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Contents
Summary 04
Introduction 05
EPC Contracts
08
09
EPCM Contracts
19
Appendix 1
29
Contacts 35
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 identified in this guide can often
mean the difference between achieving a bankable project with optimal returns for the
mining company, and an expensive project failure.
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 proper
feasibility process that the project is economically viable, it must then consider how
the project is to be delivered. We have produced several briefing papers on issues to be
considered when looking to secure finance for projects in the mining sector, but a key
aspect of securing such finance 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 first necessary to explain what we mean by the term bankable or
bankability. The terms are usually used to describe a lenders 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 financially robust party to accept full responsibility for the delivery of the works
on time, on budget and to meet the required technical and performance specification.
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.
Contract structures
The preferred option for delivery of the single point responsibility solution described
above 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 offering a balanced approach to contracting risk, the hardening of
the lending market in recent years (and especially post global financial crisis (GFC))
has seen a move away from use of these forms, in the context of a limited recourse
project finance transaction, without significant 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.
Introduction
The development of detailed design at feasibility stage may undermine the Sponsors
ability to achieve a single point of responsibility solution without being exposed to
inflated 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 significant 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 itself
manage residual risks or its achievement would adversely affect 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 differences 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.
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 contractual
structure, 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 of
an EPC contract.
Mining Company
EPC Contract
EPC Contractor
Sub-contractor A
Sub-contractor B
Sub-contractor C
The 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 Sponsors own stated initial design requirements. If this design
risk transfer is not achieved, the risk to the Sponsor of cost overrun could be significant
since there is likely to be increased exposure to claims for additional time and money
resulting from the requirement to remediate errors identified in 3rd party design.
Since the liability for cost overruns in the circumstances described above may be
significant, it is unlikely that this risk may be backed off 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 first 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 financial consequences. This may be achieved
through use of a designated cost overrun facility or a request that the Sponsor provides
additional 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 filter 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 reflect actual sub surface
conditions, will pass back to the Sponsor.
In practice, the lenders technical adviser will review the risk profile proposed under
the terms of the EPC Contract generally and will advise the lenders as to the Sponsors
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
identified 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.
Whilst we have discussed time and cost risk specifically in relation to design above, as
a general point of principle, lenders will want to limit to the fullest extent possible the
EPC contractors 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 financial 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 employers
potential cost and loss of revenue exposure arising as a result of accepting these risks
may be significant. 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 fixed 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 financial 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
10 Norton Rose Fulbright
parent company guarantees will be required. We would additionally expect the Sponsor
to formulate a strategy for managing any such risks. A lets 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 Sponsors financial
exposure is to be mitigated to fullest extent possible.
Delay damages
To the extent that the works are completed on a date later than that fixed 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 provision
for payment of liquidated and ascertained damages (LADs). These LADs will typically
be paid at a daily rate to cover anticipated lost profits 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 contractors 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 liability
Following 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 profit
occasioned by the performance shortfall for a finite period of time.
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 Sponsors loss profit and debt service costs for a specifically 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 financial 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 refine 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 contractors risk and the lenders will typically seek to retain
the right to reject at the conclusion of any such repeated testing or any subsequent posthandover 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 difficult 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 contractors 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 filled 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 liability
As 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.
There is, as may be expected, a tension between the lenders requirement for full coverage
of debt outstanding from the EPC contractors 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 specific 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 quantifiable (and therefore able to be reckoned in the sizing of the cap) at the
date of contracting.
Security package
As we have discussed above, to the extent that the EPC contractor fails to deliver the
works, the lenders and, in the first 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 finance 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
finance 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.
When 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
bonds and letters of credit, all usually provided by international banks with lender
approved 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 specific basis. The
lenders are however likely to permit a step down in performance security coverage as
the works progress to reflect reduced risk in the project for the lenders. Typically, the
level of performance security coverage may reduce by 50%, for instance, following
the 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 beneficiary must
first 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 type
described 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 fixed 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 specific and defined 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 contractors cash flow, lenders will
usually instead accept a form of retention bond as an alternative which will provide
security for monies that would have otherwise been retained. Any such instrument
should 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.
Outside 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 sufficiently robust to meet its potential liabilities under
the guarantee.
Unlike the forms of liquid security described above, a guarantee of this kind will
usually first 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 Sponsors first port of call (unless
of course there are restrictions on the order in which claims may be made under the
relevant documentation).
Termination
Lenders 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 finance 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 may
be 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 affirmative 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
finance documentation (ie, principal, interest and fees). The ability of lenders to recover
these losses tends to be very difficult for the uninitiated to understand and accept
this, but this is part and parcel of limited recourse project financing where the lenders
security is limited to the project and those responsible for delivering it.
(b) If the single point of responsibility position can not be achieved, and on the
assumption that lenders accept this, the Sponsors must consider how they will
themselves manage the risk(s) in question and in particular the concerns identified
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 and
to meet a required technical and performance specification; 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 different. 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 financial 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.
This being said, we have seen more recently the EPCM procurement route re-emerge as
the 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.
