UNDERSTANDING AND NEGOTIATING
SWEEr" MAXWELL
Published in 1997 by Thomson Reuters (Legal) Limited
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© Joseph A. Huse
1997
ACKNOWLEDGMENTS
The author would like to thank all the partners, managers and staff
at the various offices of Freshfields for their assistance. In
particular, he would like to thank Matthew Turner and Claire
Skrinda for their invaluable efforts with respect to the
preparation of the second edition of this book.
v
FOREWORD
When the first edition of "Understanding and Negotiating Turnkey
Contracts" was written by Mr. Huse, the Orange Book ("Conditions of
Contract for Design-Build and Turnkey"), issued in 1995, was the
only FIOIC form of contract intended for use in a design and build
context. FIDIC being well known for the quality of its prior
documents, it was certainly only natural for him to use the Orange
Book as a basis for discussing turnkey con tracts and proposing
negotiation points for the parties.
In 1999, three new Books were issued by FIDIC, with their basic
structure and wording harmonised around the previous Orange Book
format. These Books were the Conditions of Contract for
Construction, for Plant and Design-Build, and for EPCffurnkey
Projects. The first one is intended for construction works where
the employer is responsible for the design, similar to the old Red
Book, and with an important role for the Engineer. The two latter
ones are intended for cases when the contractor supplies the
design. The Plant and Design-Build Book has the traditional
Engineer while the EPCffurnkey Projects Book has a two-party only
arrangement.
With further development, the new (1999) "Conditions of Contract
for Plant and Design/Build" retain the essential elements of the
earlier Orange Book. It had been noted, however, that new trends in
project financing and management, especially related to PFI and
BOT, required a different set of conditions, and the "Conditions of
Contract for EPCffurnkey Projects" were drafted to cater for this.
They complement but do not replace the "Conditions of Contract for
Plant and Design/Build", in that they are intended to be used in a
rather specific context, e.g.:
• when greater certainty is sought that price and time will not be
exceeded;
• when the Contractor is required to take total responsibility for
the design and construction of the infrastructure or other
facility;
• when the Employer is willing to pay more in return for the
Contractor bearing the extra risks associated with this; and
• when uncertain or difficult ground conditions or other largely
unforeseeable risks are unlikely to be encountered.
They should rather not be used for design-build work in other
circum stances. The decision which Book to use should, therefore,
always be taken in full consideration of the particular
characteristics of the project at hand.
In a similar way, depending on the project context, the first
edition of "Understanding and Negotiating Turnkey Contracts" very
much retains its merits for a better understanding and appreciation
of FIDIC's new "Conditions of Contract for Plant and Design/Build",
while the new, second edition is equally valuable with respect to
the "Conditions of Contract for EPCffurnkey Projects".
vii
FOREWORD
In the very detailed discussion of the context and of the operation
of the various clauses, the author pays special attention to the
operation of the con tract in a BOT project. This will certainly
be much appreciated by the many employers and contractors who do
not yet have much first-hand experience of such projects but are
eager to make the best possible use of this approach to project
financing and execution. Other interesting features are the tables
summarising the employer's and the contractor's obligations under
the various clauses of the contract, and comparisons with other
standard forms of turnkey contracts.
For FIDIC, its own "FIDIC Contracts Guide", with detailed guidance
to the new contracts, remains the main reference work, especially
since it was written by the principal drafter of the three 1999
Books. However, Mr. Huse's work is still the major commentary
coming from an independent con struction lawyer and will therefore
certainly receive much positive attention from employers,
contractors, lenders and other interested parties.
Daniel Ivarsson Managing Director FIDIC
viii
INTRODUCTION
When drafting international construction contracts, practitioners
often use standard form contracts as a basis for their documents.
The form contract provides a familiar starting point to ease the
drafting burden and facilitate negotiation.
The Federation Internationale des Ingenieurs-Conseils (FIOIC) has
recently published a new form contract for use with the design and
con struction of works using the engineer, procure, construct or
turnkey con tracting method. This contract, the FIOlC Conditions
of EPCffurnkey Projects (the Silver Book), is aimed at situations
where bids are invited on an international basis; with some
modification the contract could be used, in certain countries, for
domestic contracts as well.
The purpose of this book is twofold: (i) to provide a comparison of
the terms of the principle design-buildlEPClturnkey contracts; and
(ii) to assist contract drafters in their analysis of the Silver
Book and in the modification of its provisions to meet the specific
needs of the project in question. The final chapter gives drafting
suggestions for selected contract provisions of the Silver Book
from the perspective of both the contractor and the employer.
Turnkey contracts
In a design-bid build contract, the employer supplies the design,
which often includes the designation of materials and other key
construction parameters. Under an EPC agreement, the contractor
provides all of the engineering, pro curement and construction.
Under a turnkey contract, the contractor sup plies the final
design of the project. From the perspective of the author, these
three terms are largely interchangeable and the drafting of this
book reflects this position.
These contracts place the design and construction duties in the
same hands, providing in theory a more easily co-ordinated project
with potential for increased speed of completion and decreased
cost, due to tighter project organisation. They also place primary
liability on the contractor for any defect in the design,
construction or performance of the works. Therefore, as a general
proposition, where a defect arises in the works, the employer need
not prove to what extent resultant damage was caused by faulty
design or by faulty construction, as may be the case under a
design-bid-build con tract.
As the contractor is allocated design, co-ordination and
construction responsibilities for the whole of the work, the
employer need not provide the same level of technical expertise
required under the traditional contract, e.g. he need not provide
detailed design preparation capabilities.
In complex EPC and turnkey contracts parties often use the
lump-sum
IX
TYPES OF CONTRACT
appropriate contracting method are the design function and
co-ordination of the works. The employer can himself provide one or
both of these func tions, or he can allocate them to one or more
third parties.
