Mining Guide Epc and Epcm Contracts 104178

8/17/2019 Mining Guide Epc and Epcm Contracts 104178

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EPC and EPCM contractsA guide to EPC and EPCM contractsfor junior mining companies


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A Norton Rose Fulbright Guide

EPC and EPCM contractsA guide to EPC and EPCM contractsfor junior mining companies


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Norton Rose Fulbright is a global legal practice. Weprovide the world’s pre-eminent corporations and

financial institutions with a full business law service.

We have more than 3800 lawyers based in over 50 cities

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We aim to provide the highest possible standard of legalservice in each of our offi ces and to maintain that level of

quality at every point of contact.


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Summary 04

Introduction 05

EPC Contracts 08

Key lender requirements 09

EPCM Contracts 19

Appendix 1 29

Contacts 35

Contents


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04 Norton Rose Fulbright

EPC and EPCM contracts

Summary

The importance of a robust strategy for the procurement of a mining project, from

project inception through to construction implementation, can not be underestimated.

Full consideration of the key procurement issues identied in this guide can often

mean the dierence between achieving a ‘bankable’ project with optimal returns for the

mining company, and an expensive project failure.


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Norton Rose Fulbright 05

Introduction

Introduction

General

This guide explores the key steps to be taken and considerations to be made by a junior

mining company (the Sponsor) to achieve a project structure that is both bankable and

able to deliver optimal returns for the Sponsor.

On the assumption that the Sponsor has determined through a full and properfeasibility process that the project is economically viable, it must then consider how

the project is to be delivered. We have produced several brieng papers on issues to be

considered when looking to secure nance for projects in the mining sector, but a key

aspect of securing such nance will be convincing lenders (or other backers) that the

structure for project delivery is robust.

In this guide we will look at the key considerations to be made by a Sponsor in terms

of achieving a construction structure that is both bankable and economically viable.

Bankability

It is perhaps rst necessary to explain what we mean by the term ‘bankable’ or

‘bankability’. The terms are usually used to describe a lender’s view on the robustness

of the project structure in terms of its ability to secure full repayment of outstanding

debt, either through project delivery in accordance with Sponsor requirements or,

in a default scenario, through appropriate recourse against the contractor (or other

stakeholders (as appropriate)) responsible for project delivery.

In the context of detailed engineering and construction delivery, lenders will prefer

for one nancially robust party to accept full responsibility for the delivery of the works

on time, on budget and to meet the required technical and performance specication.

The key candidates in this regard are typically large internationally recognised

engineering and construction contractors.

The identity of the contractor can certainly have an impact on the lenders’ view

on bankability.


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The importance of achieving this single point of responsibility relates to a desire bythe lenders to see the party with the ‘deepest pockets’ bearing the entire risk of project

delivery. To the extent that more than one party is responsible for delivery of the works

(in terms of direct liability to the Sponsor), lenders will be concerned that either:

• there may be gaps in liability cover or

• that there may be interface issues when it comes to identifying the party responsible

for a failure; or, perhaps worst of all

• that the party identied as being responsible for a failure can not be held to account

either because its liability is limited in some way under the terms of its contract

with either the Sponsor or the EPC contractor (as the case may be) or more generally

because it does not have the balance sheet to meet the liabilities in question.

Contract structures

The preferred option for delivery of the single point responsibility solution describedabove will typically come in the form of a turnkey engineering, procurement and

construction (EPC) contract.

Whilst it is recognised that there are several internationally recognised forms of EPC

contract, each oering a balanced approach to contracting risk, the hardening of

the lending market in recent years (and especially post global nancial crisis (GFC))

has seen a move away from use of these forms, in the context of a limited recourse

project nance transaction, without signicant amendment. When procuring an EPC

contractor, it is essential that there is transparency regarding likely lender requirements

from the outset. Raising these points post selection of the preferred EPC contractor

will place the Sponsor in a weak bargaining position if (and more likely, when), as a

consequence, the EPC contractor proposes additional contingent risk pricing.


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Introduction

The development of detailed design at feasibility stage may undermine the Sponsor’sability to achieve a single point of responsibility solution without being exposed to

inated construction pricing, either because there is a lack of appetite in the market to

take on 3rd party design risk or because those parties willing to take on such design

risk will only do so with a signicant amount of contingent risk pricing (see our

guide titled ‘A Guide to Feasibility Planning for Junior Mining Companies’ for further

consideration on these on these issues).

In circumstances where the single point responsibility position described above cannot

be achieved or is not necessary because the Sponsor is sophisticated and can itselfmanage residual risks or its achievement would adversely aect project economics such

that the Sponsor may not want it, the Sponsor may look to alternative structures. In

this respect, we will consider below, in the context of bankability considerations, the

fundamental dierences between the EPC and the alternative engineering, procurement

and construction management (EPCM) contracting structures. In particular, we will

identify the likely challenges when opting to use the EPCM structure.


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EPC Contracts

General

Figure 1 below demonstrates a typical EPC contracting structure under which lenders

and the Sponsor will look for the EPC contractor to accept single point responsibility for

all aspects of design and construction.

Notwithstanding the fact that the Sponsor may be able to achieve this contractualstructure, the bankability of the contracting structure will depend also on satisfaction

of certain key lender requirements under the terms of the EPC contract. These key

requirements will establish the obligations on the EPC contractor in terms of project

delivery and importantly, the recourse available against the EPC contractor in a

default scenario.

