‘Project Finance’ is a method of raising long-term debt financing for major projects through ‘financial engineering’, based on cash flow generated from the project alone. Project Finance techniques are now used, globally, for projects related to oil pipelines, petrochemical plants, power plants, rail systems, roads and major highways, amongst others. In 2012, an estimated $375 billion worth of investments in projects around the world were financed or refinanced using project finance techniques , indicative of the growth of Project Finance, including as a practice area for legal practitioners and attorneys world over.
In a typical project finance transaction, there are five main parties, namely the: Project Company, Sponsors, Government, Commercial parties and Financiers. The relationship between these parties is regulated by project finance contracts, which contracts define the project, set out the repayment terms, and apportion responsibilities and risks between all the project parties. Examples of such project finance contracts include the: Shareholders’ Agreement, Government Agreement, Financing Agreement, Supply Agreement and Sales/Off-take Agreement.
This article will be centred on the Construction Contracts that underpin project finance transactions, more particularly, EPC and EPCM contracts, including what they entail, and their advantages and disadvantages. In a project finance transaction, the Construction Contracts are entered into between the Project Company and Construction Contractor. The most commonly used contracts are either EPC (engineering, procurement and construction) or EPCM (engineering, procurement, and construction management) contracts. The contracts themselves are often based on industry standard forms such as JCT (Joint Contracts Tribunal forms produced by ICE Institution of Civil Engineers), FIDIC (Federation Internationale des Ingenieurs-Conseils) or IME (Institution of Mechanical Engineers).
The first type of Construction Contract commonly used in Project Finance transactions is the EPC contract. In an EPC Contract, the contractor is responsible for constructing the whole project by a fixed time and for a fixed price. EPC Contracts are distinguished by their single point responsibility , as the contractor assumes responsibility for the overall performance of all subcontractors. As a result, EPC contracts are often referred to as “turnkey” contracts.
The advantages of EPC Contracts include the fact that many of the completion related risks are shifted to the Contractor, including those related to cost and completion time. Furthermore, the single point of responsibility eliminates the risk of there being ‘gaps’ in the construction and commissioning of the project. Importantly, in an EPC Contract, remedies are pursuable by the Project Company directly against the EPC Contractor.
The disadvantages of EPC Contracts are that they are unsuitable for large scale and complex projects, where no one contractor is comfortable taking on the full turnkey risk, e.g. nuclear projects and certain petrochemical projects. Furthermore, EPC Contracts are unsuitable for ‘first of a kind’ projects, or those that involve technology beyond the skill of the main contractor, e.g. offshore wind farms.
The second type of Construction Contract commonly used in Project Finance transactions is the EPCM contract. In an EPCM Contract, the contractor provides a professional service but does not take direct and sole responsibility for the overall cost, performance or execution of the project. Accordingly, there is multi-point responsibility, as the Project Company individually negotiates and contracts with separate contractors for different elements.
The advantage of EPCM Contracts are that they are capable of being used in large scale and complex projects, where the completion related risks may be shared amongst numerous contractors.
The disadvantages of EPCM Contracts are that there is no “turnkey” responsibility on the EPCM contractor, the Project Company has to negotiate with each contractor separately and remedies have to be pursued against individual contractors with liability caps fixed by reference to their separate contract values. Though EPC and EPCM Contracts remain the popular option for major Project Finance transactions, a merged option has increasingly been adopted. This option, is to have all of the contracting companies form a construction consortium which enters into the construction contract- with joint and several liability on the part of all of its members.
The advantages of this approach are that no one contracting company in the consortium has to assume responsibility for the performance of the others (they all do) and the employer retains his single port of call for damages and remedial work. In addition to mitigating the issue of responsibility, the merged option can also include stipulations relating to both price and completion date, thus mitigating the central risks associated with the construction contract package.
Construction Contracts form one of the most essential contracts in Project Finance transactions, as they directly impact factors such as project cost and completion time. In this piece, the most common Construction Contracts, being EPC and EPCM contracts, have been explored including their main characteristics, advantages and disadvantages. This piece has further gone on to explore the fast-growing ‘merged option’ as a Construction Contract solution within the Project Finance matrix. All these options must be borne in mind when dealing with Project Finance transactions, in order to provide the most suitable advice to clients in managing existent risks
Recent Comments