1-04 Methods of contracting available to the employer can be split
into two broad categories: design-bid-build, which separates the
design and construc tion functions, and design-build, or turnkey,
which places the entire project, including design and construction,
in the hands of the contractor. The turnkey method is often
referred to as "engineering, procurement and con struction" (or
"EPC"), especially in the context of project financing. With
respect to the first category, a distinction should be made between
a design bid-build project using a single construction contract
and a design-bid-build project using several construction
contracts.
Design-bid-build
1-05 The design-bid-build method is the traditional approach to
construction contracts (see Figure 1.1). First the employer
provides for the design of the project in accordance with his
requirements. The designer chosen by the employer then provides a
set of drawings sufficient for construction. How far advanced these
designs are when used for the tendering process may vary
1-06 Figure 1.1 The design-bid-build method
I EMPLOYER I
I CONSTRUCTION I CONTRACT
CONTRACTING METHODS
in relation to the origin and experience of the employer. In
France, for example, the contractor will usually be responsible for
detailed design.
In a design-bid-build project the employer provides the design and
co-ordi nation of the project; thus he will be responsible for the
interface between the design and construction aspects of the
project. The designer often acts on behalf of the employer as the
supervisor or engineer for the project, guiding the contractor in
the progress of the works and supervising the interface between the
design and construction. Where the project requires extensive
financing, this may not be acceptable to lenders (as discussed
below).
There are a number of potential disadvantages associated with the
design bid-build form of contracting. It tends to delay the
overall completion date due to the use of distinct design and
construction phases (as opposed to the turnkey method). The
employer-provided designs will not necessarily corre spond with
the technical capacities of the contractor. There may be added
delay while the contractor familiarises himself with the designs
provided and the technology used in the designs.
Single versus multiple construction contracts
When choosing the design-bid-build method of contracting, the
employer 1-07 will need to decide whether he wants a number of
contractors to fulfil the various construction tasks of the
project, or whether to place all of these tasks into the hands of
one contractor. When using a number of contractors, the employer
may also need to decide which tasks to contract out and which tasks
can be provided by his own in-house staff.
The employer may choose the multiple-contract approach when he
wishes to establish individual construction packages in order to
achieve the lowest price. If multiple construction contracts are
used, the employer will need to provide co-ordination of the
various contractors and, under certain circum stances,
subcontractors.2 Therefore, the employer will be responsible not
only for the interfaces between the designs used and the work
methods of the various contractors and suppliers, but also the
co-ordination of each of the construction packages assigned to such
contractors and suppliers. This necessitates either that the
employer has the skills and experience to under take such
co-ordination (and understands the construction methods and
technology to be used by the various contractors and suppliers), or
that he contracts with a competent third party to undertake such
co-ordination.
The employer's first step in implementing the construction
component of 1-08 such an approach to design-bid-build is to define
the individual construction work packages. Construction packages
are sometimes defined on the basis of electrical/mechanical works
and works of civil engineering. Subject to rel- evant procurement
requirements, the employer will then be able to allocate the
individual work packages to the contractor or supplier of his
choosing.
2 I.N.D. Wallace, Construction Contracts: Principles and Policies
in Tort and Contract (Sweet & Maxwell, London, 1986), p. 401
(hereinafter Construction Contracts).
3
TYPES OF CONTRACT
Since the employer chooses the individual contractors and suppliers
for each construction package, the employer has greater control
over the quality of contractors used and materials chosen. By using
this contracting method, the employer may also achieve a lower
price for the works. The use of several contractors may enable the
employer to use local contractors, possibly under the supervision
of experienced foreign contractors, particularly where it is in the
employer's interest to effect a transfer of technical and
managerial skills to the site country. This same goal can, however,
be achieved in a single con struction contract by mandating the
use of local subcontractors for a certain percentage of the
works.
When using the multiple contract method, properly defining the
interfaces among each of the work packages may be problematic. Any
ambiguity, or the failure of any such definition, is the
responsibility of the employer and may result in contractor claims.
For the employer this constitutes one of the major risks of the
multiple contractor method.
1-09 Under the single or prime construction contract method, the
employer places the responsibility for all of the construction of
the works with one contractor. This relieves the employer of the
need to co-ordinate the inter faces among the construction
packages. It also reduces the risk of contrac tor claims in
respect of such interfaces. However, it removes from the employer a
certain amount of his control over the construction of the works.
The use of this method may also result in a higher cost for the
construction of the works (as mentioned above).
In a design-bid-build project with a single construction contract,
the employer will still be required to manage the
design/construction interface. However, the employer will be able
to pass on to the contractor the respon sibility for the
interfaces between the various construction packages.
1-10 Design-bid-build with multiple contractors provides the
employer with extensive control over the design and construction
process. Not surprisingly, this method also requires the greatest
degree of intervention on the part of the employer. He will be
responsible for interfaces between the multiple contractors and
co-ordination of their work.
The design-bid-build model can prove to be disappointing. The
designer employed by the employer is often removed from the actual
field experience of contracting; thus his designs may be distanced
from the realities of con struction. This distance could result in
inaccurate cost and scheduling esti mates, impractical or outdated
designs and failure to implement new construction methods. 3
Management contracting
1-11 Management contracting is a less traditional approach which
involves hiring a contractor whose role is the co-ordination and
management of the project.
J Brown, "Opportunities and Risks of Design Build Projects~, The
Construction Superconference, San Francisco, U.S., December 7-8,
1995.
4
CONTRACTING METHODS
This management contractor organises time, cost and quality
control. He engages a number of other contractors to do the actual
construction work. The management contract provides the employer
with the control of the project typical of a traditional
design-bid-build contract, while reducing the requirements on the
employer (a feature similar to the turnkey contract). The primary
difference between the management contract and the turnkey model is
that the management contractor generally assumes no responsibility
for the work of the other contractors or for the performance of the
design.4 He acts purely as a management intermediary.
The management contractor can be given any number of different man
dates, with greater or lesser powers of intervention in the
construction process. He can be involved from the very outset of
the project, inviting tenders, negotiating for the employer and
selecting contractors, through to the completion of the works. The
management contractor's fee can be tied to the completion time or
the overall price of the contract, or both, using a target price.