In order to gain a better understanding of the approach being seen more recently by

lenders in the mining sector, it would be helpful for us to set out what we see as being

those key commercial terms that lenders will typically be looking for under the terms ofan EPC contract.

EPC Contract

Mining Company

EPC Contractor

Sub-contractor B Sub-contractor CSub-contractor A


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Key lender requirements


Design riskThe lenders’ ideal position will be for the party delivering the works to be responsible

for all aspects of the works, including design (whether or not produced by the party

assuming responsibility for the works). This transfer of responsibility should even

extend to mistakes in the Sponsor’s own stated initial design requirements. If this design

risk transfer is not achieved, the risk to the Sponsor of cost overrun could be signicant

since there is likely to be increased exposure to claims for additional time and moneyresulting from the requirement to remediate errors identied in 3rd party design.

Since the liability for cost overruns in the circumstances described above may be

signicant, it is unlikely that this risk may be backed o fully with the party ultimately

responsible for producing the design in question. It is more likely therefore that the

residual cost overrun risk will rest with the Sponsor. Whilst in the rst instance, this

is clearly a concern for the Sponsor, lenders will also be concerned to see that the

Sponsor is able to manage the potential nancial consequences. This may be achieved

through use of a designated cost overrun facility or a request that the Sponsor providesadditional security.

Whilst the intention of the parties may be for the EPC contractor to accept entire

responsibility for the adequacy, accuracy and completeness of design, the lenders

will nonetheless want to assess fully the extent to which design risk may lter back

to the Sponsor under the terms of the EPC contract. An example of where this may

happen is in circumstances where the Sponsor accepts the risk in certain sub-surface

site conditions. For instance, the Sponsor may warrant the correctness of survey

information relating to the site and accordingly the EPC Contractor will develop

its detailed design and submit its tender price in accordance with the warranted

information. However, if this information is incorrect, the risk in the design, and in

particular the impact of the changes to the design required to reect actual sub surface

conditions, will pass back to the Sponsor.


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In practice, the lenders’ technical adviser will review the risk prole proposed underthe terms of the EPC Contract generally and will advise the lenders as to the Sponsor’s

potential exposure to cost overrun risk arising from circumstances of the type described

above. It will ultimately be for the Sponsor to convince the lenders that any such risk

identied may be managed by the Sponsor. The Sponsor should of course be aware that

lenders may again seek additional ‘mitigation’ through use of a cost overrun facility or a

request that the Sponsor provides additional security. In the alternative, Sponsors and/

or their lenders will seek to push the risk in question back to the EPC contractor, which

may of course have pricing consequences.

Time and costWhilst we have discussed time and cost risk specically in relation to design above, as

a general point of principle, lenders will want to limit to the fullest extent possible the

EPC contractor’s ability to claim for additional time and/or money under the terms of

the EPC contract. Again, lenders will be concerned about the ability of the Sponsor to

manage the nancial consequences that will accompany these time and cost claims and

more generally the extent to which exposure to such claims may impact on the delivery

of the works in accordance with the requirements of the EPC contract.

Many of the international forms of EPC contract contain scope for time and money

claims being made by the contractor. For instance, FIDIC Silver Book places time

and cost risk for the occurrence of changes in law, compliance with certain employer

instructions and the discovery of objects of antiquity at the works site with the

employer. Whilst on balance this may not appear unreasonable, the employer’s

potential cost and loss of revenue exposure arising as a result of accepting these risks

may be signicant. We have seen more recently lenders pushing back on the acceptance

by a Sponsor of these types of risk, allowing for contractor time and money claims only

in very limited circumstances.

The key point to recognise is that the acceptance by the Sponsor of any aspect of

time and/or cost risk will undermine the xed price assumption sought under the

EPC structure. On the assumption that lenders can get comfortable with this type

of risk being retained by the Sponsor, the Sponsor should itself think very carefully

before accepting such risks. The potential exposure to additional costs will need to be

appraised fully by the Sponsor as will any potential impact on the nancial model for

the project. The Sponsor should ideally seek board buy-in to any such proposals, and

in particular to the commitment of additional equity as may be required at an early

stage in the project. Parent company buy-in may also be necessary particularly where


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parent company guarantees will be required. We would additionally expect the Sponsorto formulate a strategy for managing any such risks. A ‘let’s wait and see’ approach

is unlikely to be satisfactory, since it is likely that prompt and pre-formulated action

will be necessary on the occurrence of the risk in question if the Sponsor’s nancial

exposure is to be mitigated to fullest extent possible.

Delay damagesTo the extent that the works are completed on a date later than that xed under the

terms of the EPC contract for reasons for which the EPC Contractor is responsible (or

are within its agreed liability envelope), the contract will typically include provisionfor payment of liquidated and ascertained damages (LADs). These LADs will typically

be paid at a daily rate to cover anticipated lost prots and costs (including debt service

costs (as applicable)) during the period of delay. It would be unusual for the EPC

contractor to accept unlimited exposure in this regard and any liability sub-cap agreed

will typically be sized to the level of LADs payable up to the construction long stop date.

