Anthony L. Byler and Stasha M. Sosnowicz | Cohen Seglias Pallas Greenhall & Furman
Some of the largest, and most lucrative, construction projects are those in the energy and power sector. Power plants, generating stations, oil and gas rigs, solar fields, and similar projects require complex planning and bidding, but if successfully executed, they can be a financial and reputational boon to trade subcontractors. Many of these large projects are financed and organized as engineering, procurement, and construction contracts (EPC contracts), specialized agreements between an owner and a general contractor with unique features and pitfalls. While EPC contracts are utilized for large power and energy construction projects nationally and internationally, there is little information about subcontractor-specific considerations for bidding and executing a subcontract on such a project. Due to this lack of guidance, trade subcontractors seeking to perform successfully on an EPC project in the energy and power industry should heed the following considerations.
In contrast to the traditional design-bid-build delivery method, EPC contracts are design-build. In EPC contracting, an owner maintains a single contract for the project with a general or prime contractor, known as the “EPC contractor.” An EPC contractor supervises and manages nearly all facets of the project, designing the project and often procuring the major equipment and trade services required, allowing the owner to be less involved on a day-to-day basis. In addition, the EPC contractor is usually responsible for providing the owner with a “turnkey” build, delivering a completed product from start to finish so the owner only needs to “turn the key” to operate the finished project.
EPC contracts are inherently risky for the EPC contractor because of the number of responsibilities that can include: obtaining relevant permits; creating a complete design and specifications; competently constructing the project; commissioning the project; performing start-up; and delivering the project to the owner. Because of the single contract between the EPC contractor and the owner, if the project goes awry, the EPC contractor has few parties outside its own designers and subcontracting partners at which to point a finger. For accepting the bulk of design and construction risk, EPC contractors are paid a “risk premium” by the owner, who would otherwise be responsible for design and other potential risks of direct involvement. Inevitably, the EPC contractor will seek to pass down as much of its risk to its subcontractors with as little risk premium as possible.
Subcontractors interested in bidding on and building power and energy projects must be aware of the risks inherent in EPC contracting to avoid project impacts, overruns and legal issues. Understanding the relationship between the owner and the EPC contractor is essential for the subcontractor to protect its interests. In fact, many EPC subcontracts specifically incorporate provisions of the EPC contract into the subcontract, so it is crucial for subcontractors to obtain a copy of the EPC contract between the owner and the EPC contractor at bid time to understand how the EPC contract operates and how it will impact the subcontract.
Pricing Structure and Design Completion
EPC contracts and their subcontracts typically come in three pricing types: lump sum, cost-plus/cost-reimbursable, or unit price.
- Lump sum pricing, where work performance is tied to a fixed price, is by far the riskiest for a subcontractor, especially because EPC design is not always well-developed at bid time. Lenders and owners may prefer a fixed lump sum price to ensure near financial certainty in its revenue coverage ratios for debt repayment. However, lump sum pricing provides little room for error both in the overall design and the labor and materials. That means that adjustments to the subcontract will depend principally on the subcontract’s change provisions and the subcontractor’s ability to comply with those provisions. Thus, it is crucial at bid time to gauge the design completeness and detail level to determine whether lump sum pricing is an appropriate structure for the subcontract.
- In comparison, unit pricing—when a subcontractor is paid based on its actual costs per an agreed-upon rate—is usually the least risky for the subcontractor. The key to successful unit price subcontracts, especially in a recovering post-pandemic environment, is correctly estimating the unit prices and obtaining the flexibility to re-set those unit prices by an appropriate escalation clause should supply-chain problems and/or inflation significantly impact the cost and availability of labor and material.
- Cost-plus and cost-reimbursable arrangements float somewhere in the middle of the risk spectrum, especially as they are often tied to a guaranteed maximum price (GMP) structure. Cost-plus contracts can have the benefit of a large margin for the allowable subcontract balance but include the challenge of requiring strict notice and record-keeping requirements to substantiate the subcontractor’s costs.
Scope of Work
Any subcontractor knows having a detailed and accurate scope of work is critical to success on a project, especially when seeking compensation for any necessary or directed out-of-scope work. This is particularly important for EPC subcontracts. Due to the sheer size, complexity and tight schedule of typical EPC projects in the energy and power industries, a subcontractor must be prepared to submit written notice of any changed condition the moment they encounter a need to perform out-of-scope work, even if the full value of that work is unknown. Subcontracts universally require this prompt written response, along with other notice elements and timely submission of change order requests.
Change Provisions and Schedule Impacts
Change provisions, and provisions relating to required notices of schedule impacts (delays, hindrances, acceleration), can sometimes be located in a single subcontract section but are more frequently found scattered throughout. Changes can impact cost, performance time, or both. And subcontracts often contain separate notice and change provisions depending upon the remedy sought (e.g., for additional time or compensation).
A vigilant subcontractor will always take steps to become familiar with the specific notice and timing requirements for change order requests under its subcontract. This is especially important when operating on an EPC contract because of the project’s size, complexity, and number of involved trades. Consider, for example, a power plant project where trades are frequently required to operate simultaneously within partially erected and enclosed spaces, each working with cumbersome equipment and materials among cranes, lifts and scaffolding. A hold-up in any area or system can affect all surrounding trades and create time or cost impacts. As it follows, providing timely notice of those realized or potential impacts is crucial to protecting the subcontractor’s rights to an equitable adjustment of time and/or price. Additionally, change provisions usually require the subcontractor to provide specific supporting information to substantiate its request for additional time or money.