The management contractor's fees will decrease where the actual
price surpasses the target price, and increase where costs are less
than those targeted. Under this system by using target pricing the
management contractor has an incentive to control the price of the
contract in the employer's favour. Similarly, the management
contractor can be required to assume some of the liability for the
performance of the works or the quality of construction to provide
an incentive to supervise closely the quality of the workmanship
and materials that go into the works.
Design-build, turnkey and EPC
The "turnkey" arrangement, (also known as the "package deal",
"design 1-12 and build", "cle-en-main " , "design and construct" or
"EPC") places the duty to design and construct solely on the
contractor. There is no accepted definition for each of these terms
in the construction field. The term "turnkey" tends to mean the
most extreme form of placing design and con struction
responsibility on the contractor, such that after completion the
employer need only turn the key to commence operation of the
constructed facility. Notwithstanding this, the term "turnkey" will
be used here to describe the more general global arrangement of
placing all design, pro curement and construction responsibilities
on one contractor.
In recent years, design-build projects have seen rapid growth in
some parts of the world. For example, use of the design-build
method increased from an $18 billion (in the mid-1980s) to a $69
billion (in the mid-1990s) indus try and now represents roughly 25
per cent of the United States construction industry.s
4 For a detailed analysis of the management contracting method, see
generally Freshfields' Construction & Engineering Group,
Freshfields Guide to Management Contracting: Law and Practice
(1994). .
5 M.L. McAlpine, "Construction Law: Will Design·Build Contracting
Really Solve All of the Problems?" (1997) 76 MI Bar Jnl. 522,
online: LEXIS at 533.
5
TYPES OF CONTRACT
Where the contractor takes responsibility for the design of the
works, the employer's advisers find their involvement limited
primarily to the tender process and supervision of the contractor's
work. The definition of supervi sion is likely to be the subject
of extensive negotiation between the parties, as the employer will
want to maintain control over the construction process.
The turnkey system generally uses the lump-sum pricing method.
Certain practitioners believe that it is ill-suited to interim
payment based on the cost of work done, due to the difficulty of
verification by outside experts of the figures submitted by the
contractor.6
The turnkey contract places the responsibility for the entire
project in the hands of the contractor. Thus, there is no need to
identify whether a defect has been caused by defective design or
defective construction of the works. As a general rule, any defect
falling within the scope of works will be the respon sibility of
the contractor. Contractor liability makes design-build contracts
particularly attractive for employers.7 The potential liability of
the employer under other construction contracts (where, for
example, he provides any design specification) has led to a
dramatic growth of design-build contracting.8
1-13 The use of the turnkey method of construction results in a
considerable reduction of intervention by the employer in the
design and construction process, as compared with other contracting
methods. The role of the employer will consist primarily of
contract administration. His role may also include, depending upon
the terms of the turnkey contract, review and/or approval of
designs. Further, the design used ought to be consistent with the
technical capacities of the contractor, resulting in a more
efficient and cost effective application of the design to the
construction of the works.
The combination of the design and construction responsibilities
should also decrease the overall time for completion. This
phenomenon is known as "fast track" construction. Efficiencies in
the design and construction process may potentially reduce the
price of the project. However, certain construc tion professionals
maintain that the claims of earlier completion with design build
construction are exaggerated and that design-bid-build projects
achieve similar completion times.
1-14 As the responsibility for co-ordination of the project passes
from the employer to the contractor, so does some of the control.
The employer will experience a decrease in his day-to-day control
of the construction of the works. As the contractor's control of
the construction increases, so does his need to be experienced in
the management of large-scale projects. This may include handling
interfaces between multiple methods of construction, inter faces
between different industries, and the various designs used by sub
contractors and suppliers.
Under the turnkey method of contracting, the tender stage takes on
greater importance. Given the short time period available, it may
be difficult for the
6 Construction Contracts, op. cit. n. 2 above, p. 365. ? M.L.
McAlpine, op. cit. n. 5 above, 522, online: LEXIS at 555. 8 C.G.
Hammond, "Dealing with Defects: Defective Owner· Provided
Preliminary Design in
Design-Build Contracting" (1998) 15 1.C.L.R. 193 at 196.
6
CONTRACTING METHODS
employer to analyse properly each design at tender.9 Therefore, he
will need to be extremely precise in his "request for tender" as to
the performance and capacities desired from the works, (known, in
the Silver Book, as the Employer's Requirements). The employer will
need to spend a greater amount of resources on the tender stage to
ensure the contractor and his pro posed design are of the
requisite quality. Similarly, the contractor may need to expend
heavily on bid preparation to ensure the buildability of the
project and the profitability of his bid price. to
The employer may choose to use a turnkey model for only part of the
project 1-15 (called "part-turnkey" or "semi-turnkey"). The
co-ordination responsibility for the entire project will then
either fall on the employer's consultants or the turnkey
contractor. The contractor will, therefore, bear design
responsibility for only a part of the works. ll Thus, for example,
the turnkey contractor can provide certain aspects of the works
such as heavy civil facilities which require specialised design and
attention, while the employer can contract on a design bid-build
basis for the finishing of the works and equipment systems.
This method decreases necessary interfaces, thus simplifying the
co-ordi nation of the project. It may also separate the
responsibility for differing types of work, for example equipment
systems work and heavy civil work, thus reducing contact between
various industries not necessarily familiar with each other's
working methods. The advantages and disadvantages of the
part-turnkey model are generally the same as those for the turnkey
and design-bid-build models, including considerations related to
the combina tion of the two contract models.
Reference should also be made to a variant of the EPC construction
methodology referred to as "EPCM" or "engineering, procurement and
con struction management". The essential difference between EPC
and EPCM methodology is that the contractor under an EPCM contract
assumes responsiblity for supervision/management of construction
but does not assume responsibility for the construction
itself.