Whether or not any such sub-cap will fall within the contractor’s overall liability cap is

likely to be an area of debate between lenders, the Sponsor and the EPC contractor. This

issue will tend to be considered by lenders in the context of the EPC security package as

a whole and we will discuss this point in further detail below.

Performance liabilityFollowing completion of construction and the handover of the works, the Sponsor and

the lenders will be keen to ensure that any process system or plant forming part of the

works is able to achieve certain minimum performance requirements. This is usually

required in order to provide both parties with a degree of comfort that projected project

revenues can be achieved by the completed plant over a sustained period. It is usual

therefore for the EPC contract to also document the requirement for a post completion

testing regime.

To the extent that the minimum performance required (or performance guarantees) can

not be achieved for a sustained period of operations, the EPC contractor will typically

be liable for payment of performance liquidated damages up to an agreed liability

cap. The damages will usually be sized according to the loss of revenue and/or prot

occasioned by the performance shortfall for a nite period of time.


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It would be unusual for the Sponsor to achieve a life of mine performance guarantee and,as such, it would be usual for the liability cap in relation to performance damages to be

capped at the Sponsor’s loss prot and debt service costs for a specically negotiated

period. Whilst residual liability will be a Sponsor risk, it would be usual for the Sponsor

to manage this risk by building headroom into the nancial model for the project and

through plant optimisation over time (including through lifecycle type maintenance).

The pre and post-handover testing regime will be subject to scrutiny by the lenders’

technical adviser. If, for instance, it is apparent prior to handover of the works that the

plant is not going to achieve the lenders’ base case performance/output requirements,the lenders may look for a right to reject the plant in its entirety with full recourse

against the EPC contractor for debt outstanding. For obvious reasons, EPC contractors

will tend to resist any such position. They may, for example, look for an extended

period of additional testing in order to rene the plant and to achieve the required

performance levels. If this is permitted, time and cost impact of this additional testing

will tend to be at the EPC contractor’s risk and the lenders will typically seek to retain

the right to reject at the conclusion of any such repeated testing or any subsequent post-

handover testing regime, if a required level of performance is not demonstrated.

Again, where detailed process design is not provided by the EPC contractor, it may

be more dicult to require this party to accept performance risk in full, particularly

in circumstances where the technology is more complex in nature. Carving out these

types of risks from the EPC contractor’s liability under the terms of the EPC Contract

is however likely to make potential lenders nervous for the reasons discussed above.

Whilst lenders may accept the interface risk in this liability gap being lled by the

designer itself (whether under the terms of a design contract with the Sponsors or

under the terms of a collateral warranty), it is often the case that the party providing the

detailed process design is either unwilling or unable to accept the type and extent of

liability for design failure that would usually rest with an EPC contractor under the terms

of the EPC contract. If this is the case, lenders may require additional security from the

Sponsor to bridge the liability gap and to help manage any additional interface risk.

Limitations on liabilityAs indicated above, a key consideration for lenders when considering lending into

a mining project will be the extent to which they will have recourse against the EPC

contractor for debt outstanding in an EPC contractor default scenario.


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There is, as may be expected, a tension between the lenders’ requirement for full coverageof debt outstanding from the EPC contractor’s security package and the legitimate

requirement of a contractor to limit its liability exposure. It is not unusual however for

lenders in the current market to look for an aggregate liability cap of up to 100 per cent

of the contract price, especially where the works include an unproven technical solution.

The lenders may however accept a lower liability cap on the basis that liability for certain

key risks is excluded from the aggregate liability cap. It is not uncommon for instance

for lenders to seek to exclude liabilities that are the subject of a sub-cap, such as delay or

performance liquidated damages, from the aggregate liability cap.

The appropriate exclusions from the aggregate liability cap will be negotiated on a

project specic basis by the lenders following adviser input. The list of exclusions will

typically include those liabilities that are not able to be limited at law (and this will

require local law advice), those liabilities that are uninsurable and those liabilities that

are not quantiable (and therefore able to be reckoned in the sizing of the cap) at the

date of contracting.

Security packageAs we have discussed above, to the extent that the EPC contractor fails to deliver theworks, the lenders and, in the rst instance, the Sponsor, must have direct recourse

against the EPC contractor to recover relevant losses. The lenders will ultimately control

this process through restrictions placed on the Sponsor in the nance documentation.

For instance, the lenders will not allow the Sponsors to use (and ultimately deplete) the

EPC security package to replace a defaulting EPC contractor in circumstances where

such replacement is unlikely, in itself, to secure delivery of the project. It is more likely

in these circumstances that the lenders will look to call a default under the terms of the

nance documentation, trigger its security over the project documentation and access

the EPC security package to recover debt outstanding.

The security provided by the EPC contractor in respect of its potential liabilities will

typically be formed, in part, by a form or forms of liquid security.

Liquid security and bondingWhen we talk of liquid security, we are talking about forms of security that should be

as good as money in the bank for the Sponsor. The Sponsor should be able to claim any

such monies by simply serving a demand on the party providing the security on behalf

of the EPC contractor. Typical forms of liquid security are performance bonds, retention


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bonds and letters of credit, all usually provided by international banks with lenderapproved credit ratings.

