EXPERTISE

Regional: EPC Projects in the era of the global pandemic. Practical guide to approach your EPC Contracts during the COVID-19 crisis

6 April 2020 – The current global pandemic situation has dire consequences for the energy & natural resources sector, including on energy and petrochemical development projects and revamp / refurbishment projects across the sub-systems in the energy & natural resources plethora. The majority of such projects are usually governed by so-called Engineering, Procurement and Construction (“EPC”) Contracts, which often follow international templates prepared by international organizations such as the International Federation of Consulting Engineers (“FIDIC”)[1]. The FIDIC model agreements contain specific provisions that may be relevant when reviewing the impact of the COVID-19 crisis on your EPC project, which we have looked at based on the standard provisions of the 2017 Silver Book template.

Energy sector and petrochemical development projects are complex and typically involve longer-term commitments from both the Project Owner (in the FIDIC terminology: the Employer) and the EPC Contractor, requiring a substantial period of time to bring such projects to completion, often in the range of 12 – 24 months or more. Needless to say, larger-scale energy sector EPC projects are very often of also high-value, in the several hundreds of millions of euros or dollars range, with high stakes for both the Project Owners and the EPC Contractors. As a consequence, the full scale of risks and exposures stemming from the global pandemic situation can hardly be predicted.

Different EPC Contract phases – entailing different key risks

In general, we find that different exposures exist in different phases of the EPC Contracts, which can be broken down according to the main constituent parts of the EPC Contract, i.e. the design and engineering phase, the procurement and then the construction phase. These may include the following risks connected to the COVID-19 crisis:

Design & Engineering Phase

  • Workforce disruption and inefficiencies due to home-office working of engineers
  • Delay in delivery of engineering works by the Contractor
  • Longer response times by the Owner
  • Knock-on effect of the delays accumulated during the design & engineering phase to the procurement phase

Procurement Phase

  • Supply chain disruption – one or more key suppliers unable to deliver, partly or entirely
  • Increase of the costs of supplies, goods and materials
  • Inability to perform in-the-shop observing of key equipment manufacturing due to travel bans
  • Transportation disruption – transportation routes becoming closed down by public authority or government intervention
  • Difficulties with replacing stranded suppliers and/or finding new transportation routes
  • Long-lead items becoming stranded whilst under transportation

Construction Phase

  • Workforce disruption potentially arising from several factors including inability to bring workforce to the site, restrictions on using large-scale workforce on site, contamination among workers on the site etc.
  • Revisiting Health, Safety & Environment (HSE) policies and re-defining best HSE approach to on-site activities
  • Liability for contamination / spread of the coronavirus
  • Delays due to numerous factors, including lack of workforce, impairment of transportation of equipment, ban on travel to the site of required experts for e.g. installation works etc.
  • Breach of financing agreement by the Project Owner
  • Delays of the public authorities in issuing permits, or providing approvals/consents

 

Mitigating the risks posed by the coronavirus crisis for EPC projects, some of which we have outlined in the table above, is not only complex and difficult due to the unpredictability of the situation, but requires careful and coordinated assessment of the current and the forthcoming period, alignment between the Project Owner and the EPC Contractor, even possibly with the involvement of key suppliers and subcontractors of the EPC Contractor. Moreover, with respect to several risk factors, the involvement of public authorities will also be desirable and often even required. Importantly, if a serious disruption affects a major EPC project in the energy & natural resources space, this could have very substantial economic impact for the economic viability of the entire project, as the Project Owner may not be able to start commercial operation at times when it would be badly needed to generate revenues or, in case of e.g. revamp projects, may run into huge losses by a delay in re-commencing the operation of its refurbished units.

This puts additional burdens on both the Project Owner and the EPC Contractor, whose teams are normally already under significant pressure during the implementation phase of any complex energy sector EPC project. This means that the parties to EPC Contracts will need to find novel ways to quickly identify, assess and find solutions for the most relevant risks for their common project – failing which disputes will become inevitable.

Key EPC Contract mechanisms under the microscope

In order to assess how the contractual rights and obligations of the EPC Contractor or Project Owner (in the FIDIC terminology: the Employer) may be impacted as a result of the coronavirus pandemic under the terms of a typical FIDIC-based EPC Contract, the following questions are worth for review and careful consideration:

  • Actual EPC Contract versus FIDIC Template – It is advisable to review the actual terms of your EPC Contract and assess its terms against the standard provisions of the underlying FIDIC template, in particular with respect to the further issues set out below. If your EPC Contract contains in substance the same regulation as the underlying FIDIC template, then you will likely be able to rely on the accumulated experience relating to the relevant FIDIC template under the relevant applicable law.
  • Force Majeure and Notice provisions – Most EPC Contracts contain specific Force Majeure provisions which will be tested in the current coronavirus crisis. The FIDIC standard specifies the general criteria pursuant to which an exceptional event or circumstance qualifies Force Majeure such as e.g. which is beyond a Party’s control, that the affected Party could not reasonably have provided against before entering into the contract, which, once arisen, the affected Party could not reasonably have avoided or overcome, and which is not substantially attributable to the other Party.