BOT (Build Operate Transfer)12
The typical BOT (along with its variants such as BOO (Build Own
Operate), 1-16 BLT (Build Lease Transfer) and others) contract
encapsulates the process whereby a government grants a concession
or similar right to a project devel opment company to develop and
operate what would normally be a public sector project, for a given
period of time known as the concession period. The project
development company obtains financing for the project, and then
designs and constructs the facility; it then operates the facility
during the agreed period and thereafter turns the plant over to the
government. The
9 M.L. McAlpine, op. cit. n. 5 above, 522, online: LEX IS at 554;
I.N.D. Wallace, "Design and-Build: a No-No for Owners" (1999) 4
Const. & Eng. L. 7 at 8 (hereinafter "No-No").
10 For an outline of how this process might look under the Silver
Book, see the applicable sec tions of the FIDIC Guide.
11 Construction Contracts, op. cit. n. 2 above. . 12 For further
analysis of this concept, in relation to the Silver Book, see Chap.
4.
7
TYPES OF CONTRACT
parties generally intend that the income received by the project
development company during the concession period (including, in
certain circumstances, subsidies) will pay for the cost of
financing and running the plant with an ade quate return for the
investors. These investors often include the contractor. 13
Any BOT project involves a potentially complex contractual
structure. However, in most cases, the BOT project will use a
turnkey or EPC contract for the actual design and construction.
Thus the BOT is not really a separ ate method of construction
contracting, but rather a method of financing the project. Indeed,
the lenders of the BOT projects have significant influence on the
terms of the underlying construction contract, including the
requirement that such a contract be turnkey and, often, in the form
of an EPC contract. 14
In a BOT project, the operation period between completion and
transfer also gives the transferee an opportunity to verify the
quality and quantity of output of the works. The contractor can be
required to provide the trans feree's personnel with training
prior to the transfer, thereby easing transition. The transferee
will need to take care to maintain the operator's incentive to
maintain properly the works, in order to avoid deterioration in the
final period before transfer to the transferee (the operator, in an
attempt to save on costs, may towards the end of the operating
period decrease maintenance and operating expenditures resulting in
accelerated deterioration of the works). In certain BOT projects,
the operator is required to assume defects liability for a limited
period of time subsequent to the transfer.
l-17 A BOT project, in practice, is often not as simple as its
definition implies. There may be a large number of parties. For
example, in a recent hydroelectric project, the project development
company (granted a concession by the govern ment), entered into
various contracts for the building of the facility, its opera tion
and maintenance during the concession period and a power purchase
agreement with an electrical utility. The construction of the
facility was pro vided through a turnkey contract with a
consortium of contractors. Each of the turnkey contractors was also
an investor in the project development company. A subsidiary of one
of these turnkey contractors also acted as the operator of the
facility after completion. This complex structure is typical of
power plant BOT projects in developing nations, as developing
economies struggle to meet the dramatic increase in demand for
energy (see Chapter 4 BOT)Y
The increasing popularity of the BOT project is largely due to a
shortage of public funding and the opinion that the facility will
be more efficiently managed by a private entity.16 In theory, the
BOT scheme provides develop ing countries with much-needed
infrastructure at a reduced direct cost to the government. I?
However, BOT projects are high-cost and high-risk ventures for
private entities operating in a traditionally public domain.
IJ j. Scriven, "A Banking Perspective on Construction Risks in BOT
Schemes" (1994) 11 I.C.L.R. 313 at 314.
14 C. Wade, "History and Scope of the Three Major Books" (1998)
online: FIDIC http://www.fidic.comldocumentsllaunchlwade1.html(date
accessed: November 19, 1999).
IS D. Blumental, "Sources of Funds and Risk Management for
International Energy Projects" (1998) 16 Berk. J. Int'J Law 267,
online: LEXIS at 270.
16 j. Scriven, op. cit. n. 13 above, 313. 17 S.W. Stein,
"Build-Own-Transfer (BOT) ARe-Evaluation" (1994) 2I.C.L.R.
101.
8
CONTRACTING METHODS
The cost of tender being high, the project company members should
take great care to examine the risks associated with the project
prior to tender ing. The project company will prefer an exclusive
and specific mandate from a host country interested in the project
and supportive of it. 18 Project company members should have
experience not only in constructing large projects but also in
investing in and operating such projects. 19
Where the grantor of a concession for a project is a political
entity, it takes 1-18 on a further political risk in that the
project is placed in the hands of an entity not necessarily
affected by the political repercussions of its actions. The public
may not understand that the grantor is removed from the day-to-day
operations of the public service subject of a BOT project (e.g., an
under- ground railway) and thus any mismanagement or politically
unpopular deci- sion may be imputed to the grantor. Although the
contract may provide for grantor influence in the selection of
personnel in order to ensure proper oper- ation, the effectiveness
of such influence may be practically minimal. The grantor will,
thus, want to consider the independent status of the project
development company and the potential effect the company's actions
may have on the grantor's political position and the public
welfare.
Banks and other financing institutions will make it a condition of
their financing of a project that there is implementation of a
contractual scheme that provides them with some certainty as to
their financial risk. By using a lump-sum price and placing much of
the completion risk on the contractor, the turnkey contract can
provide the lenders with a significant amount of cer tainty and
thereby confidence in the project. (A more detailed discussion of
the issues can be found in Chapter 4 BOT.) Some authors assert that
the "contractor and employer are very likely to rely on the Silver
Book as a good compromise approach». 20
Pricing Methods
Some of the most common methods of pricing a construction project
are: 1-19
(a) lump-sum; (b) cost-reimbursable; and (c) unit price.
T.hey can be used alone or in combination. The selection of a
pricing method directly affects the distribution of certain risks,
such as changes in the cost of labour and materials.
18 Gurun, . " Build-Own-Tran.sfer Projects: The Contractor's Role
in Risk Management", 19 InternatIOnal Ba~ ASSOCIation Conference in
Tokyo, japan, February 1993, at 11.