Leaving retention bonds to one side for the time being, the lenders in the current

lending market will typically require the EPC contractor to procure performance

security (ie, performance bonds and/or letters of credit) with a value no less than

15-20 per cent of the contract sum, but this may vary on a project specic basis. The

lenders are however likely to permit a step down in performance security coverage as

the works progress to reect reduced risk in the project for the lenders. Typically, the

level of performance security coverage may reduce by 50%, for instance, followingthe completion of operational testing and will usually be discharged completely upon

expiry of the defects liability period (ie, 12-24 months post-handover of the works).

In the UK domestic market, there has been a shift in recent years away from providing

performance bonds of the type described above. This is not to say that such bonds are

not available, however procuring them can be prohibitively expensive. Instead the

UK has increasingly seen use of conditional bonds under which the beneciary must

rst establish the right to make a claim and the quantum of any claim before a call is

made on the bond. Whilst a fraudulent claim under an unconditional bond of the typedescribed above can be challenged, a conditional bond is less ‘liquid’ in nature and is

more akin to a form of guarantee and for the reasons set below will be less attractive to

both the Sponsor and its lenders.

It is usual for lenders to also require that a xed amount of any payment being made to

the EPC contractor is retained and held by the Sponsor as security for the remedying of

defects subsequently discovered in the works. Unlike the performance security which

secures more general performance by the EPC contractor under the terms of the EPC

contract, retentions are held for a specic and dened purpose. However, in reality

this is somewhat of a falsity as lenders generally view retentions as part of the wider

security package available to the Sponsor, and ultimately the lenders, as security for

non-performance by the EPC contractor.

The level of retention required by lenders will vary but typically will be between

3-5 per cent of the contract sum. Instead of a cash retention being made on any

payment to the EPC contractor, and to assist the EPC contractor’s cash ow, lenders will

usually instead accept a form of retention bond as an alternative which will provide


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security for monies that would have otherwise been retained. Any such instrumentshould be in the same form as the performance bond discussed above, ie, provided

by an international bank with an approved credit rating and permitting claims for

payment upon the presentation by the Sponsor of a demand for payment. Again, any

such bond should be as good as money in the bank for the Sponsor.

To the extent that any advance payment is made to cover the cost of the ordering of

plant and materials or mobilisation, lenders will expect the Sponsor to secure such

payments by requiring the contractor to procure an advance payment bond. Again, any

such bond should be unconditional and as good as cash in the bank for the Sponsor.

Liquid security and guaranteesOutside of liquid forms of security, lenders will typically require a guarantee from the

ultimate parent of the EPC contractor. The ultimate parent is usually a requirement as a

shell holding company, for instance, with limited or no assets will not be acceptable to

the lenders.

In practice, lenders will carry out their own due diligence on the parent company

proposed to ensure that it is suciently robust to meet its potential liabilities underthe guarantee.

Unlike the forms of liquid security described above, a guarantee of this kind will

usually rst require the establishment by the Sponsor of liability against the EPC

contractor, which the EPC contractor has failed to discharge. Furthermore, the Sponsor

will run the risk that any claim made under the guarantee will be subject to challenge

by the guarantor. Far from being akin to cash in the banks, the pursuit of a claim

under a parent company guarantee can be a lengthily process which is why claims

under the liquid forms of security will usually be the Sponsor’s rst port of call (unless

of course there are restrictions on the order in which claims may be made under the

relevant documentation).


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TerminationLenders will tend to have certain minimum requirements in terms of the circumstances

where they will expect the Sponsor to have the right to terminate the EPC contractor

and access the EPC security package to either replace the defaulting EPC contractor and

secure project continuance or bring the project to an end. As we have indicated earlier,

the lenders will control the actions of the Sponsor in this regard through the restrictions

imposed on the Sponsor under the terms of the nance documentation.

It would be usual for lenders to look for the EPC contract to contain a right to terminate

the EPC contractor in circumstances where recourse against the EPC contractor maybe limited in some way or where key requirements relating to performance are not

achieved. Lenders will typically look for advance warning of any problems relating to the

works so that armative action may be taken before the circumstances become critical.

Lenders will be especially concerned to see that the losses recoverable on termination

will (to the fullest extent possible) cover amounts outstanding under the terms of the

nance documentation (ie, principal, interest and fees). The ability of lenders to recover

these losses tends to be very dicult for the uninitiated to understand and accept

this, but this is part and parcel of limited recourse project nancing where the lenders’security is limited to the project and those responsible for delivering it.

EPC contracts – key point summary

(a) In terms of delivery of the detailed engineering and construction phase of a

project, lenders will usually prefer for one nancially robust party to accept full

responsibility for the delivery of all aspects of the works on time, on budget and to

meet the required technical and performance specication. In achieving this single

point of responsibility position there will be reduced risk that:

— there may be gaps in liability cover;

— there may be interface issues when it comes to identifying the party responsible

for a failure; or

— the party identied as being responsible for a failure can not be held to account

either because its liability is limited contractually or more generally because it

does not have the balance sheet to meet the liabilities in question.


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(b) If the single point of responsibility position can not be achieved, and on theassumption that lenders accept this, the Sponsors must consider how they will

themselves manage the risk(s) in question and in particular the concerns identied

in sub-paragraph (a) above. The Sponsors should at an early stage plan for the

management of the relevant risk(s) and obtain board approval to the provision of

additional security or the need for any additional cost overrun facility.

