Main model contracts for project implementaion

Projects in the field of renewable (alternative) energy are often not entirely transparent and understandable for potential participants. One of the most frequently asked questions, which requires explanation and clarification, is the possibility of implementing the project, using the EPC contract model (as an option – EPCM-contract) in the construction of solar power plants. The purpose of this publication is to provide an accurate definition of what the EPC or EPCM contract model is, their varieties, advantages and disadvantages for the customer and contractor, and the specifics of using it in practice.

Realization of investment projects: main models of contracts, especially their application

Different forms of contracts are used in the international practice of the realisation of multiple projects in order to regulate the relations between the contracting parties in the field of the construction management and supervision. The same model contracts may be applied to the implementation of solar energy projects in Ukraine. Besides, one can define  main model contracts, which include and regulate  the relations between the contracting parties at all stages of the solar power plant installation process (project development, procurement, construction):

  • EPC (abbreviation of “engineering (here and hereafter used with the meaning of project development), procurement, construction”) contract.
  • EPCM (abbreviation of “engineering, procurement and construction management”) contract.
  • EPCS (abbreviation of “engineering, procurement and construction supervision”) contract.
  • PCM (abbreviation from “project construction management”) contract.

It is necessary to remember that there are not uniform or standard terms in the classification of the construction contracts, which would be enshrined in the legislation, neither on international level nor on national one. For example, in terms of the solar power plant construction. EPC contract is a unique model contract which determines a fixed price and deadlines enough precisely and exactly. It also stipulates clearly that just the contractor shall assume all risks and liabilities referring to the project construction process. At the same time, other types of model contracts can often intermix their terms with one another and with the terms of EPC contract.

In general, the analysis of the statistics shows that in the cases of the contract conclusion when the client needs to accomplish the full-scope cycle of construction works, EPC or EPCM contracts are used more frequently than other model contracts.

Модели договоров проектов ВДЕ

Main features of EPC contract:

  1. Fixed price, as the practice shows, is a lump sum in most of the cases. Besides, it is necessary to notice that in spite of the definition of a fixed price as a lump sum, the presence of the estimate in the project development process is not completely excluded. Furthermore, just the contractor is responsible for any excess of the stipulated expenses for materials, hardware and performing works. Force majeure, modifications of the work scope and the volume of works, which are initiated by the client, cases of the client’s failure to meet its commitments stipulated in the EPC contract terms shall be considered as the exceptions.
  2. The upper limit of the contractor liability is determined by the contract price in most of the cases. However, the cases, when the stipulated limit of the contractor liability comprises only the part of the EPC contract price, are possible.
  3. The contractor possesses by a considerable independence in the construction realisation. Besides, the influence of the client on the EPC contractor (subcontractor) is minimal.
  4. According to the EPC contract provisions, the EPC contractor assumes a major part of the risks (including disbursements and contingent expenses).

The EPC contract, in most of the cases, is concluded when the client does not have the personnel, which would be able to manage the project construction management, lack of construction and manufacturing capacities and does not want to interfere with performing work or have an influence on it, letting the contractor carry all risks. The EPC contract is, in addition, one of main model contract forms for the implementation of the projects, which are funded by banks or other financial establishments (especially when the case of project financing takes place). It is conditioned by the fact that the lending banks strive to minimise the number of risks assumed directly by the borrower. From the point of view of the owner of a future solar power plant, the EPC model contract is the most convenient also for the reduction of the implementation period for the projects bringing “green tariff” into practice.

There is the number of reasons, which prevent the contractor companies from concluding EPC contracts:

  1. There is a high degree of economic and political risks with underdeveloped labour market and a poor offer of the services necessary for performing work in the country, where the contractor abroad shall realise the project (the situation is very typical for developing countries).
  2. There are the complications and the unpredictability of the conditions in the process of a non-typical project implementation. Besides, it is impossible to determine the scope or the volume of work necessary to be performed.
  3. The underdevelopment of the supply of local building and assembly organisation can cause the necessity to involve a considerable number of subcontractors, in particular, local ones, in the construction process.

Because of the reasons listed above the EPC contractors do not want to assume the risks on the project implementation, especially the risks resulting from the failure of local subcontractors to meet their commitments, taking into consideration the high level of the EPC contractor liability (unlimited or restricted by the contract price) and the fact that the rate of the EPC contractor fee does not exceed 10-15% of the total price stipulated in the EPC contract.