S.W. Stem, op. CIt. n. 17 above, 101. 20 C. Pedamon, "~ow is
Convergence Best Achieved in International Project Finance?"
(2001)
24 Fordham Int J L.}. 1272, online: LEXIS at 1300.
9
Lump-sum method
L-20 The lump-sum method gives a price for the whole of the
contract, irrespec tive of the contractor's as-built cost. The
difference between the price and the actual cost of the works to
the contractor will constitute the contractor's profit or loss. The
contractor assumes substantial risk, including the risk of most
changes of circumstances (for example, a change in the price of
mate rials or labour). Although most lump-sum contracts provide
for modifica tion of the price in certain limited circumstances,
such contracts usually provide that the contractor may not claim
additional payment for work indispensably necessary to completion,
even where omitted from the specifi cations of the contract. The
employer is therefore given a figure representing his global
exposure, although this figure may be subject to adjustment as
provided by the contract.
The contractor will usually be paid the lump-sum price in
instalments. The instalments will be based on a schedule of
payments or payable at specified stages of completion. In certain
cases the lump-sum price may only be payable by the employer to the
contractor upon completion, i.e. where com pletion is a condition
precedent to payment.21
1-21 The lump-sum is generally easier and less expensive to
administer than the other pricing methods, as the price is clearly
specified (although variations and other alterations to the
contract and its price are still possible). Rather than having to
calculate the pricing of completion based on the amount of
construction units required or the extent of materials, equipment
and ser vices used (e.g. a calculation of the cost of
construction), the parties need only refer to the lump-sum
price.
The employer will need to provide for compilation and transfer of
infor mation concerning the site in order to enable the contractor
to formulate a realistic lump-sum price. Construction contracts
often provide that the contractor will not be required to go
through the expense of verifying employer-supplied information.
However, the contractor will almost invar iably be required to
investigate, or be deemed to have investigated, the site and the
conditions present at the site. The time and cost associated with
lump-sum tendering required of both parties may exceed the cost of
tender ing in contracts priced in accordance with actual
cost.22
The employer may require the contractor to provide him with a
break down of the lump-sum price into specific amounts payable for
different activities or portions of the works. In a tender process,
this information will enable the employer to obtain a better
understanding of the basis of the con tractor's price. This
breakdown will facilitate adjustment or revision of the contract
price where provided for in the contract. It may also be used for
the pricing of variations.
2\ A. Burns ed., Construction Disputes: Liability and the Expert
Witness (Butterworths, London, 1989) p. 26 (hereinafter
Construction Disputes). ,
22 P.O. Marsh, Contracting for Engineering and Construction
Proiects (Institute of Purchasmg & Supply, 1988), p. 164.
10
PRICING METHODS
The lump-sum price regime does not allow for adjustment or revision
of the contract price, unless specifically provided for in the
contract. There may be adjustment for incorrect data provided by
the employer, unforeseeable adverse sub-surface conditions, or
changes in the works required by the employer. The employer may
also decide to assume the risk of inflation and exchange rate risk.
The parties should specify with clarity the situations in which
adjustment is available.
Cost-reimbursable or cost-plus
Under cost-reimbursable conditions the employer pays the contractor
for 1-22 costs incurred plus a predetermined margin of profit. The
margin or fee can be fixed, fluctuating or determined as a
percentage of actual costs. For example, the margin for building a
tunnel may be a flat fee on completion, a percentage of the actual
costs incurred in building the tunnel, or a fee that will fluctuate
in accordance with some external measure such as the rate of
inflation or the base rate of the central bank of the country in
which the tunnel is built. This form of payment may create no
incentive to work eco nomically or rapidly, since, for example,
the greater the cost, the greater the profit, irrespective of
progress. In order to compensate for this lack of incen- tive the
parties can include, as part of the pricing provisions of the
contract, an incentive mechanism.
One example of an incentive mechanism is target cost. This
mechanism may be implemented in a number of ways. One possibility
is that any cost above a maximum "upset" or "target" cost will not
receive any profit or "fee", and may incur a decrease in "fees"
already earned.23 To increase the incentive to finish within a
given time period, the contract could also increase or decrease the
fee in relation to the completion date of the project.24
The cost-plus system is generally only used as a last resort, where
it is 1-23 impossible to calculate construction costs, such as
tunnelling works. For example, the Eurotunnel project used a target
cost mechanism for the tun- nelling works. The construction
contract awarded the contractor 50 per cent of the savings should
the actual price be les:; than the target price. Where the actual
price exceeded the target price then the contractor was liable for
30 per cent of the difference. The contractor's liability was
limited to half of the fee, or 12.36 per cent of the contract price
for such works.25
Another method of reducing the employer's risk in respect of the
cost reimbursement price is to apply a reasonableness standard. The
contractor is then only compensated for costs reasonably expended.
However, it may
23 "Contracts", op. cit. n. 1 above at 345. Z4 P.O. Marsh,
Contracting for Engineering and Construction Projects (Institute of
Purchasing
& Supply, 1988), p. 167. IS Huse, Kirkland and Shumway, "The
Use of the Target Concept for Tunnelling Projects in
Light of the Eurotunnel Experience", Options for Tunnelling
Conference of the International Tunnelling Association, Amsterdam,
the Netherlands, April 19-22, 1993, at 6.
11
TYPES OF CONTRACT
be difficult to determine the reasonableness of a given cost.26
This difficulty arises in the pricing mechanism of any
cost-reimbursable contract, requir ing detailed provisions
regarding verification and administration of the con tractor's
costs, detailed schedules and care in eliminating the possibility
that the contractor could make a profit at the costs level before
the fee element has been calculatedP An employer becomes dependent
on the reliability and efficiency of the contractor, despite
protection placed in the body of the contract.28
The contract may also provide that the employer pay to the
contractor only the amount paid for materials and services actually
used by the contrac tor (to take into account any over-ordering by
the contractor and sub contractors). The definition of costs may
also take into consideration any discounts offered by suppliers.
