The inclusion of ‘sub-contracting’ rights under EPC Contracts

Depending on their size and local capacity, the Contractor may not be able to carry out all construction activities.  In fact it is unlikely that they will be competent in all of the aspects of work necessary to complete the facility’s construction.  They will naturally need to be able to sub-contract parts of the works accordingly.  Renewable energy projects require cross-disciplinary competency in civil, structural, electrical, mechanical and electronic engineering, and the appointed Contractor may not have all this in-house.

SUBCONTRACTING

This should not be a complicated part of the contract (at least from a technical point of view; legal speak may be different.)  There is normally a schedule of approved sub-contractors that the Contractor can approach and appoint directly, and this schedule will often include a limit on the overall contracting price or value of works that may be carried out by each sub-contractor.  The list of approved sub-contractors should have been reviewed prior to signing the contract.  This will help to ensure that all the sub-contractors are considered to be competent, and that no single sub-contractor is awarded work that is considered to be more than they have capacity for, or competency to manage.

The Employer may also wish to limit the types of works that may be sub-contracted or require that approval is required prior to the Contractor sub-contracting certain aspects of work.  For instance, they may require that onsite project management responsibilities remain with the Contractor.

The appointment of any new sub-contractors, after the conclusion of the contract, needs to be passed by the Employer and the Employer should have the right to present objections or comments on the suitability of the proposed sub-contractor.

It is important that the appointment of a sub-contractor does not, in any way, relieve the Contractor of their obligations under the contract.  They should also be required to pay sub-contractors timeously for completed works. The non-payment of sub-contractors for work that has been demonstrably completed according to task orders presents a risk to the Employer, as this could result in lengthy disputes, or the sub-contractors downing tools.  While the responsibility for resolving this lies with the Contractor, it can be the Employer who’s left with poor quality work, or extended project delays down the line.

The same principles apply for equipment suppliers.  There should be an approved list of suppliers for major equipment, and any changes should need to be passed by the Employer.  Refer to a previous post on contract variations if you’d like to read a bit more on this.

The importance of original equipment manufacturer’s guidelines in EPC Contracts

Your EPC Contractor should be very good at carrying out the facility’s E, the P and the C.  They should be able to design the facility, procure the equipment necessary and then manage the construction thereof.  They are not necessarily experts in the the manufacture, storage, handling, installation and operation of complex electronic equipment.  Or even of basic structural steels.  They will be procuring from the experts (or they should be at least).

What this means is that someone else, the original equipment manufacturer (OEM) has gone to the trouble of thinking about how the equipment should be handled, and what some things should and shouldn’t be done around or to this equipment.  They should have written this up very nicely in an installation manual or something similarly named.  There are often links between the requirements set out in these manuals and the warranties that the OEM provides on the equipment.

If the equipment malfunctions and the OEM can point to a requirement in the manuals and say “you didn’t do what we listed” they may be well within their rights to say that the warranty is no longer valid.

If the warranty is voided, the EPC may be required, under the warranty obligations in the Contract, to pick this warranty up themselves, but OEM’s should have a bunch of money set aside for warranty claims, or they may be able to make good on the equipment using their skill and knowledge of how to remediate malfunctioning equipment.  Again, the Contractor is unlikely to be an expert in this, and may approach a rectification task like a cat with a welding torch.  i.e. not well.  They may also not have the kind of money to replace the equipment if there is a facility-wide malfunction.

Welding_cat

So how do you avoid burnt fur and angry felines?  Make sure that the Contractor is required to source all of the relevant manuals from the OEM’s and that they are obliged to comply with these.  This should be set out in the Contract, but it is very much recommended that the Employer is aware of the content of these manuals, and that they can spot any non-compliance.  If this is observed, the Contractor will be violating the requirements of the contract, and perhaps this can be avoided going forward, before any damage is done and some paws have been scorched.

