontractors
and designers)
Cost, time and quality can be defined with a higher
degree of certainty due to contractor EPC scope
Interface between engineering and construction is
more streamlined because it is managed by the same
contractor
Key Advantages
7

General Overview of EPC Contracts (Cont.)
Contractors will add a substantial risk premium to the
bid price
Contractor will often aim for the minimum compliant
standard to decrease costs
Competition is reduced because most contractors
don’t have the financial capability or bonding
capacity to take on the risk of an EPC project
Contractors are often times motivated to make claims
to compensate for risk transfer and recoup losses
Key Disadvantages
8

EPC Risk Compared to Other Contract Forms
Construction
Management
Owner/Sponsors Contractor
Traditional Design &
Build
EPC
R I S K SEVERITY
Summary of Major Project EPC Risks
The Contractor retains most of the risk in an
EPC Contract when compared to other contract
forms.
9

Construction Related Risks
Financial and Economic Risks
Geographical and Political Risks
Incomplete and Unbalanced Contract
Project Management Risks
General Categories of Project Risks
10

 Contractor experience and expertise: Does the
contractor have experience performing similar
projects or working in the area (or country)?
 Contractor financial stability: Can the contractor
fund the project especially if problems are
encountered?
 Procurement: Can the contractor or vendor keep
up with the procurement demands of the project?
 Operational Risks: Has the contractor taken into
account local labor and subcontractor risk?
 Force Majeure: What unexpected or uncontrollable
event may disrupt construction?
Construction Related Risks
11

Construction Related Risks
Case Study No. 1: Power Plant (International)
 Key Facts (Expertise of Contractor)
 Contractor’s prior experience is with supply side with
minimal construction management experience
 Contractor’s internal construction management
personnel pool is limited to support project demands and
must be outsourced
 Contractor’s collaboration partner lacks experience with
similar projects and has not worked in the region
 Management of project is negatively impacted by lack of
expertise
12

 Offshore payment security and accounts: Does
the Owner have accounts set up for payment to the
Contractor?
 Payment for cost overruns: Does the contract
provide payment for cost overruns during the
course of the Project?
 Payment milestones: Are payment milestones in
advance of cost incurred to provide adequate cash
flow for the Contractor?
Financial & Economic Related Risks
13

Financial & Economic Related Risks
 Key Facts (Financial Impact Example)
 Owner obligated to procure Letter of Credit (LC) within
two months of NTP but encounters difficulty with bank on
LC terms
 LC is not procured until almost 11 months after NTP
resulting in delay to issuance of Advance Payment to
Contractor
 Procurement of equipment is delayed until LC and
payment means in place resulting in delays to project
14

 Political Instability: Is there a risk of terrorism, mass labor
strikes, civil wars, rioting?
 Regulatory Changes: Have the risks of regulatory changes
specific to the host country been analyzed?
 Customs Requirements: Have the customs requirements
been investigated to ensure that any impact to procurement
has been accounted for?
 Social Customs: Have social customs been analyzed such as
extended public or religious holidays or working hours?
 Labor Market: Is skilled labor available in the region or will
expats have to be utilized?
 Supplier Availability: Is there a local source for materials or
will materials have to be imported?
Geographical and Political Risks
15

 Key Facts (Possible Force Majeure Event)
 Terrorist event at another site in region results in the
evacuation of expats from construction site
 Evacuation of personnel is based on Contractor’s internal
security policy due to regional risks
 Force Majeure clause applies to “any act or event which
is unpredictable, unstoppable and independent from the
will of the parties”
 Project is impacted due to lack of expat management
personnel on site
16

 Key Facts (Social Customs)
 Project located in a region which celebrates Ramadan
 Ramadan observes fasting for a 30 day period
 Project is impacted due to productivity impacts during
Ramadan period
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 Uncontrollable work scope expansion: Are the
parameters of the contractor’s work scope defined
enough to limit scope expansion?
 Deficient changes or dispute provisions: Does the
Contract adequately address scope changes,
contractor compensation, and dispute resolution?
 Disproportional allocation of risk and reward
benefits: Does the Contract disproportionally
allocate risk to one of the parties?
 Adverse legal forum: Is the contractor or Owner
subjected to an adverse legal forum or choice of
law?
Incomplete & Unbalanced Contract
18

Incomplete & Unbalanced Contract
 Key Facts (Incomplete Contract)
 Contract did not adequately define parameters of
Contractor’s scope for major structures and equipment
 Simple building structures were substantially increased
in size by the Owner during the design phase
 High end finishes were requested instead of submitted
finishes
 Contractor incurs substantial cost overruns in
engineering and construction related work
19

 Deviation from Contract: Is the contractor
performing work without approval or additional
compensation?
 Failing to Document Impacts: Is the contractor
waiving its contractual rights?
 Failing to manage costs: Is the contractor
monitoring cost expenditures against an
established budget?
 Failing to sufficiently staff project: Is the project
properly staffed from the beginning of the project
so that schedule and costs are properly managed?
Project Management Risks
20

Project Management Risks
 Key Facts (Project and Site Management)
 Contractor elected to rely solely on the expertise of the
collaboration partner for onshore scope of work
 Contractor did not set up its own project control and
schedule oversight
 Contractor project management team was not adequately
staffed to support simultaneous execution of three
separate sites
 Contractor was not willing to assert contractual demands
to the Owner; resulting in Owner’s ever growing demand
for more capabilities
21

Proposed Risk Mitigation or Avoidance Techniques
 Fixed price/lump sum Contracts which limit price escalation
 Clear identification of performance and completion
targets/milestones
 Inclusion of a liquidated damages provision for delay and
underperformance
 Testing and rejection rights
 Extended warranties and provisions addressing defects
liability
 Requirement for contractor to provide performance
guarantees
 Favourable choice of law/venue provisions
 Contract change provisions which require strict notice
procedures and limit compensability
Owner Risk Mitigation
22

 Contract Provisions
Change provisions which allow for an extension of time
and increased costs for delay as a result of circumstances
beyond the contractor’s control
Broad force majeure protection which allows contractor to
pursue compensation for both cost and time
Clear contract provisions which require the Owner to
timely process payments and turnaround submittals
Caps on liquidated damages exposure and inclusion of
favourable limitation of liability provisions
Payment provisions which allow contractor to maintain a
positive cash flow
Contractor Risk Mitigation
23

 Contract Provisions (Cont.)
Performance requirements that can be reasonably
achieved including an achievable contract schedule
Clearly defined dispute resolution procedure with
favorable venue/choice of law
Termination clause allowing contractor to terminate for
lack of payment, material breach by Owner or prolonged
force majeure event
Clearly defined scope parameters which limit Owner’s
ability to cause “scope growth” without being subjected
to the Changes provisions
24

 Project Management Risk Mitigation
JV partnerships or subcontractor arrangements to compensate
for contractor’s inexperience or lack of in-house resources
Understand host country risks and procure in-country
assistance to address financial, procurement, construction, and
legal related risks
Adequately staff project from inception with experienced
individuals rather than waiting until it is too late
Manage project costs on a continuing basis to identify potential
overruns before they occur and can be mitigated
Provide accurate and timely updates to the project schedule
and project critical path
Ensure management personnel understands scope and does
not proceed with extra work without a Change Order
25

Questions
QUESTIONS
26

Criterium epc project risks (5.28.13)

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