The obligation of the contractor to keep extensive records will
provide some measure of protection for the employer in calculating
costs.
Unit price or bill of quantities
1-24 According to the unit pricing method, the price of the project
is calculated in accordance with the amount of work done. The price
is established per unit of quantity with reference to a bill of
quantities or a schedule included in the contract which specifies
the amount of materials and labour needed for a particular task.
This method places the risk of the number of units used on the
employer but transfers risk of change in the cost or rate of each
unit to the contractor.29 Thus, if the cost of a unit of excavation
in a tunnelling contract is provided at 100, the employer will pay
where more units are excavated than expected. However, in the
absence of unforeseeable adverse sub-surface conditions (assuming
the contract provides a changed conditions clause), the contractor
is responsible for added cost where the unit of exca vation costs
more than 100.
The unit pricing method is common in construction contracts.
Employers have traditionally used this method where the quantity of
construction inputs is not ascertained at the time of contracting.
Thus, for example, where the amount of concrete to be used for the
construction of a building is not yet ascertained, the employer can
price the contract in accordance with the cost of a unit of
concrete. The contractor will then be compensated for the actual
amount of concrete required, while the employer will be assured a
fixed price per unit of concrete.
This method continues to be used extensively today, even in
projects where the quantity of materials is certain. Certain
publications, such as the
26 ibid. at 3. 21 "Contracts", op. cit. n. 1 above at 345-346. 28
Construction Disputes, op. cit. n. 21 above, p. 26. 29 Huse,
Kirkland and Shumway, op. cit. n. 25 above, at 3.
12
PRICING METHODS
Standard Methods of Measurement in England, provide forms of
schedules as a pricing method.
As with the lump-sum pricing mechanism, the parties may provide for
a 1-25 system of adjusting the unit price. The pricing mechanism
may provide for changes beyond the parties' control, such as
unforeseeable sub-surface con ditions, or changes in law or
regulations that affect some aspect of the con- tract. The contract
may even provide for adjustment on the basis of changes in the cost
of materials or labour. The ability of the contractor to obtain an
adjustment to the contract price in respect of certain defined
circumstances shifts the risk in respect of such circumstances from
the contractor to the employer. The parties should, of course,
define carefully any such circum- stances and their potential
impact on the unit price.
The parties will need to agree on a precise method of calculating
the quan tities used. Although the costs of valuation and
measurement associated with a project carried out under a
unit-priced contract are not as high as those of a similar project
under a cost-reimbursable contract, they are still higher than
those necessary under a lump-sum contract.
While a good idea in theory, and often in practice, parties should
be wary of the potential for the bills of quantities system to be
abused. After the Second World War, widespread usage of contracts
of this type "rapidly pro duced a whole science of upward price
manipulation bearing no relation to the site realities which lasted
for decades due to the apathy of clients' legal advisors and ~he
collusion of architects, engineers, etc".30 Eventual disillu
sionment with the bill of quantities method is perhaps one of the
reasons for the growing interest in, and popularity of, the turnkey
(and therefore lump sum) contracting method.
Bonus schemes and currency of the price
In addition to the pricing mechanism, the parties may want to add a
bonus 1-26 scheme to create an incentive for early completion. Such
a bonus can be cal- culated in a manner similar to the calculation
of liquidated damages, provid- ing for a fixed amount or percentage
of the contract price for each day of early completion. The
employer may wish to defer payment of the bonus to the contractor
until after the works have been operational for a period of time,
such as after the defects liability period, to ensure proper
performance of the works. Further, it is not normally advisable to
use the bonus system in a cost-reimbursable contract without
including a mechanism designed to eliminate any incentive that the
contractor might have to construct using more costly methods in
order to achieve early completion.
The parties will also need to consider the currency in which the
price is 1-27 paid. If the price is to be paid in the currency of
the costs incurred by the contractor and such currency is different
from the currency of the employer's
30 "No-No" op. cit. n. 9 above at 7.
13
TYPES OF CONTRACT
country, then the employer carries the risk of a change in the
exchange rate between the currency of the employer's country and
the currency of the price. Where the currency of the price is the
currency of the employer's country then the contractor bears the
risk of a change in the exchange rates. If the currency of the
contract is a third currency, not that of the employer's country
and not that of the costs incurred, then both parties will bear a
portion of the risk of a change in exchange rates. In certain
countries, the parties may also have to consider exchange control
regulations, including restrictions on the currency of payment of a
contract and restrictions on indexation tied to a currency other
than the currency of the locale of the project.
Currency ledging may also be available to layoff part or all of the
cur rency risk onto one or more financial institutions.
Payment Methods
1-28 When considering the payment provisions of the contract, the
parties must agree upon the methods of payment. The contract may
provide for a certain portion of the price to be payable upon
commencement of the works, through advance payments, in order to
provide the contractor with sufficient cash flow to cover the
substantial expenditures which may be required at the early stages
of construction. For example, in a power plant project, advance
payments may be provided for the purchase of certain equipment and
machinery such as the generator and the turbines. This advance
payment would then be repaid through reduction of future payments.
The employer may also want a security to be provided for the amount
of the advance payment. An advance payment guarantee for the amount
can be provided by a third party much in the same way as a
performance security, with the employer giving his consent to the
guarantor chosen or a guarantor being indicated in the contract
itself. The cost of the guarantee will lessen the benefit of the
advance payment to the contractor, but may allow the employer to
provide a larger sum than he would otherwise have supplied without
the protection of the guarantee.
Where funds must be transferred to different locations the parties
must consider risks relating to exchange rate fluctuation during
transfer, and the tax regulations concerning such transfers. The
form of payment may also incorporate some guarantee of payment,
such as the use of a letter of credit.
There exist a number of methods of payment, three of which are
discussed below. The second and third methods are the most commonly
used.
