Tips and tactics for negotiating and drafting EPC contracts for power and energy projects.
By Daniel A. Kapner, Esq.
Power and energy projects involve significant, unavoidable risks that must be allocated between project participants, including complex systems and equipment, high costs, substantial time and technology. To increase the likelihood of a project’s success, it is critical that each owner and engineering, procurement and construction (EPC) contractor understand these risks and weigh the likelihood of both positive and negative outcomes. They must also analyze the pros and cons of the available contracting and pricing models, and identify key contractual rights and responsibilities that will maximize that party’s legitimate self-interests.
The following are tried-and-true tactics and tips for owners or EPC contractors entering into an EPC contract for a power and energy project.
Determine the optimal contracting model – A critical initial decision for an owner is whether it wishes to – and is financially and practically able to – allocate all risks for major equipment such as turbines and generators, and related technology onto the EPC contractor.
Under a “full wrap” contracting model, the EPC contractor assumes all responsibility and risks for major equipment. An obvious benefit to an owner using this model is that if a major problem – such as an equipment defect or failure – arises, the owner will not have to pursue multiple parties to determine the root cause and responsible entity. However, to the extent that an EPC contractor will agree to incur these substantial risks, it will cost a premium.
By contrast, under a “partial wrap” model, the EPC contractor assumes the responsibility and risks for everything except formajor equipment, and the owner must purchase the major equipment and obtain the relevant equipment warranties. An owner may also have reason to furnish and install the major equipment itself and through a separate installation contractor. Project participants must carefully evaluate the available contracting models and weigh the benefits and risks of each model.
Determine the optimal pricing model – Project participants also must carefully analyze and determine the optimal pricing model. This can include a “fixed price” for the entire EPC scope, a “firm price” – i.e., a fixed price that is subject to escalation for certain price increases, such as an increase in the cost of steel – or a “target price,” which is a cost-reimbursement model established through an open book estimate process. Each of these pricing models carries significant risk implications, so it is critical that the project participants understand and evaluate which model is most appropriate for the project.
Negotiate and draft the mechanical completion and substantial completion provisions very carefully – While conventional wisdom may suggest that “mechanical completion” means that all work necessary for the project to operate safely has been completed, “mechanical completion” in fact means whatever the EPC contract says it means. An owner may wish, for example, that mechanical completion also requires the EPC contractor to provide operation and maintenance manuals and systems turnover packages as well as conduct training. The same concept is true for “substantial completion.”
Carefully negotiate and draft other key provisions – Claims often arise because a project member did not fully understand a key contract provision, for example, because he thought it was simply “boilerplate” and did not read or understand defined terms, or did not read exhibits incorporated into the contract. Project participants should pay careful attention to the provisions most likely to give rise to claims, including project time and schedule, delays, completion milestones, delay damages, technology, the contractor’s standard of performance, and price and payment.
Avoiding and managing claims begins at project inception – When core project team members fail to plan for the unexpected, poorly allocate and/or manage risk, maintain unreasonable expectations or an unreasonable budget, or are more interested in being “right” than in achieving solutions, claims often arise.
In addition to the above tips, project participants should focus early in the process on developing a reasonable budget and achievable schedule, identifying key regulatory requirements and restrictions, actively vetting project teams and obtaining appropriate financial guarantees and/or security, such as performance or payment bonds or letters of credit. Given the significant risks inherent to power and energy projects, no project will proceed as initially planned so parties should always anticipate the unexpected.
Daniel A. Kapner, Esq., is a member of Shapiro, Lifschitz & Schram’s trial practice, construction law, and power and energy construction groups. He has significant experience advising clients in various sectors of the construction industry to achieve solutions to complex contract and commercial disputes. Kapner co-teaches a seminar several times a year on “EPC Contracts for Power & Energy Projects.” Contact him at 202-689-1900 or firstname.lastname@example.org.