FIDIC Conditions of Contract for EPC Turnkey Project

FIDIC Conditions of Contract for EPC Turnkey Project

In 1998 FIDIC issued the Test Edition of the Conditions of Contract for EPC Turnkey Projects a Standard Form of Contract also referred to as the Silver Book due to the colour of its front cover. Following the review by FIDIC of the comments received on the Test Edition from various organizations, the First Edition of the Silver Book was released in 1999.

The FIDIC Silver Book is not the first standard form available to the industry for international turnkey contracts. Other organizations have published standard forms over the years. The 1988 MF/1 Conditions for the Supply of Electrical, Electronic or Mechanical Plant, the 1993 New Engineering Contract and the 1995 Conditions of Contract for Process Plant are examples. FIDIC had produced as recently as 1995 an earlier standard form for turnkey contracts, the Conditions of Contract for Design-Build and Turnkey, also referred to as the Orange Book again due to the colour of its cover.

The Orange book enjoyed limited success since its release in 1995 this together with the rapidly developing world market for turnkey infrastructure and EPC contracts involving private project financing were the main factors which led to FIDIC releasing the Silver Book in 1999.

EPC turnkey projects were the result of a wave of liberalization of certain economies, mainly in Asia and Latin America. This is especially true of the power generation and distribution sector where deregulation and privatisation have enabled independent power producers to enter the market, creating a significant number of privately financed power plants construction projects. Nowhere is this demonstrated more than in Malaysia which by allowing investors to be awarded operation concessions for certain infrastructures such as power plants or water supply and treatment systems it as enabled the Malaysian Government to invest more funds in the development of its local economies. Compared with more traditional projects where the turnkey contractor deals only and directly with a public or semi-public entity, EPC turnkey projects involve multiple parties and a complex web of contracts.

An interesting feature of such projects is that the purchaser (usually called Owner) is almost invariably a company created specifically for the particular project (a so-called Special Purpose Company). From the perspective of the Contractor, this company is nothing more than a client with no assets apart perhaps from a concession agreement and hopefully a power plant or treatment plant.

Another major feature of EPC projects is the strong involvement of the financing institutions in the contractual relations between the Contractor and the Owner. It is not surprising for the banks (usually called Lenders) to be entitled to specified rights of supervision during the performance of the contract, such as the right to witness major tests or to visit the construction area during construction.

These particular features of EPC turnkey projects create the need for specific contract terms which are not needed for contracts involving publicly financed turnkey infrastructures. Because the Silver Book is specifically designed for the private financing context, it represents the first and only international Standard Form of Contract for EPC turnkey projects.

As with many other Standard Form of Contract for a Turnkey project, the Silver Book contains a detailed description of the general obligations imposed on the purchaser (referred to in the FIDIC terminology as the Employer) and the Contractor.

Giving the Contractor access to the site (Sub-Clause 2.1), assisting the Contractor with obtaining licenses and permits (Sub-Clause 2.2) and of course, paying the contract price (Sub-Clause 14) are included among the traditional obligations of the Employer. An interesting addition to the Silver Book is the requirement that the Employer is to provide the Contractor with reasonable evidence that financial arrangements have been made to enable the Employer to pay the contract price (Sub-Clause 2.4), in the absence of which the Contractor may terminate the contract (Sub-Clause 16.1a). This obligation clearly takes account of the fact that, as explained earlier, the Employer in a typical EPC turnkey project is a Special Purpose Company with minimal assets. The Contractor’s payment protection therefore depends heavily on the soundness of the financing package of the Employer.

The Contractor’s main obligations are to obtain the necessary permits and licenses (Sub-Clause 1.131), to carry out the design of the works (Sub-Clause 5.1), to provide the Employer with the required operation and maintenance manuals (Sub-Clause 5.7), to put in place the agreed performance bond(s) as security for the due performance of the contract (Sub-Clause 4.2) and, more generally, to provide the works on a turnkey basis and remedy defects in accordance with the contract (Sub-Clause 4.1). A peculiarity of the Silver Book is to place on the Contractor the risk of unforeseen ground conditions. This results from the general principle according to which the Contractor is to accept “total responsibility for having foreseen all difficulties and costs of successfully completing the Works” (Sub-Clause 4.12). The rationale behind this burden allocation is the recognition that in many EPC projects the Lenders rely heavily on the certainty of the project costs and schedule. As a result, Lenders insist on limiting the number of possibilities for the Contractor to claim extra costs or extra time to perform the works (17).

In addition to the description of the Employer’s and Contractor’s respective obligations, the Silver Book contains a full array of standard clauses for major turnkey contracts. Among the best known are those:

Providing for i) the payment of damages in the event of a delay in performing the works (Sub-Clause 8.7) or ii) a reduction in the contract price to account for the failure of equipment supplied to perform as guaranteed (Sub-Clause 9.4);

Describing the procedure for the take-over of the works by   the Employer (Sub-Clause 10);

Detailing the Contractor’s obligations to remedy defects in the works (Sub-Clause 11);

Stating the conditions under which the Employer may order variations in the scope of work (Sub-Clause 13); and

Enabling a modification in the contract price and schedule as a result of a change in laws affecting the works (Sub-Clause 13.7).