Payment after completion
1-29 The first is rare in large construction contracts, involving
the payment of the contract price only after completion of the
works involved. This method is more common for smaller subcontracts
or simple task-oriented contracts but
14
PAYMENT METHODS
it is not unknown on larger projects. When used on such large
projects the payment after completion provides a form of contractor
financing of the project, requiring the contractor to obtain
outside financing himself or to auto-finance the construction.
Sometimes this method will be used to finance a portion of the
construction with payments extending well beyond comple tion of
the construction.
Milestone payments
Under milestone payments the parties set up a schedule of tasks for
the 1-30 contractor to perform. For each milestone achieved, the
contractor is paid a portion of the lump-sum price or an amount in
accordance with rate sched- ules, bills of quantities or cost-plus
pricing. Payment occurs only after com- pletion of the tasks
required. Milestone payments at specified stages of completion
provide an incentive for rapid progress. 31 Milestone payments can
occur either at the completion of each given milestone, or
periodically, resulting in payment for all milestones completed
within the period involved. Thus the greater the progress during a
payment period the greater the value of the payment received.
Contractors may be tempted to carry out the more expensive tasks at
the early stages of construction, resulting in less of an;
incentive to progress at later stages of completion. Where combined
with lump-sum pricing, mile stone payments can avoid such
"front-loading" by the contractor.32
This approach may be combined with the progress payment method for
certain portions of the works. For example, the parties may decide
that the contract will be paid in accordance with milestones except
for the price of the plant or certain materials for which the
contractor will be compensated once they are in the employer's
possession (such as upon delivery to the site).
Progress or scheduled payments
The contract can provide for payment for work completed during a
given 1-31 period of time, calculating the value of the work done
during the period, or simply setting a percentage of the contract
price to be paid at the end of each period. The former method of
payment is frequently used in connection with the unit-price method
of pricing. The latter method of payment is not fre quently used.
There is little incentive for efficient completion under this
latter type of periodic payment since the contractor receives
remuneration irre spective of the progress achieved by the work
completed.
In order to balance the need for progress and timely completion
with the use of progress payments, parties may institute different
pricing or incentive
)1 Construction Contracts op. cit. n. 2 above, p. 380. J2
"Contracts" op. cit. n. 1 above at 345-349.
15
TYPES OF CONTRACT
programmes. The use of target costs, as described under
cost-reimbursable pricing, will provide the contractor with an
incentive to decrease the real cost of the project, while the use
of unit pricing will define the value of work com pleted in order
to avoid the effects of increases in costs of materials and
labour.
16
Advantages and Disadvantages of Turnkey and EPC Contracts
In recent years the use of turnkey and EPC contracts for
construction pro- 2-01 jects, and in particular infrastructure
projects, ha~ become popular with employers and financing
institutions. However, · although the turnkey approach is in
fashion and it provides many benefits to these entities, it also
has certain disadvantages.
Advantages
In traditional design-bid-build projects, responsibility for design
and con- 2-02 struction is often spread between a number of
parties. Design and construc- tion tasks are often performed by
separate entities or pursuant to separate contracts.
Such projects are often split into different elements, or works
packages. These packages will interact with one another (their
"interface"). Interfaces exist between the design and all the
construction packages but also between the individual construction
packages themselves.
Generally, in design-bid-build projects the employer takes the
responsibil ity for co-ordinating these various project elements
and their respective inter facing. For example, in the
construction of a hydroelectric project the employer will have to
ensure that the design element and the civil and electri cal works
interface correctly as well as between the civil and electrical
works elements themselves- by seeing, for example, that the
foundations can sustain vibration from turbines. Each contractor or
participant will only have liability for the discrete project
package for which he is responsible. This may lead to a number of
problems. Contractors may make claims as a result of poor
co-ordination between packages. One contractor may delay the work
of others. Furthermore, it may be very difficult to allocate
respon sibility for defects between a designer and a
contractor.
By contrast, the turnkey or EPC contract makes the contractor
entirely 2-03 responsible for both the design and construction of
the works. The employer receives a completed project in accordance
with his performance specifica- tions. When he looks for
accountability as to the performance and quality of the works, he
need look no further than the contractor.
17
TURNKEY AND EPC CONTRACTS
This means that the employer does not need to worry about
co-ordinat ing contractors effectively (and avoids claims
resulting from lack of interface definition). If he wishes to make
a claim concerning a defect he can look to the contractor without
the need to address whether it is a design or work manship
problem.
In addition, single-point responsibility can also reduce the
opportunity for claims by the contractor. Under more traditional
contracting arrangements, these claims are often based on
directions given by the engineer. Since the engineer is no longer a
central co-ordinating figure in the turnkey contract and the
contractor has taken on the responsibility for the design and con
struction the turnkey contract may provide decreased opportunity
for claims.
The contractor must deliver works that are fully operational to the
spec ifications of the employer; any defect or fault is
necessarily his responsibility except where the contract provides
otherwise. Everything relating to the works can, thus, be
concentrated in a single point of responsibility-the
contractor.
2-04 This single point responsibility has two notable consequences:
first, the role of performance criteria; secondly, the standard of
performance expected from the contractor. The contractor must
design and build the works in a manner such that the performance of
the finished works satisfies the criteria set out in the contract
(otherwise known as performance criteria). The employer will define
these performance criteria in such a way as to ensure that the
works provide at least the level of performance required for
profit able production. The performance criteria may specify
output, input, waste, and any other performances the employer may
desire. For example, in the construction of a coal-fired power
plant the employer will want to ensure that the plant produces
sufficient power to satisfy his commercial needs, in particular
where he has entered separately into an agreement for a third party
to purchase a certain amount of the electricity produced. Thus,
these criteria set out levels of performance the employer expects;
it is then the responsibility of the contractor to produce works
that are in conformity with them.
2-05 Under a traditional design-bid-build contract the construction
contractor and the designer are held to different standards of
performance for the com pletion of the works.
