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 ConsultingB. Goals of presentationC. Agenda

1. General overview of EPC contracts2. Summary of major project risks and case study

examples3. Proposed risk mitigation or avoidance

techniques4. Questions

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Introduction to Criterium

Criterium Consulting Group, Inc. focuses on litigation support,alternative dispute resolution services, claims analysis and projectadvisory services to the construction, government contracts andbusiness 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.

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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.

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“EPC” Contracts Basics

General Overview of EPC Contracts

E – Engineering

P – Procurement

C – Construction

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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

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General Overview of EPC Contracts (Cont.)

Owner has less administrative burdenPotential for multiple disputes is limitedThe 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

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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

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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.

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Construction Related RisksFinancial and Economic RisksGeographical and Political RisksIncomplete and Unbalanced ContractProject Management Risks

General Categories of Project Risks

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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

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Construction Related RisksCase 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

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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

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Financial & Economic Related RisksCase Study No. 2: Power Plant (International) 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

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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

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Geographical and Political RisksCase Study No. 3: Power Plant (International) 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

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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

Geographical and Political RisksCase Study No. 4: Power Plant (International)

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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

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Incomplete & Unbalanced ContractCase Study No. 5: Power Plant (International) 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

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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

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Project Management RisksCase Study No. 6: Power Plant (International) 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

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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

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Contract ProvisionsChange 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

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Contract Provisions (Cont.)Performance requirements that can be reasonably

achieved including an achievable contract scheduleClearly defined dispute resolution procedure with

favorable venue/choice of lawTermination 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


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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


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Questions

QUESTIONS

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Business

Criterium epc project risks (5.28.13)