Other key clauses are those relating to the parties’ respective indemnity obligations (Sub-Clause 17.1),the right to suspend and/or terminate the contract (Sub-Clauses 15 and 16), the allocation of risk and responsibility for the care of the works (Sub-Clauses 17.2, 17.3 and 17.4), the exclusions and limitations of liability (Sub-Clause 17.6), and the conditions under which a force majeure event may be claimed (Sub-Clause 19).

Finally, the Silver Book contains a detailed clause regarding the settlement of disputes which, absent of an agreement to the contrary, are to be settled under the arbitration rules of the International Chamber of Commerce (Sub-Clause 20).

A notable characteristic of the settlement of disputes clause is the provision of a fast track pre-arbitration procedure through the constituting of a Dispute Adjudication Board. The Board must render decisions within 84 days from submission of the matter in dispute (Sub-Clause 20.4). Disputes will go to full-fledged arbitration only if the parties are not satisfied with the outcome of the litigation in front of the Dispute Adjudication Board. Apart from the fact that such fast track procedure seems to correspond to a trend in the international construction industry, it appears to be justified in the light of the provisions of Sub-Clause 3.5 of the Silver Book. According to this Sub-Clause, the Contractor is to give effect to Employer’s determinations made on various contractual issues unless the Contractor sends to the Employer a notice of dissatisfaction with such determinations within 14 days, at which point either party may refer the dispute to the Dispute Adjudication Board. An example of such determinations would be those made on the issue of a contract price and schedule adjustment following a change in the laws affecting the performance of the works (Sub-Clause 13.7). Obviously, the Employer’s determinations on an extension to the time for completion or extra costs will invariably be quite significant to the proper performance of the works by the Contractor. It is therefore in both parties’ interest to solve in a timely fashion any dissatisfaction on such determinations, so as to avoid any detrimental effects to the harmonious continuation of their contractual relations. This is exactly what the Dispute Adjudication Board procedure is designed to allow.

Several factors need to be considered in evaluating the probable use of the Silver Book.

First, it is likely that potential Employers and Contractors will be dissatisfied by the position taken by the Silver Book on certain crucial issues. For example, Contractors will undoubtedly challenge the principle that they are responsible for ground risks, since no reasonable Contractor will commit to a fixed price and schedule without the possibility of making modifications in the event of unforeseen ground conditions. Employers, on the other hand, are likely to require some more clarity as to what is to be understood in Sub-Clause 2.4 by “reasonable evidence” that financial arrangements have been made to enable payment of the contract price. As a result, Employers and Contractors may both view the Silver Book as a contractual document that may not be implemented without substantial changes, so that the ready to-use advantage that standard forms ordinarily offer may be lost. The need to amend the Silver Book to suit a particular project or the general corporate policy of the participants should not, therefore, be viewed as a significant impairment to its use in Malaysia.

Second, although the Silver Book is primarily intended for EPC turnkey projects involving private finance, it appears that several features typically present in such projects are missing. For example, the Lenders systematically insist in such projects on the signature of a so-called “direct agreement with the Contractor whereby, in the event of default of the Employer under the loan agreements, the Contractor accepts to make payments due under the EPC contract directly to the Lenders. Surprisingly, the Silver Book does not provide a sample form of direct agreement, merely making reference in Sub-Clause 1.71) to the possibility of an assignment of moneys due under the EPC contract to a bank or financial institution. The Silver Book is generally silent on the Lenders’ involvement in the project and makes no concrete references to the Lenders’ rights or those of their designated representative. It should be noted, however, that the Silver Book guidance notes for the preparation of particular conditions recognize that there may be a need for additional clauses to satisfy the requirements of financing institutions. Again, it will be the responsibility of the potential users to tailor the Silver Book via the special conditions to respond to the particular requirements of the lenders.

The Silver Book arrived on the market at a time when EPC projects developed with private project finance had been in existence for several years. The major law firms with significant project finance lawyers have already developed their own standard forms of EPC contract that they use when hired as outside legal counsel by private owners. It would be surprising if they simply substituted the Silver Book for their own standard forms. However, it has been recently underlined by several authors that the use of standard contract conditions, such as the FIDIC model contracts, reduces legal costs and speeds up contractual negotiations. This may create an incentive for Employers to instruct their outside legal advisors to use the Silver Book as the main basis of the tender documentation.

It is evident that a few years will be needed to fully appreciate how the Silver Book is being received by the Malaysian construction industry. Potential users will perhaps be reluctant to use the Silver Book as their sole source of contract terms in upcoming EPC turnkey projects, but it will it seems certainly be used by Employers and Contractors alike as a negotiating tool in the course of contractual negotiations.

MALCONLAW