Meeting these criteria needs to be assessed with respect to the particular circumstances of your EPC project. You will of course want to check if your EPC Contract regulates the process relating to exercising the rights and obligations of a Party in case of a Force Majeure event. Are you obliged to give notice to the other party under your EPC Contract regarding your actual or foreseeable impairment to fulfil the contract due to the coronavirus crisis situation?

Under the FIDIC template, if a Party is or will be prevented from performing any of its obligations under the contract by Force Majeure, then it shall give notice to the other Party of the event or circumstances constituting the Force Majeure and shall specify the obligations, the performance of which is or will be prevented. The notice shall be given within 14 days of the date when the affected Party has become or should have become aware of the relevant event or circumstance constituting Force Majeure.

  • Frustration – It is also advisable to check whether your EPC Contract provides for an express mechanism to deal with the frustration of the contract or does it exclude the application of the otherwise relevant frustration rules under the applicable governing law? The FIDIC template regulates frustration essentially as a special Force Majeure event, which makes it impossible or unlawful for either or both of the Parties to fulfil their contractual obligations or which, under the law governing the EPC Contract, entitles the Parties to be released from further performance of the EPC Contract. Therefore, the relevant rules under the governing law of the EPC Contract also need to be considered in this context.
  • Material Adverse Change or Hardship – A further point to verify is whether your EPC Contract regulates specifically the cases of Material Adverse Change or Hardship. Contrary to the well-known “MAC Clause” in e.g. M&A and financing transactions, the FIDIC template does not contain a separate regime for the occurrence of material adverse change or economic hardship events. However, the FIDIC template still provides that the contract price shall be adjusted to take account of any increase (or decrease) in costs resulting from a change in the laws of the country in which the EPC Contract is realized (including the introduction of new laws and the repeal or modification of existing laws), passed after the base date, which affect the Contractor in the performance of its obligations under the EPC Contract.
  • Change in Law – It is worth checking whether your EPC Contract provides for an express mechanism for change in law, in particular because we find that in many of the countries where our clients have ongoing EPC projects the impacts of the coronavirus crisis are handled by the national governments through extraordinary legislative measures, often setting aside normally applicable legal rules and introducing extraordinary legal provisions that may affect the EPC Contract’s parties. As noted above, in substance the FIDIC template links the change in law to the variation and contract price adjustment mechanisms, under which increased costs stemming from new mandatory local laws have to be reimbursed to the Contractor. Therefore, in the current pandemic crisis situation this mechanism deserves particular attention by the Parties to any FIDIC-based EPC Contract.
  • HSE Requirements – According to the FIDIC template, the Contractor shall at all times take all reasonable precautions to maintain the health and safety of the Contractor’s Personnel, whether they are performing off-site or on-site activities. Given the novel nature of the COVID-19 pandemic and its unprecedented speed of global contagion, revisiting the Health, Safety & Environment (HSE) policies and re-defining best HSE approach within the context of your EPC Contract are very likely required.
  • Delay Provisions – in a typical EPC Contract addressing delay situations is in most cases a complex issue. Within the FIDIC template, the performance of the Contractor is based on Interim Milestones, missing which is usually subject to the payment of liquidated damages. On the other hand, the Employer is normally obliged to make Interim Payments when the preconditions set out in the EPC Contract for the given Interim Milestones are met. Given that widespread effects of the COVID-19 crisis across the value chain and the supply chain on a global level, the current pandemic may well affect both Parties, not only the EPC Contractor. This means that the delay provisions need to be very carefully looked at and, if necessary, amended by the mutual consent of the Parties to the EPC Contract to reflect the new realities caused by the coronavirus crisis.
  • Suspension – Does your EPC Contract recognize suspension of the works and, if yes, how does it regulate such a scenario? Under the FIDIC template, the Employer may at any time instruct the Contractor to suspend progress of part or all of the works, during which the Contractor shall protect, store and secure the already existing part or the works against any deterioration, loss or damage. Should such suspension of work continue for more than 84 days, the Contractor may request the Employer’s permission to proceed with the works. However, If the Employer does not give permission within 28 days after being requested so, the Contractor may, by giving notice to the Employer, treat the suspension as an omission of the affected part of the works. More importantly, if the suspension affects the whole of the works, the Contractor may give notice of termination to the Employer.
  • Termination – You will of course also want to carefully review what specific termination events are regulated in your EPC Contract, the occurrence of which can trigger the right to terminate the EPC Contract. In the FIDIC template, Force Majeure does not constitute such a termination event automatically, only if the execution of substantially all the works in progress is prevented for a continuous period of 84 days by reason of Force Majeure of which notice has been given, or for multiple periods which total more than 140 days due to the same notified Force Majeure, then either Party may give to the other Party a notice of termination of the EPC Contract, in which case the termination shall take effect 7 days after the notice is given. However, your EPC Contract may regulate it otherwise and could provide e.g. that a prolonged case of Force Majeure (typically lasting uninterruptedly for 180 days or more) might trigger a termination right to any of the Parties. Similarly, we often see EPC Contracts providing that if due to serious delays in performance the overall cap on delay liquidated damages is reached this constitutes a termination event for the non-defaulting Party. Therefore, provisions relating to termination of the EPC Contract will have to be reviewed very thoroughly in any case.
  • Dispute Resolution and Escalation – It is important to check the dispute resolution and escalation mechanisms in your EPC Contract. The FIDIC template contains a very detailed and transparent dispute resolution mechanism, pursuant to which disputes shall be adjudicated by a three-members Dispute Adjudication Board (DAB), which shall be appointed by the Parties within 28 days of a Party giving notice to the other Party of its intention to refer a dispute to a DAB. Unless settled amicably, any dispute in respect of which the DAB’s decision (if any) has not become final and binding shall be finally settled by international arbitration.
  • Governing Law – Importantly, make sure you also check the governing law of your EPC Contract, as the provisions of applicable law may also very well be relevant for your particular situation. By way of an example, many continental legal regimes regulate frustration and Force Majeure differently from the related common law legal doctrines – so the same wording may lead to different conclusions depending on the chosen governing law.