(c) The lenders will have key requirements in terms of:

(i) the obligations on the EPC contract to deliver the works on time, on budget andto meet a required technical and performance specication; and

(ii) the recourse available against the EPC contractor to the extent that it fails to

discharge its obligations under the terms of the EPC contract.

The preferred EPC contractor should be procured on the basis that these key

requirements will be included in the form of EPC contract eventually signed. This will

allow for certainty of EPC price at the conclusion of EPC procurement process and will

mitigate the likelihood of price escalation following EPC contractor selection.

General

The acronym ‘EPCM’ is commonly mentioned in the same breath as the EPC structure

described above. However, from both a structuring and risk allocation perspective, the

two contracting solutions are fundamentally dierent. The confusion would appear

to come from the shared use of the work ‘construction’ in their titles. It is important

however to recognise that an EPCM contract is (amongst other things) essentially a

design and construction management contract and that no physical construction will

actually be carried out by the EPCM contractor.

The EPCM structure has been used extensively in the mining sector, especially in the

years leading up to the global nancial crisis (GFC) where the lending market became

more contractor friendly in terms of both risk allocation and pricing. However, post GFC

the lending market has hardened and the liquidity gap has meant that lenders have been

increasingly risk averse and far more selective about the projects they are willing back.


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This being said, we have seen more recently the EPCM procurement route re-emerge asthe preferred procurement model in the mining sector.

For all that has been said above around the need for a single point responsibility etc.,

lenders may consider backing a project being procured on an EPCM basis provided that

certain minimum requirements have been met. This is certainly the way we are seeing

the market move.


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EPCM Contracts

EPCM Contracts

The EPCM structure

In contrast with an EPC contract (and as mentioned above), the EPCM contractor does

not undertake primary responsibility for delivery of the construction works. The EPCM

contract is essentially a professional services contract under which the EPCM contractor

will typically carry out the following services:

• Engineering services – the EPCM contractor will typically be the party producing

the basic design at feasibility stage or will be appointed post feasibility under the

terms of the EPCM contract to complete the basic design developed by or on behalf

of the Sponsor. The EPCM contractor will typically be responsible for overall co-

ordination of design for the project to ensure that the completed works meet the

required technical and performance specication (but note Appendix 1 to this guide

describing the limited liability typically accepted by EPCM contractors in this regard).

• Procurement services – the EPCM contractor will be responsible for the overallprocurement strategy and will source contractors, consultants and the necessary

plant and equipment in accordance with the Sponsor’s requirements and the

assumptions established at feasibility stage. The EPCM will advise on the timing

of the letting of the relevant packages and will advise the Sponsor on the terms

available and will negotiate the contract packages on the Sponsor’s behalf.

• Construction Management services – the EPCM contractor will typically be

responsible for overall management of the carrying out and completion of the works.

This will include the co-ordination of the works and services being procured on the

Sponsor’s behalf to achieve completion of the works in accordance with the project

schedule, the project budget and to meet the required technical and performance

specication (but again, note Appendix 1 to this guide and the limited liability

typically accepted by EPCM contractors in this regard). The construction management

services will also typically include the management of health and safety at the

site, the establishment of quality assurance systems and the management of the

remedying of defective works and or services provided by other parties.

Some Sponsors are adopting a slight variant to the EPCM arrangement which is

essentially a split EP & CM structure. Under this variant the Sponsor will appoint a


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rm generally with greater expertise in engineering design and, possibly procurement,as the EP Contractor. The Sponsor will then appoint a specialist ‘construction

management’ rm to appoint and manage the trade contractors and the rest of supply

chain (including the engineering designer). This assists getting lenders comfortable

that an appropriate party will be in place having expertise in procurement to ensure the

best chance of success and avoiding cost overruns.

Whilst the EPCM contractor will negotiate the terms of the contract packages, whether

for delivery of works, services or the provision of plant and equipment, it is usual

that the Sponsor will enter into direct contractual relations with the relevant thirdparties and assume the rights and obligations under the relevant contracts. We have

however seen arrangements under which the EPCM Contractor will itself enter into the

contracts with the third parties as agent for the Sponsor. Whilst this is perfectly ne,

consideration will be required on the provisions necessary to protect the Sponsor and to

maintain the supply chain arrangements should the EPCM Contractor be terminated.

For reference, we have set out below the typical EPCM structure.

EPC Contract

EPCM ContractorMining Company

Contractor B Contractor CContractor A

As we have indicated above, the EPCM structure may be considered by a Sponsor where

the single point of responsibility EPC structure can not be achieved or is not attractive

for one reason or another. This may be because:


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EPCM Contracts

• The securing of the single point of responsibility EPC solution may expose theSponsor to inated pricing which may have an impact on project aordability and

which may not be considered by the Sponsor to oer value for money.

• There may be a general lack of appetite in the market to take on the project in

question on a turn key EPC basis.

• The Sponsor has a good track record in project delivery and has a large internal

management resource and as a result prefers to adopt the EPCM structure to

signicantly reduce overall outturn cost and increase equity returns.

In the context of a mining project, the EPCM contractor will typically be the party

developing the basic design at feasibility stage. This party may then be retained

to develop the nal design and to provide the other relevant EPCM services for the

construction phase of the project. This structure will obviously generate continuity

in design responsibility throughout works planning and implementation and will

typically allow for greater employer inuence in design evolution than would otherwise

be available under the EPC structure.

