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Chapter 7

Project Contracts:
(2) Ancillary Contracts

This chapter summarizes the key provisions usually found in the Project Con-
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tracts that may be signed by the Project Company apart from the Project Agree-
ment discussed in the last chapter, namely

• Construction contract (cf. §7.1)

• Operation and maintenance (O & M) contracts (cf. §7.2)
• Fuel or other input supply contract (cf. §7.3)
• Permits — not a contract as such but an important underpinning for all the
Project Contracts (cf. §7.4)
• Government Support Agreement (cf. §7.5)
• Insurance (cf. §7.6)
• Direct Agreements, which link the lenders to the Project Contracts (cf. §7.7)

As already mentioned (cf. §2.4), all of these contractual building blocks are not
found in every project financing, but one or more of them usually are, and it is im-
portant to understand their general scope, purpose, and structure as they usually
form a major element of the foundation on which the project financing is built.

§7.1 EPC CONTRACT

In the conventional contracting procedure for a major project, the project de-
veloper has a consulting engineer draw up the design for the project, based on
which a bid for the construction is invited with detailed drawings, bill of quanti-
ties, etc.; any specific equipment required is procured separately. But even if the
Sponsors have the experience to arrange the work under separate contracts and

105
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106 Chapter 7 Project Contracts: (2) Ancillary Contracts

coordinate different responsibilities between different parties, this is not usually

acceptable to lenders in project finance who want there to be “one-stop” responsi-
bility for completing the project satisfactorily, since they do not want the Project
Company to be caught in the middle of disputes as to who is responsible for a fail-
ure to the do the job correctly.
Therefore the construction contract in a project-financed project is usually in
the form of a contract to design and engineer the project, procure or manufacture
any plant or equipment required, and construct and erect the project (i.e. a “turn-
key” responsibility to deliver a complete project fully equipped and ready for oper-
ation). This is known as an engineering, procurement, and construction (EPC)
contract. (It is also known as a design, procurement, and construction or DPC
contract.)
Another approach to contracting for major projects is to appoint a contracting
or engineering company as construction manager, with the responsibility of han-
dling all aspects of the construction of the project, against payment of a manage-
ment fee. The fee may vary according to the final outcome of the construction
costs. Although this may be an economically efficient way of handling major proj-
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ects, a variable construction cost is not acceptable to lenders because of the risk of
a cost overrun for which there may not be sufficient funding, or which adds so
much to the costs that the project cannot operate economically (cf. §8.5.4). The
EPC Contract therefore also provides for the work to be done by the EPC Con-
tractor at a fixed price and to be completed by a fixed date.
Such a fixed-price, date-certain, turnkey EPC Contract transfers a significant
amount of responsibility (and thus risk) to the EPC Contractor, which is clearly
likely to be reflected in the EPC Contractor building more contingencies into the
contract costings, and hence a higher contract price than the price if the work were
done on a cost-plus basis.
Fixed-price, date-certain EPC Contracts are standard in power and infrastruc-
ture projects. Sponsors who want to adopt a different approach normally have to
give lenders completion guarantees, thus diluting the nonrecourse nature of the
transaction (cf. §8.12). Certain types of projects do not or cannot usually use such
contracts—for example mining and oil and gas extraction projects, as well as
projects involving a gradual investment in a network, influenced by changing de-
mand, such as in telecommunications projects (cf. §8.5.9).
It should be noted that standard forms of EPC Contracts, such as those pro-
duced by the International Federation of Consulting Engineers (FIDIC) are gen-
erally not suitable for project finance, first because they tend to be too “contractor
friendly,” and second because there are some differences of structure compared to
project finance requirements.1
1
A useful detailed commentary on construction contracts can be found in United Nations Com-
mission on International Trade Law: UNCITRAL Legal Guide on Drawing up International Contracts
for the Construction of Industrial Works (United Nations, New York [1988]).
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§7.1 EPC Contract 107

Key aspects of an EPC Contract from the project finance point of view are:

• Contract scope (cf. §7.1.1)

• Commencement of the works (cf. §7.1.2)
• The Project Company’s responsibilities and risks (cf. §7.1.3)
• Contract price, payments, and variations (cf. §7.1.4)
• Construction supervision (cf. §7.1.5)
• Definition of completion (cf. §7.1.6)
• Force majeure (cf. §7.1.7)
• Liquidated damages (cf. §7.1.8)
• suspension and termination (cf. §7.1.9)
• Security (cf. §7.1.10)
• Dispute resolution (cf. §7.1.11)

§7.1.1 SCOPE OF CONTRACT

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The EPC Contract sets out the design, technical specifications, and perfor-
mance criteria for the project. Nonetheless the EPC Contractor remains respon-
sible for constructing a project that is capable of performing as specified, even if
something has been omitted from the detailed description.
An EPC Contract offers a “fast-track” route to construction of the project, since
the contract is signed and construction can begin before all the detailed design
work is complete; however, the Project Company has the right to object to detailed
designs as these are produced by the EPC Contractor.
The EPC Contractor is responsible for employing (and paying) any necessary
subcontractors or equipment suppliers, although the Project Company may have a
right of prior approval over major subcontractors or equipment suppliers, to en-
sure that appropriately qualified subcontractors or suppliers with relevant tech-
nology are being used.
Work “outside the fence,” such as fuel and grid connections for a power station,
or road or rail connections being built by the Offtaker or Contracting Authority
under a Project Agreement, or a third party, is not normally within the scope of the
EPC Contract. Therefore, if noncompletion of this work affects the completion or
operation of the project the EPC Contractor is not liable.
Another exception to the turnkey responsibility of the EPC Contractor arises
where the project is being constructed using technology licensed by a third party,
which is commonly the case in refinery or petrochemical plant projects. The EPC
Contractor does not take responsibility for the operation of the plant insofar as this
depends on such a third-party license.
Construction insurance should normally be excluded from the scope of the
EPC Contract price (cf. §7.6.1).
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