Ultimate Objective

Another essential point to determine, whether you are the Project Owner or the EPC Contractor, is what your ultimate objective is in the crisis situation in terms of your EPC Contract. Do you intend to save the project and continue with the EPC Contract, or do you rather seek a temporary relief from your payment and/or performance obligations thereunder? Or do you actually want to terminate or cancel the project entirely? The answers to these questions will have to determine your next steps.

In any case, having extensively assisted clients on both sides of the trenches, we think that this never-seen-crisis will ultimately show that both Project Owners and EPC Contractors have a genuine interest to promptly start good faith discussions with each other to properly assess the actual scale and scope of the risks affecting their EPC Contract due to the coronavirus pandemic, and also with a view to find amicable solutions to handle such risks as best as is possible in the fast-changing circumstances in which we all find ourselves at present. In the course of such good faith discussions the Parties should address issues such as:

a) What impacts the Parties can identify to the works falling under the scope of the EPC Contract;

b)  To what extent the project implementation schedule (including in particular the milestones and the final completion date), the procurement plan and the transportation study have to be revisited and, possibly, amended;

c) Does the coronavirus crisis constitute an event of Force Majeure under the given EPC íContract and, if yes, has appropriate notice thereof been given by the affected Party;

d) Is there any delay at present or imminently threatening which qualifies as a material breach of the EPC Contract, has an event of default occurred or is it imminent;

e) Is there any circumstance, which could trigger either liquidates damages payment obligation or a termination right of either or both Parties;

f)  Is there any Governmental or other local law or regulation which makes it impossible or unlawful for either or both Parties to fulfil their contractual obligations or which, under the governing law of the EPC Contract, entitles any of the Parties to be released from its obligations under the EPC Contract;

g) Does the change in law provision (if any) under the EPC Contract apply to the present situation and, if yes, with what consequences;

h) Are there any grounds to invoke the suspension or termination mechanisms under the EPC Contract and, if yes, what are those grounds and with what consequences?

[1] FIDIC has developed well-known model agreements for the implementation of various types of projects, such as Plant and Design-Build Contract 2nd Edition (“2017 Yellow Book”), Construction Contract 2nd Edition (“2017 Red Book”) or Turnkey Contract 2nd Edition (“2017 Silver Book”).

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Kristóf Ferenczi
Firm-wide Head of Energy & Natural Resources
Managing Partner
Kinstellar, Budapest

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