In considering the use of an alternative structure (eg, EPCM) (and on the assumption

that an EPC structure is otherwise achievable) the Sponsor will typically balance,

amongst other things, the increased cost and reduced equity return that is likely

to accompany use of the single point of responsibility EPC solution against the

corresponding key benets, namely, price certainty for project delivery and the

increased likelihood of securing project nance. If the negatives of the EPC solution

outweigh the positives, the Sponsor may be inclined to consider use of an alternative

contracting structure.


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EPCM and bankabilityThe fundamental point for the Sponsor to consider will however be the extent to which

the EPCM solution may be considered bankable by potential lenders.

A key dierence between the EPC and the EPCM solutions is that the EPCM solution

does not oer a single point of responsibility for delivery of the works. There will be

multiple interfaces which must be carefully managed by the EPCM contractor and the

Sponsor and there will remain a risk that there may be gaps in liability or that a party

identied as be liable for a failure will not, on its own or collectively with other culpable

parties, be willing to accept the measure of liability typically recoverable by a Sponsorwhen using the EPC structure.

The provisions of the EPCM contract, in terms of both scope (as identied above) and

liability for the services provided, will dier fundamentally from the terms seen in a

typical EPC contract. To illustrate these dierences, we have provided at Appendix 1

to this guide a comparison between the key requirements under the EPC structure and

the corresponding terms and risk allocation typically achieved in the context of an

EPCM structure.

The reader should note that the summary at Appendix 1 provides only a high level

overview for the purposes of comparing the risk allocation typically seen under the

EPC and EPCM structures. There will of course be exceptions to these positions on a

case-by-case basis. To provide a more detailed picture, we provide our clients with

EPC and EPCM risk matrices that essentially show the positions taken on the key risk

issues on recent projects closed in the mining sector. These invaluable tools allow us to

quickly identify the market position on any given risk and more particularly show how

a particular risk allocation has been banked (if at all).

From the high level summary at Appendix 1, it is apparent that the usual risk prole

under the EPCM solution is far less favourable from the Sponsor’s (and ultimately the

lenders’) perspective when compared with the position typically secured by Sponsors

under the EPC structure. It is perhaps a little unfair to compare the two on a like-for-like

basis given the material dierences in what each structure seeks to achieve.

It is easy to see however why lenders may prefer the certainty and security that comes

with the EPC solution and also why many of the key principles under that solution

may gain support from the Sponsor. However, whilst risk allocation considerations are


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EPCM Contracts

very important, the Sponsor will also be looking at the commercial imperative of (a)bringing a project to market where, for instance, the EPC structure is not achievable

and, (b) maximising equity returns from the project by securing a signicantly lower

construction cost.

EPCM – key requirementsIf the EPCM solution is to be considered, it will be important for the Sponsor to rst

satisfy itself and ultimately the lenders that the proposed solution can oer a robust

structure for project delivery. The following requirements will, in the writers’ view, be

key to demonstrating a robust EPCM structure best equipped to secure project delivery:

(a) The selected EPCM contractor should be a robust experienced organisation with

a strong track record of securing project delivery on an EPCM basis in the mining

sector. The terms of the EPCM contract should reect an appropriate risk transfer to

the EPCM contractor.

(b) In view of the more limited liability typically accepted by an EPCM contractor

under the EPCM structure, the Sponsor should appoint a full time experienced and

well resourced owner’s team to monitor and manage the execution of the projectin order to ensure that the Sponsor’s key requirements are being achieved and

to permit early identication of issues that may impact on project delivery. There

should be developed a clear internal strategy for the management and resolution of

all risks retained in part or whole by the Sponsor.

(c) The contractors, service providers and equipment and plant suppliers should also

be robust entities with experience and a track record of project delivery in the

mining sector. Where possible, these contracts should be nalised on a xed price

basis with any limits on liability and security requirements being appropriately

determined in accordance with the role assumed by the relevant party.

(d) The Sponsor should identify possible interface issues and put in place an

appropriate mechanism to co-ordinate the completion of the works and to address

the allocation of risks that may impact on delivery of the work. This mechanism

should provide for prompt resolution of the relevant circumstances in a manner

which does not detract in any material respect from project delivery.


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Whilst the points identied above will be important in developing robustness in thestructure for project delivery, there is little doubt that potential lenders will seek from

the Sponsor security for the residual risks that may be retained at Sponsor level under

the EPCM solution.

In the rst instance this is usually achieved through use of a designated cost overrun

facility to meet likely cost and/or time overrun exposure.

A more robust view on EPCM risk transfer

As Sponsors and contractors operating in the mining sector are usually large

sophisticated entities, it is perhaps surprising that the approach taken to risk transfer in

the context of EPCM solutions has traditionally been relatively simplistic in nature when

compared to the approach taken in other sectors. This approach is however changing.

Given that the role of an EPCM (or EP&CM) contractor will be fundamentally dierent to

that adopted by an EPC contractor and given, as a consequence, the signicantly lower

price paid for EPCM services when compared with that payable under a typical EPCcontract, the wholesale transfer of risk from the Sponsors to the EPCM contractor will

not be appropriate.

