Performance guarantees under an EPCM contract

Introduction

The structure and liabilities for Engineering Procurement and Construction Management (EPCM) contracting are fundamentally different for an EPCM Contract, as compared to an EPC Contract. This is particularly the case in relation to performance guarantees. Under an EPC Contract, the Contractor offers a single point of responsibility for defects liability and performance guarantees. By contrast, where an EPCM procurement has been used, the defects and performance guarantee position needs to be pieced together through the various works contracts (the Client’s contracts for the works packages and supply of materials/equipment) and the EPCM Contract. There may therefore often be a “fragmentation” of defects liability between the various works contracts / EPCM Contract. Looking at each of these in turn:

Works contracts

When a works contract involves the supply of a system (i.e. where the output and inputs can be measured) an individual works contract may itself have a performance guarantee for part of the project.

This performance guarantee might be a “fix-it” only guarantee; meaning that the works contractor should fix the relevant defect in a reasonable period of time. Failure to do so usually allows the Client to get a third party to fix the defect and seek to recover the cost of doing so from the defaulting works contractor. Many works contracts expressly exclude consequential losses so losses incurred by the Client during any operational down time might not be recoverable through the fix it guarantee structure. This can mean that the relevant works contractor may not have a commercial incentive to fix the defect quickly.

Some performance guarantees are supported by liquidated damages – pre-agreed sums that are payable by the works contractor to the Client if a particular output is not achieved. This may be a static one time measurement or measured over a period of time through availability and reliability guarantees. The mechanisms surrounding performance guarantees need to be closely considered for each works contract – what is the opportunity (and obligation) to seek better performance and how do the defect and performance guarantee mechanisms interact?

The impact of failure of a performance guarantee on another works contractor’s package also needs to be closely considered within an EPCM structure. If an individual works package is dependent upon the output of another works contract, what is the impact?

The individual works contractor performance guarantees under an EPCM structure may have less value for some projects than might be available through an EPC structure due to one or more of the following:

1. being linked to individual packages of work rather than the whole of the works
2. being only “fix it” guarantees meaning no liquidated damages will be available relating to the performance of some or all of the works
3. for those packages where liquidated damages are available, the value of liquidated damages being set at a lower value than would be available through an EPC contractual structure
4. the increased chance of arguments over the cause of the defect and whether it is one that can clearly be allocated to a specific works contractor (as noted above, there may be a division of defects responsibilities between the different works contracts)

EPCM Contractor’s liability

Under an EPCM contractual structure, the EPCM Contractor may have a number of design responsibilities, such as:

1. producing the whole or elements of the design
2. verification of the Client’s design
3.  co-ordination of individual works contractors’ design into the overall design
4. ongoing monitoring responsibilities through the construction management services during the execution phase of a project

Where the EPCM Contractor is fully responsible for the design of the project, a performance guarantee may also be offered.

There are two ways in which a design related performance guarantee from the EPCM Contractor may operate. As is the case for the works contracts, a design related performance guarantee from the EPCM Contractor can either be offered by way of a “Fix it” guarantee or linking failure to the payment of liquidated damages.

For a Fix it guarantee, this needs to be considered against the backdrop that the EPCM Contractor doesn’t undertake the works. Fixing a design related performance guarantee issue is likely to involve the need for some additional construction works to be undertaken and the works contracts need to be drafted in a way to assist with this process.

For a design related performance guarantee that is linked to liquidated damages, such as where design of the completed works must achieve a minimum performance output, there may be an interface with the works contractors also having delivered in compliance with their contracts. Certain other conditions may also need to be satisfied for the design performance guarantee to apply, e.g. the works having been maintained or operated correctly by the Client. As with the fix it guarantee, adjusting the plant to allow for the design related performance guarantees to be retested may require additional works to be undertaken by the works contractors.

Conclusion 

Understanding how performance guarantees operate for an individual project is key to the success of an EPCM Contract. The contract mechanics under both the works contracts and the EPCM Contract need to work together to deliver an effective and comprehensive performance guarantee regime.