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 coordination of design for the project to ensure that the completed works meet the
required technical and performance specification (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 overall
procurement strategy and will source contractors, consultants and the necessary
plant and equipment in accordance with the Sponsors 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 Sponsors 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
Sponsors behalf to achieve completion of the works in accordance with the project
schedule, the project budget and to meet the required technical and performance
specification (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
Norton Rose Fulbright 19
firm generally with greater expertise in engineering design and, possibly procurement,
as the EP Contractor. The Sponsor will then appoint a specialist construction
management firm 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 third
parties 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 fine,
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
Mining Company
Contractor A
Contractor B
EPCM Contractor
Contractor C
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:
EPCM Contracts
The securing of the single point of responsibility EPC solution may expose the
Sponsor to inflated pricing which may have an impact on project affordability and
which may not be considered by the Sponsor to offer 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
significantly 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 final 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 influence 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 benefits, namely, price certainty for project delivery and the
increased likelihood of securing project finance. If the negatives of the EPC solution
outweigh the positives, the Sponsor may be inclined to consider use of an alternative
contracting structure.
The 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 difference between the EPC and the EPCM solutions is that the EPCM solution
does not offer 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
identified 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 Sponsor
when using the EPC structure.
The provisions of the EPCM contract, in terms of both scope (as identified above) and
liability for the services provided, will differ fundamentally from the terms seen in a
typical EPC contract. To illustrate these differences, 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 profile
under the EPCM solution is far less favourable from the Sponsors (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 differences 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
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 significantly lower
construction cost.
If the EPCM solution is to be considered, it will be important for the Sponsor to first
satisfy itself and ultimately the lenders that the proposed solution can offer 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 reflect 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 owners team to monitor and manage the execution of the project
in order to ensure that the Sponsors key requirements are being achieved and
to permit early identification 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 finalised on a fixed 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.
Whilst the points identified above will be important in developing robustness in the
structure 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 first instance this is usually achieved through use of a designated cost overrun
facility to meet likely cost and/or time overrun exposure.
Incentivisation
EPCM Contracts
Whilst these risks are not passed to the EPCM contractor in full, the EPCM contractor
will 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 financial 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 risk
in question on a contingent basis, and this will of course not offer 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 contractors risk in the project will be limited
to its agreed profit 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 Contracts
The only defence for an entity being prosecuted for failing to prevent bribery is to show
that 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 significant scope and extraterritorial reach of the Bribery Act, it will be
extremely important for Sponsors to firstly 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.
Specific advice should be sought by Sponsors having any particular concerns about
the scope and implications of the Act.
Note
The 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).
Appendix 1
Appendix 1
EPC risk
allocation
Contractor to be
responsible for
completing the
works on time.
EPCM risk
allocation
As the delay
damages
recoverable
from the EPCM
contractor,
and any other
contractors
identified
as being
responsible
for delayed
completion of
the works, will
not be sufficient
to cover the
Sponsors
potential loss
in revenue and
debt service
costs occasioned
by such delay,
the financial
risk of delayed
completion of
the works will
ultimately rest
with the Sponsor.
Risk typically
transferred
to the
contractor
EPC
EPCM
EPC risk
allocation
Completion
of works for
a lump sum
fixed price.
EPCM risk
allocation
Risk typically
transferred
to the
contractor
EPC
EPCM
Appendix 1
EPC risk
allocation
EPC contractor
to provide
performance
guarantees
in respect of
the completed
plant.
Any limit
on liability
to provide
sufficient
coverage
for recovery
of amounts
outstanding
under the terms
of the finance
documentation.
Appropriate
carve outs
to be agreed
in respect of
which the EPC
contractors
liability will
be unlimited.
EPCM risk
allocation
Risk typically
transferred
to the
contractor
EPC
EPCM
Due to interface
issues relating to
identifying the
party responsible
for performance
failure and the
more limited
liabilities
accepted by
parties under the
EPCM structure,
it is more likely
that the majority
of the liability for
any substantive
performance
failure will
retained by
the Sponsor.
The Sponsors
(and ultimately
the lenders)
recourse for
recovery of debt
outstanding and
other losses in a
project default
scenario will
be limited. The
residual liability
in this regard
will ultimately be
a Sponsor risk.
EPC risk
allocation
Security
package to
include liquid
performance
security,
retentions
and parent
company
guarantees.
EPCM risk
allocation
Sponsors accept
cash flow risk
during the period
in which a claim
is established
against the
EPCM contractor
and sums for
which the EPCM
contractor
is liable are
recovered from
the parent
company.
Risk typically
transferred
to the
contractor
EPC
EPCM
Appendix 1
Contacts
Contacts
Martin McCann
Global head of mining,
infrastructure and commodities
Norton Rose Fulbright LLP
Tel +44 20 7444 3573
martin.mccann@nortonrosefulbright.com
Mark Berry
Partner, London
Norton Rose Fulbright LLP
Tel +44 20 7444 3531
mark.berry@nortonrosefulbright.com
Matthew Hardwick
Senior associate, London
Norton Rose Fulbright LLP
Tel +44 20 7444 5550
matthew.hardwick@nortonrosefulbright.com
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