However, use of more innovative ways to transfer risk to the contractor, without

necessarily seeing a dollar for dollar pricing consequence, are getting more serious

consideration in the mining context. Whilst use of these solutions will not, in

themselves, secure a bankable position for the Sponsors, they will however create a more

robust EPCM structure by ensuring that the EPCM contractor has ‘skin in the game’ and

is further motivated to secure project delivery in accordance with Sponsor requirements.

IncentivisationA key aspect of EPCM risk allocation is the concept of incentivisation.

Incentivisation provisions will typically provide for EPCM contractors accepting

nancial risk and reward in the achievement of key project requirements, including,

completion of the works within the agreed project budget, completion of the works

in accordance with the project programme, achievement of certain health and safety

targets and the nal works achieving key performance and other quality requirements.


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EPCM Contracts

Whilst these risks are not passed to the EPCM contractor in full, the EPCM contractorwill be accepting a degree of liability in the relevant risk, so will be more motivated

to manage it. The key point to understand is that the EPCM contractor will usually be

responsible for the nancial downside of the incentivisation provisions irrespective

of whether it has used reasonable skill and care in managing the risk in question.

There is a therefore clear imperative for the EPCM contractor taking ownership of the

management of the risk in question from that date of contract to secure project delivery

in accordance with the Sponsors requirements.

There would ordinarily be concerns that the EPCM contractor will simply price the riskin question on a contingent basis, and this will of course not oer value for money for

the Sponsor, particularly if the risk never materialises. These concerns however tend

to be mitigated by the fact that the EPCM contractor’s risk in the project will be limited

to its agreed prot margin on which there should, in theory, be absolute transparency

beyond the actual agreed cost for providing the EPCM services.

Conversely, there will also typically be a bonus structure under which the EPCM

contractor will receive additional payments (up to an agreed cap) for meeting and

surpassing key project delivery requirements.

EPCM – key points summary

(a) An EPCM contract is essentially a professional services contract under which the

contractor will not accept primary responsibility for the carrying out of the works.

(b) The EPCM contractor will be responsible for:

— completion of detailed engineering;

— the procurement of contractors, service providers and plant and equipment

suppliers on behalf of the Sponsor; and

— management of the carrying out and completion of the works on behalf of the

Sponsor.


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(c) The contracting structure under an EPCM solution is fundamentally dierent tothat adopted under a typical EPC solution. Unlike the EPC solution, it will usually

be the Sponsor, not the contractor (but see our comments above where this can be

an option), that will enter into contractual relations with the contractors, service

providers and plant and equipment suppliers responsible for delivery of the works.

(d) The risk prole under an EPCM solution is substantially more onerous from a

Sponsor perspective when compared with the EPC structure. In order to attract

project nance the Sponsor will need to:

— demonstrate an allocation of risk between the Sponsor and the EPCM contractor

appropriate in the post GFC lending market; and

— demonstrate to potential lenders how the risks retained by the Sponsors will be

managed (eg, through use of cost overrun facilities etc.).

Bribery Act – new legislation for companies with UK links

Whilst not an issue that will directly aect the nancing of a mining project or more

generally its economic viability, any Sponsor incorporated in the UK or carrying out

business or any part of their business in the UK should from now be considering very

carefully the requirements of the Bribery Act 2010 (the Act).

The Act will make it a criminal oence, for persons to whom the Act relates, to bribe

another person or to be bribed, but perhaps most signicantly it also introduces a new

criminal oence for corporates of ‘failing to prevent bribery’.

Corporate entities can be guilty of this oence if an ‘associated person’, which given

the scope of this denition is likely to include any EPC or EPCM contractor, otaker or

operator, carries out an act of bribery when acting on their behalf. It is important to

recognise that the ‘associated person’ does not need to be incorporated in the UK or

indeed have any business connection with the UK.


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EPCM Contracts

The only defence for an entity being prosecuted for failing to prevent bribery is to showthat it had ‘adequate procedures’ in place designed to prevent bribery being carried out

on its behalf. Whilst the precise meaning of ‘adequate measures’ is not clear, the UK

Government has made available guidance as to the key principles to be followed.

Given the signicant scope and extraterritorial reach of the Bribery Act, it will be

extremely important for Sponsors to rstly ensure that they have robust internal

policies in place to guard against bribery and secondly to ensure that its supply chain

members have robust anti-corruption compliance programmes and are subject to

appropriate due diligence and monitoring.

Specic advice should be sought by Sponsors having any particular concerns about

the scope and implications of the Act.


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NoteThe reader should note that this summary provides only a high level overview for the

purposes of comparing the risk allocation typically seen under the EPC and EPCM

structures. There will of course be exceptions to these positions on a case by case

basis. To provide a more detailed picture, we provide our clients with EPC and EPCM

risk matrices that essentially show the positions taken on the key risk issues on recent

projects closed in the mining sector. These invaluable tools allow us to quickly identify

the market position on any given risk and more particularly show how a particular risk

allocation has been banked (if at all).


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Appendix 1

Appendix 1

EPC risk

allocation

Typical EPCM position EPCM risk

allocation

Risk typically

transferred

to the

contractor

EPC EPCM

Contractor to be

responsible forcompleting the

works on time.

The EPCM contractor will not usuallyguarantee delivering the works on time

and will therefore not usually have

responsibility for the payment of delay

liquidated damages in this regard.