The EPCM (engineering, procurement, construction management) model contract

The EPCM contract contains less strict requirements to the contractor compliance with the deadlines set for the accomplishment of construction works. Moreover, the client shall have a considerable power that allows participating in the project realisation management: the client company has the right to decline or to approve the choice of subcontractors, supervise over their activities, set requirements directly to them. As a rule, the subcontractors are selected through tender in this case. There are several forms of the EPCM model contract:

  1. According to this form of the EPCM contract, the EPCM contractor provides only the services on the construction project management. Besides, the client concludes most of the contractor agreements on its own behalf, assuming the risks resulting from a contractor’s failure to meet its commitments. This form of the EPCM contract transfers the majority of risks, including the estimated cost overruns and the project implementation delays, to the client.
  2. The EPCM model contract, as a variety of the EPC contract, is based on the principle “cost plus fee”. The main features of this form of the EPCM model contract are listed below:
    • The contractor is compensated for all expenses related to the construction of the project and, in addition, receives the fee, that is calculated on the basis of the agreed rate of return.
    • The fee paid to the contractor for the project realisation management may be determined as a fixed value stipulated in the contract.
    • Detailing the structure of the contract price, one defines the fee paid directly to the contractor as a fixed value, whereas the expenses related to the volume of project construction works accomplishment shall not be determined.
    • The EPCM contractor acts as the EPC contractor. The EPCM contractor company concludes the agreements with the subcontractors on its own behalf and shall be responsible to the client for the cases of the subcontractors’ failures to meet their commitments.
    • The total of the EPCM contractor liabilities is determined by the value of its fee (in some cases by the part of the fee if it is stipulated in the contract). The cases, when the breach of the EPCM contractor obligations stipulated in the contract takes place because of a gross negligence or intentionally, and it is established, are considered as exceptional ones.
  3. The EPCM model contract as a variety of the EPC contract with the fixed EPCM target price is also based on the principle “cost plus fee”, but besides, the target total value of the expenses related to the construction works performing is determined. The main features of this form of the EPCM model contract are listed below:
    • The contract price shall consist of two parts: namely, the fee, which shall be paid to the EPCM contractor and direct costs comprising the total of expenses related to the project construction (the purchase of the hardware, including solar batteries, inverters and metal structures for the installation of solar modules; materials and performing works).
    • Only the fee, which shall be paid to the EPCM contractor, is the fixed value within the contract price structure.
    • The total of expenses related to the project construction is not limited strictly. It is a variable cost and may be higher or lower than the value stipulated in the contract. If the total of direct expense overruns the value stipulated by the contract, the difference shall be subtracted from the contractor fee. Nevertheless, the contractor shall not reimburse the total of the cost overruns. The risks resulting from the total of the contract direct cost overrun are shared between the contractor and the client in this way.
    • If the EPCM contractor is able to ensure cost saving without decreasing the quality of performing works, the contractor company shall receive the benefit calculated as a percentage of the cost savings.
    • The contract can stipulate the total value of maximum overspending limit, namely the diapason, within which actual expenditure overrun is acceptable. If the total of the expenditure overrun does not exceed the limits of this diapason, the forfeits shall not be deducted from the contractor fee.
    • The application of the stipulation on maximum overspending limit to the EPCM contract has also another aspect. The total of cost saving for which the EPCM contractor shall not receive the benefit is also determined in the contract.
    • If one considers the client’s discretion in the project realisation management, it is almost the same as in the case of the EPCM contract basing on the principle “cost plus fee”.
    • The total of the EPCM contractor liabilities is determined by the value of its fee. The cases, when the breach of the EPCM contractor obligations stipulated by the contract takes place because of a gross negligence or intentionally and it is established, are considered as exceptional ones.

In most of the cases, one does not assign a full scope of work (or its significant part) for one subcontractor to get the maximum cost saving. This model contract is the compromise between the EPC contract and the EPCM contract basing on the principle “cost plus fee” (the upper limit of the target value, in addition, is not determined). Some sources define this form as the EPC contract with target price.

Other varieties of the EPC contract

EPC and EPCM model contracts condition the conduct of the full-scope cycle of works (including engineering, provision of necessary equipment and materials and the full cycle of construction works) by the contractor in order to realize the project of a solar power plant. However, the cases when the client ensures on its own the execution of a certain part of work related to the project implementation: e.g., the project development or the supply of the hardware (solar panels, inverters, other items). It is proper, in particular, to the contractors abroad, who are ready to perform the design work and the provision of the hardware, but do not want to bring the responsibility for performing the cycle of the construction works. Therefore, it is recommended to use so-called “abridged” model contracts:

  • The EP (abbreviation of “engineering, procurement”) contract.
  • The EC (abbreviation of “engineering & construction”) contract.
  • The EPCS (abbreviation of “engineering, procurement & construction supervision”) contract.

Sometimes the client conducts a certain part of work related to the solar energy project implementation on its own or divide this volume of work between several contractors. For example, the client shall realise the construction site preparation on its own, one contractor shall conduct the development of the photo power station project and the provision of hardware, other contractor shall ensure performing the construction work volume. In general, If all volumes of work are divided between the contractors in this way, the total cost of the project realisation can be lower than in the case when the EPC contractor conducts all process of the realisation of an analogous project because each of several contractors assumes much less risk than the EPC contractor. This approach has also another aspect. This way of the project construction (the conclusion of agreements with several independent contractors) conditions the increase of the risks related to the cost of the project, which are assumed by the client. When the first contractor performs the assigned works with a poor quality or with the delay, it is possible that the second contractor will come to a halt in performing the works (if the works are performed in succession) and the prolongation of the project implementation period or the increase in the cost of work (if it is necessary to correct the mistakes of the prior contractor). Besides, the situation, when it is difficult enough to establish the failure of a certain contractor, especially in the case when the defect occurs within the interface between the work scopes, which are performed by different contractors, is also possible.