It is often a good idea for the subcontractor to provide its own onsite scheduler, competent in using the scheduling software utilized by the EPC contractor and capable of meeting regularly with the EPC’s master project scheduler. This may be the only way for the subcontractor to identify and review impacts to the schedule as they occur, which is essential to making adjustments, providing timely notice of impact, and advocating for the performance of the subcontractor’s activities in a congested worksite.
Because the cost and time impact of given change conditions can be extremely hard to calculate at the time of impact, subcontractors must maintain precise records throughout the project. Conditions may even warrant engaging a scheduling and/or accounting consultant to help calculate and potentially present a formal claim.
Claims and Dispute Resolution
Related to change provisions are claims, dispute resolution, and limitations of liability provisions of a subcontract. While not every subcontractor will have a lawyer on standby to review a subcontract, before execution, every subcontractor should carefully examine the following provisions of any potential EPC subcontract:
Incorporation of EPC Contract and/or Flow-Down Provisions
“Flow-down” provisions bind a subcontractor to the same rights and obligations the prime contractor has with the owner. Subcontracts on EPC projects frequently incorporate, among other things, the EPC contract’s claims and dispute resolution provisions. such, a subcontractor who fails to obtain a copy of that prime contract before entering into the subcontract will have little, if any, understanding of its true incorporated contract rights and remedies.
Liquidated Damages and Dispute Resolution Provisions
Subcontracts for EPC projects often permit the EPC contractor to withhold liquidated damages, or a stipulated sum of money, from a subcontractor. Liquidated damages are typically, but not always, calculated on a per diem basis for untimely completion of work. On EPC projects, liquidated damages can amount to tens or hundreds of thousands of dollars per day. A vigilant subcontractor, especially one with finish-trade responsibilities, must carefully examine the project’s overall status at bid time to ensure that the project is progressing as planned and that the current schedule is one with which the subcontractor can comply. If the project deadlines have frequently shifted, or if the current schedule cannot be achieved, a subcontractor should think twice about bidding on the project, as it is likely to lead to the ultimate imposition of liquidated damages. Even on projects where the subcontractor has confidence in the timely performance of its work under the proposed project schedule, the subcontractor should consider modifying the liquidated damage provisions to restrict the EPC contractor from assessing liquidated damages where the subcontractor can show that it was not the source of the delay.
To avoid responsibility for delay damages on EPC projects, it is imperative for a subcontractor to act proactively. This includes not only being fully informed of the subcontract’s notice and change requirements for schedule impacts but also employing an onsite scheduler to provide oversight on the timeliness of day-to-day activities on the project.
A subcontractor must also be aware of its subcontract’s dispute resolution provisions. For example, is there a limitation of liability, providing for a maximum amount of recoverable damages? Is the subcontractor required to arbitrate or litigate and, depending upon which one, what state’s law governs and where is the resolution required to take place? A subcontractor needs to know which law applies because this will often determine the availability of and the manner of preserving crucial remedies such as liens, bonds and prompt payment rights.
For example, a subcontractor must know whether the applicable jurisdiction considers the project public or not. Since many EPC projects are energy or power projects run by a public utility, the jurisdiction may classify it as a public project with a public owner. This is significant because many jurisdictions prohibit liens on public property. Additionally, is the subcontractor required to mediate first? Are the subcontractor’s claims tolled if they involve a claim the EPC contractor can pass along to the owner? Is the subcontractor required to let the EPC pursue its rights against the project owner on its behalf? Each of these questions is important because they all determine what the subcontractor must do to pursue its remedies and they ultimately impact the cost and outcome of claims.
Role and Identity of the Owner
Subcontractors need to understand who their point of contact is with the project owner and how frequently, if at all, they will be able to communicate with the owner’s representative. Owners generally seek to communicate only with the EPC contractor, as having a single point of contact is one of the principal reasons for EPC arrangements. An EPC contractor is likely to discourage direct communication between a subcontractor and the owner for this reason alone and to ensure the EPC continues to control project messaging to the owner. In light of a contractor’s practical and contractual ability to control project communications with the owner, an owner may be ignorant of ongoing project hindrances, accelerations and delays. While the contractor is responsible for managing schedule impacts, an owner has legitimate interests in knowing the true status of its project, and it is capable of making decisions that can impact the subcontractor’s rights, especially where provisions of the EPC contract are incorporated into the subcontract. Therefore, it is extremely valuable for a subcontractor to have contact with an owner at monthly meetings to communicate, in a constructive and professional manner, project impacts on its work. This is all the more reason for a subcontractor to select project managers and executives who can clearly communicate issues to the owner.
Conclusion
While EPC projects in the energy and power sector present significant risks to trade subcontractors, the rewards for projects of this size are great when parties can mitigate the risks. With planning and careful review of the subcontract and the EPC contract, there is no reason why a subcontractor cannot profit from these projects.
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