Things that are in these manuals:

  • How should the equipment be packaged for transportation?
  • How should the equipment be hoisted and moved?
  • What are the suitable environmental conditions for transportation, storage and operation?
  • Are the Contractor’s choices, in terms of the method of transportation, the layout of the laydown facility and the overall facility’s design in compliance with these environmental considerations?
  • How should the equipment be installed – are there any specific checks that need to be done, or should any activities take place in a specific sequence?
  • Is there any specific action that should be avoided? (such as making onsite modifications to the equipment, like cutting through a galvanising layer on structural steel)
  • How should the equipment be commissioned and tested?

They seem pretty obvious when you read them in the manuals, but keep in mind that not everyone will be aware of the requirements, and time constraints may lead people to cut corners.  These cut corners can have an enormous impact if an OEM says that the latest corner cut was cut too fine.

The difference between contract variations and design amendments

Contract variations

The processes to be followed for any changes to the contract terms, clauses and schedules should be outlined and detailed appropriately; we’ll call these contract ‘variations.’  The contract should cover how to deal with variations proposed by the Employer or the Contractor.  Variations are important to understand fully, as they will almost inevitably end up with additional time and/or cost requirements.

dilbert_misinterpretation

If the variations relate to the technical specifications, they should result in improvements to how the facility operates; to generate more energy, to operate more safely or to result in cost reductions.  Variations may also change certain clauses or obligations set out in the contract, relating to either party’s obligations.  For example, the Employer may require additional reporting functions over and above what is required in the original contract, or there may need to be changes made to the way that performance guarantees are calculated.  These naturally need to be negotiated and agreed upon.

What is important here is that there will be requirements for written notification of the intention for a variation, the impact of this variation will need to be reviewed, and any additional cost imposed on the Contractor will inevitably be reflected in changes to the overall contract price.  Extensions to the scheduled completion date may also come into effect (if, for instance, additional equipment needs to be procured, impacting on the critical path.)

Variations requests and the outcomes of the requests should be documented and recorded and all relevant parties and stakeholders should be informed of the variation and the impact that this has on the project.  Reports, programme of works, design documentation, test plans, manuals etc should be updated accordingly.

Design amendments

Changes to the design are different.  The contract should outline the process to be followed for the Employer to review Contractor designs.  This will typically provide the Employer with a certain period in which they are able to provide comment on the design.  At the end of this period the Contractor may proceed as if the Employer has no comment if no feedback has been received.

This does not mean that the Employer has accepted that the design is in compliance with technical specifications of the contract.  Regardless of the Employer’s review, the responsibility for ensuring that the design is in compliance with contract remains with the Contractor.  This is very important, and both parties should understand this key concept well.  This is also an important reason for the Employer to be incredibly cautious in directing the Contractor to include any specific items in the design, as this may cause a conflict between what is set out in the contract, and what the Employer requested.

I digress slightly here, but the above is very important and is relevant for the point I want to make here which is as follows: the Contractor can make amendments to the design, submitting said amendments to the Employer for comment, but as long as the overall design is still in compliance with the technical requirements set out in the contract, this does not constitute a contract variation, and the variation clauses should not be triggered.  The Employer may comment or not, but if the Contractor has simply issued a drawing update, or a minor layout change, for instance, no formal contract variation processes apply.

I’ve seen confusion over this principal in practice.  The Contractor submits a design change for comment (a design change that was not in accordance with the specs), and when no response from the Employer is received they considered it to have been accepted as a variation.  When the Employer later questions why they are not fulfilling the technical requirement of the contract, the Contractor has said, “well, you accepted a change when we submitted the design.”

“No Mr Contractor”, you say, “where did you submit in writing that you were after a contract variation, and what documentation did you provide to me to show that this presented an improvement to the facility’s efficiency, safety, or cost?”

Clever Employer.

But first, to be such a clever employer, you first need to ensure that you have the correct tools at your disposal, which, in this case, are the suitable contract clauses are in place, where the processes to be followed for contract variations and design reviews are clearly defined.