Any damages recoverable from other

contractors, who are identied as being

responsible for delayed completion of the

works, will not typically be of the order

recoverable under the EPC structure

(either because of quantum or cappingarrangements agreed).

Nominal delay liquidated damages

may be payable by the EPCM contractor

to the extent that the design, or otherdeliverables for which the EPCM

contractor is responsible, are delivered

otherwise than in accordance with the

project programme.

The EPCM contractor will be responsible

for managing the overall works

programme and any failure to use

reasonable skill and care in doing so will

give rise to liability. Any such liability

will usually be restricted to a contractualdamages claim and will be subject to the

limitations on liability identied below.

As the delay

damages

recoverable

from the EPCM

contractor,

and any other

contractors

identied

as being

responsible

for delayed

completion of

the works, will

not be sucient

to cover theSponsor’s

potential loss

in revenue and

debt service

costs occasioned

by such delay,

the nancial

risk of delayed

completion of

the works will

ultimately rest

with the Sponsor.

✔ ✗


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EPC riskallocation

Typical EPCM position EPCM riskallocation

Risk typicallytransferred

to the

contractor

EPC EPCM

Completion

of works for

a lump sumxed price.

The EPCM contractor will not usually

guarantee the overall outturn cost ofthe works.

The EPCM contract will provide for the

EPCM contractor setting the budgetand managing adherence to the budget.

Any failure by the EPCM contractor to use

reasonable skill and care in doing so

will give rise to liability. Given the

limits on the EPCM contractor’s liability

typically agreed under the terms of an

EPCM contract (see below), it is unlikelythat liability for any signicant cost

overrun will be recoverable from the

EPCM contractor.

In procuring the works, services andplant and equipment supply packages

on behalf of the Sponsor, the EPCM

should attempt to procure such packages

on a xed price basis. However, this is

not always possible. Notwithstanding

the fact that xed price solutions maybe achieved, the multiple interfaces

will however widen the scope for timeand money claims by the third party

contractors which will be a Sponsor risk

to the extent that the liability giving rise

to any such claim can not backed o fully

with other contractors.

Payments to the EPCM contractor for

services performed are typically made on

a monthly basis based on actually costsincurred at agreed rates (ie, payment is

on a fully reimbursable basis).

The Sponsor will

ultimately accept

the risk of any

material cost

overrun.

✔ ✗


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Appendix 1

EPC riskallocation



to the

contractor

EPC EPCM

EPC contractor

to provide

performance

guarantees

in respect ofthe completed

plant.

The EPCM contractor typically accepts

full responsibility for the nal design

and for it meeting the required technical

and performance requirements and will

usually be responsible for coordinatingthe design produced by other parties.

Establishing that a performance failure

has resulted from the design produced

by the EPCM contractor and not fromthe implementation of such design by

other contractors may not always be

straightforward.

The liability of the EPCM contractor for

design failure will however be limitedas set out below.

Due to interface

issues relating to

identifying the

party responsible

for performancefailure and the

more limited

liabilities

accepted by

parties under theEPCM structure,

it is more likely

that the majority

of the liability for

any substantiveperformance

failure willretained by

the Sponsor.

✔ ✗

Any limit

on liability

to provide

sucient

coveragefor recovery

of amounts

outstanding

under the terms

of the nancedocumentation.

Appropriate

carve outs

to be agreed

in respect ofwhich the EPC

contractor’sliability will

be unlimited.

The EPCM contractor’s liability willtypically be limited to anything from

10-20 per cent the EPCM contract price

(which will typically equate to the EPCM

Contractor’s prot margin).Carve outs from the liability cap are

usually limited to those liabilities than

can not be limited at law.

Sums recoverable from the other

contractors in the aggregate (on the

assumption that the parties responsible

can be held to account) are unlikely to be

of the order of sums recoverable from an

EPC contractor under the EPC structure.

The Sponsor’s

(and ultimately

the lenders’)

recourse for

recovery of debtoutstanding andother losses in a

project default

scenario will

be limited. The

residual liability

in this regardwill ultimately be

a Sponsor risk.

✔ ✗


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EPC riskallocation



to the

contractor

EPC EPCM

Security

package to

include liquid

performance

security,retentions

and parent

company

guarantees.

Whilst parent company guarantees tend

to be procured, it would be less usual for

EPCM contractors in the mining sector to

provide other liquid forms of security.

The EPCM position in this regard is

symptomatic of the nature and extent

of liability being accepted by the EPCM

contractor.

The nature and extent of the security

package obtainable from contractors,

services providers and plant andequipment suppliers will be determined

on a project specic basis.

Sponsors accept

cash ow riskduring the period

in which a claim

is establishedagainst the

EPCM contractor

and sums for

which the EPCMcontractor

is liable are

recovered from

the parent

company.

✔ ✔/ ✗


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Appendix 1


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Contacts

Martin McCann

Global head of mining,

infrastructure and commodities

Norton Rose Fulbright LLP

Tel +44 20 7444 3573

[email protected]

Mark Berry

Partner, London

Norton Rose Fulbright LLP

Tel +44 20 7444 3531

[email protected]

Matthew Hardwick

Senior associate, London

Norton Rose Fulbright LLPTel +44 20 7444 5550

[email protected]

Contacts


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Mining Guide Epc and Epcm Contracts 104178