Introduction
Engineering projects require different engineering companies, contractors, and manufacturers to provide engineering services.
There are two types of construction contracts most commonly used in large-scale projects – (1) Engineering, Procurement and Construction (EPC) and (2) Engineering, Procurement, Construction and Management (EPCM).
These types of contracts are most widely used in large and complex construction projects, especially in the oil and gas, energy, and infrastructure industries.
The EPC contract is a form of design and construction contract whereas the EPCM is regarded as a professional services contract.
What is an Engineering, Procurement and Construction contract
An EPC contract refers to a complete engineering project, and is sometimes called ‘turnkey’ project – the client can expect to go to the site and turn it on with the ‘turn of the key’ as the engineering company is responsible for the entire project with a pre-determined remuneration structure.
The EPC company bears all the risks associated with the project; the client can expect a finalised project at a fixed price.
The owner/client enters into an EPC contract with an EPC firm. The EPC firm will then enter into contracts with the sub-contractors for the engineering, procurement and construction of the project.
The contractor is fully responsible for the project.
The contractor takes on the risk of the project.
There is a fixed date for completion.
The contractor agrees to perform the entire project for a fixed price.
The contractor is responsible for procurement.
The contractor guarantees the performance of the completed facility.
The contractor is in control of the project.
The contractor rectifies any defects.
How are delays and non-performance dealt with in an EPC contract?
As the EPC contract is a date-certain contract, any penalties due to delay and performance by the sub-contractors will need to be paid by the EPC firm – this is known as liquidated damages.
The EPC firm will have to pay any penalties, interest, and loss of profit that the owner/client suffers due to the delay – also known as delay liquidated damages. This is usually a USD per day figure.
If the guaranteed performance is not achieved, performance liquidated damages will need to be paid. The penalty is the difference between the project’s NPV value at guaranteed performance and at current performance.
If the project is rejected by the owner/client because it fails to meet minimum performance requirements, the typical penalty for this is the total project cost.
Because the EPC firm will be supplying all the equipment, these will usually come with warranties of 1-2 years. Any defects will therefore be paid by the contractor.EPC<
EPCM
An EPCM contract refers to an engineering project where an engineering company will design and guide the project. The engineering company provides the services of designing the solution and helps the owner/client to procure the parts. The engineering company manages the contractors and manufacturers on behalf of the client but is not responsible for the final product. The client is responsible for the end-result.
The EPCM contractor is responsible for ensuring that the engineering and design of the project is in compliance with the project’s technical and functional requirements specifications.
The owner is responsible for the project, ie he deals with all the contractors directly.
The owner bears the risk of the project.
There is no fixed date for completion.
There is no fixed price – instead, there is a schedule of rates/cost plus.
The EPCM acts as a procurement agent for the owner.
The contractor does not guarantee performance or quality.
The owner is in control of the project.
The EPCM assists the owner in managing the rectification of any defects.
Why EPCM?
When the demand for construction services is high, contractors often do not offer EPC services.
EPC services are significantly more expensive than EPCM.
For certain projects (eg in mining), an EPC contract can be difficult to do (eg complex engineering).
How is risk mitigated with an EPCM contract?
As the owner would bear a lot more risk under an EPCM contract than an EPC contract, the lender will want:
An experienced construction firm with a proven track record.
An experienced owner who will be able to manage these construction firms.
Experienced sub-contractors and equipment suppliers.
Incentives given to the project company and contractors to complete the project within budget and on schedule,
Security from the sponsor such as completion guarantees, cost over-run guarantees, and any other guarantees that transfer the risk from the lender to the sponsor during the course of the construction.
EPC vs EPCM: Pros and cons for the owner/client
EPC Pros
Single point of responsibility.
All risks are transferred to EPC – design, construction, price, and timing.
EPC Cons
Expensive
EPCM Pros
Low cost.
Greater flexibility.
Shorter project timeline.
Higher quality result.
EPCM Cons
The owner/project company retains the risk.
EPC vs EPCM: Main terms
EPC
Turnkey contract. Guarantees the work of sub-contractors.
Project cost and schedule. Fixed price contract, date-certain (any delays resulting in a higher amount will be borne by the EPC firm).
Payment terms. Based on performance milestones:
Deposit.
NTP.
Work progress.
Completion.
Acceptance.
Testing and commissioning. Extensive testing before acceptance (mechanical, substantial, final completion).
Minimum and guaranteed performance. Included in the contract.
Warranties. For equipment defects (usually 1-2 years).
Security. Performance bonds (letter of credit, bank guarantees) (usually 10-15% of the project cost).
Force majeure. Sponsor/client takes the risk.
Step-in rights and termination. If the sponsor defaults, the lender will have rights to appoint another sponsor.
An EPC contract is all about the construction risk allocation, and this is reflected in the contract price.
EPCM
Project cost. Based on hourly rates of employees.
Timing and schedule. Owner/client’s responsibility.
Liquidated damages for design and performance. Yes, but much less than in an EPC contract.
Performance bonds. Parent guarantees.
In conclusion
The key difference between EPC and EPCM is the level of control and responsibility assumed by the client. EPC places more responsibility on a single contractor for the entire project (including managing all sub-contractors) based on turn-key principle. EPCM allows the client to maintain greater control by directly appointing multiple contracting parties for the project and relying on the EPCM to manage those parties on a service basis. Ultimately, which one is used depends on the level of risk the client wants to take, the resources it has available, and cost.
What has been your experience with EPC or EPCM contracts? Share your thoughts and questions in the comments below to help others navigate these complex agreements!
To view a short-form infographic on EPC vs EPCM that acts as a quick reference guide, click on the image below.
The information provided is for information purposes and does not constitute legal advice. Contact a lawyer should you require assistance. Legal Dynamix is not a law firm and does not provide legal advice on the subject matter contained herein.
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