Defining the Contractor’s scope of work

The EPC Contractor will develop and refine the contract price based on their assumptions on what work will be required to fulfil their obligations under the contract.  In order to do this, the full scope of work needs to be fully developed, without leaving gaps or ambiguous clauses that could conflict down the road.

The less common, but still very important "Smell-O-Scope of Works"
The less common, but still very important “Smell-O-Scope of Works”

The biggest disagreements that I’ve seen during construction have been the result of the Employer thinking that it was clear that a certain scope item was included in the contract, and the Contractor flat out denying this to be the case.  Hold all requirements such as “all works required for the facility to perform as intended” may seem like they cover all bases, but the Contractor could argue that the facility could perform perfectly well without them having to provide the Employer with well graded and compacted internal roads.

This is naturally linked very closely to the Employer’s requirements, or technical specifications, and definitions or clauses relating to the scope of works will cross reference these. But it goes further than that.  The Employer’s requirements set out what technical items need to be met in the design, procurement, construction, commissioning and initial operation of the facility, but the overall scope of works also looks into the Contractor’s general obligations and the manner in which they carry out their work.

Do they have to ensure that all relevant permits are in place?  Do they need to provide the engineering and design documentation to the Employer for review?  Is the design meant to be fit for purpose or just carried out with reasonable skill and care?  Do they need to meet any specified quality and reporting obligations?   Do they need to provide all labour/materials/equipment/tools?  Do they need to allow the Employer access to visit the site, witness activities and inspect completed work?  Do they need to provide documents, plans and manuals, such as the programme of works, testing and commissioning procedures, operations and maintenance manuals, training manuals, as-built documentation etc?  Do they have to ensure that all staff working onsite are adequately trained, suitably competent and authorised to carry out works?  Do they need to notify the Employer prior to conducting certain aspects of work?

The questions above are naturally not fully comprehensive and are clearly not unique to renewable projects.  In addition, not all of the answers to the questions above will necessarily be covered under a convenient “scope of works” section of the contract, and may be distributed through different contract sections, but all expectations, deliverables and responsibilities should be outlined and covered somewhere.

Technical considerations in Renewable Energy EPC Contracts

Over the next few months I will be writing up on technical factors to consider when drafting and negotiating EPC Contracts for renewable energy projects.  I will be doing this as an engineer and project manager; i.e. I am not a lawyer.  This is based on my experience on some pretty tough renewables projects in South Africa, under REIPPP.  Working on these projects gave me a very good sense of where technical risks manifest, and how the contract forms an incredibly important part of mitigating against risk.  For now, I will only be focusing on fully-wrapped, lump-sum EPC Contracts, and will not be looking at split contract structures.

The series will be mainly aimed at protecting the Employer, but there is natural overlap for items that protect the Lender/Investor.  In addition, ensuring that certain items are adequately clarified will help to protect the Contractor, through the avoidance of misinterpretation or ambiguity.

In parallel to the posts, I will be writing up a series of documents that will be available for sale.  The posts will focus on some key issues, but the long form documents will go into some of the details, and include some quick ‘watch-it’s and checks.

As a taster, I will be breaking my writing down into the following topics and themes:

Scope of works

  • Contractor’s obligations/general scope of works
  • Technical specifications/Employer’s requirements
  • Changes and Variations

Milestones and scheduling

  • Milestone schedules
  • Payment schedules & processing of claims
  • EPC programme of works
  • Certification of completed works

Construction management

  • Onsite management and obligations
  • Contractor competency
  • Sub-contracting

Quality and inspections

  • Reporting and inspection requirements
  • Testing and commissioning

Guarantees and warranties

  • Defects and product warranties
  • Liquidated damages
  • Performance guarantees

Other contractual considerations

  • Definitions
  • Conditions precedent
  • Horizontal defence clauses
  • Pass through principals
  • Employer’s obligations

The above may be expanded on as I go.