Designers in many jurisdictions traditionally have not been
required to guarantee results, but rather method. They are held to
have a superior base of knowledge, sufficient in competency and
ability to complete the design with a reasonable degree of
technical skill. For example, courts in the United States have held
that the designer, in the preparation of designs and draw ings,
must exercise his skill and ability, judgment and taste reasonably
and without neglect.! This standard represents a professional duty
of care. The contractor, on the other hand, often may be required
to construct the works
I Stated in the U.S. case of Surf Realt)' Corp. v. Standing 78
S.E.2d 901 at 907 (1953) cited in Gravel), v. Providence
Partnerships 549 F2d 958 (4th Cir. 1977).
18
ADVANTAGES AND DISADVANTAGES OF TURNKEY AND EPC CONTRACTS
with due care and diligence. The standards are often defined by the
relevant legal system and in accordance with industry practice. The
standard of per formance can 'vary from contract to contract, and
construction contractors are required to complete the works in
accordance with the contract. Therefore, the contractor will not
generally be held responsible for design deficiencies.
Under a turnkey or EPe contract both the designer and contractor
respon- 2-06 sibilities are placed on the contractor along with a
:stricter standard of per formance. The standard of performance
applied will be provided by the contract, or in the absence of a
specific provision, by the applicable law. Under the Silver Book
the standard is "fitness for purpose".2 According to English case
law, a turnkey contractor is under strict liability to deliver a
structure "fit for the purpose" for which it was made. 3
The "fitness for purpose" standard goes beyond a "professional"
duty of care, placing on the contractor liability for any failure
of the design to perform to the standards required. This provides
the employer with works constructed and operational in accordance
with the intended purpose or use of the works as provided in the
contract. For example, in the construction of a thermal power plant
the employer can set out in the employer's require ments the size
and nature of the plant desired, as well as its operational output
and the consumption necessary to reach such output. Therefore, if
the employer's original conception of the works lacked some element
neces sary for it to be fit for the purpose intended, the
contractor would be respon sible for ensuring that the finished
works contained the missing element.4
Lump-sum price. The lump-sum pricing method is often used for
turnkey 2-07 and EPe contracts and enables the use of fixed
payments by stages of com- pletion. Lump-sum pricing and fixed
insta lment payments provide the employer with greater certainty in
overall cost as well as in the timing of pay- ments.s This system
reduces front-loading by the contractor and encourages rapid
completion. It also facilitates financing, as lenders will have
greater certainty of financial exposure and the timing of
draw-downs.
However, even where the contract is priced on a lump-sum basis, the
contractor will normally have the right, under certain limited
circumstances, to claim an increase in the contract price (as
discussed above).
The role and influence of project financing. Lending institutions,
such as the 2-08 European Bank for Reconstruction and Development,
often insist on lump- sum turnkey contracts for construction
projects which they finance. Project lenders believe that lump-sum
pricing and single-point completion respon- sibility reduce the
completion risk to project lenders and provide greater
2 Silver Book sub-clause 4.1. J IBA v. EMI and BICC (1980), 14
B.L.R. 1. 4 For a more detailed discussion of the "fitness for
purpose" obligation, see Chap. 8. 5 I.N.D. Wallace, Construction
Contracts: Principles and Policies in Tort and Contract
(Sweet
& Maxwell, London, 1986), p. 408 (hereinafter Constmction
Contracts).
19
TURNKEY AND EPC CONTRACTS
certainty of overall financial exposure. This method of contracting
is becom ing increasingly prevalent for international
infrastructure projects. This is particularly true in BOT and
similar projects, where limited recourse financ ing makes lenders
wary of taking further risks when it comes to the pricing of the
construction project.6
2-09 Speed of procurement. The traditional design-bid-build method
of contract ing contemplates separate and distinct design and
construction phases. The turnkey or EPC method combines these two
phases and allows construction to proceed along a "fast-track"; in
certain cases the contractor can even com mence construction prior
to the completion of the design phase. Consequently, the turnkey
method of contracting may result in earlier project
completion.
2-10 Efficiency. Since the contractor both builds and designs the
works, the contractor no longer needs to take the time to
understand the employer's designs.7 The design should also take
into consideration the contractor's methods of construction,
providing more efficient and timely completion.8
The control given to the contractor should facilitate
implementation of new and better approaches to design, developed
through his experience and expertise. The contractor will have an
incentive to implement such time saving changes under the turnkey
structure, which may not be true under more traditional contracting
methods.
Since the designer and the constructor work as a team, they are
more likely to identify critical flaws in the design at an earlier
stage, ensuring avoidance or mitigation of the flaw when such
action is more effective. This team approach will help avoid many
design and construction risks which a separate designer and
constructor would not be able to identify.9 The joining of the
design and construction task under one contractor may also reduce
the number of disputes which arise between the contractor and
employer.
Disadvantages
2-11 Loss of control. The overall design and construction
supervision role of the engineer is absent from the turnkey
contract. Under the Silver Book, the engineer's supervisory role
has been replaced, but in part only, by that of the employer's
representative. This new role is relatively flexible,
allowing
6 D. Blumental, "Sources of Funds and Risk Management for
International Energy Projects" (1998) 16 Berk. J. /nt'/ Law 267,
online: LEXIS at 271, 288-289.
7 However, contractors operating under the terms of the Silver Book
would be wise to take time to understand employer designs, as the
contractor is strictly liable for any designs pro VIded by the
employer under the Silver Book. See discussion in Chap. 9
(design)
• Construction Contracts, op. cit. n. 5 above, p. 407. 9 Brown,
"Opportunities and Risks of Design Build Projects", The
Construction
Superconference, San Francisco, U.S., December 7-8, 1995, p.
5.
20
ADVANTAGES AND DISADVANTAGES OF TURNKEY AND EPC CONTRACTS
input in and control of the design and construction of the works.
However, the turnkey model generally contemplates less day-to-day
intervention than is present under a traditional design-bid-build
contract. Under the turnkey contract, it may be more difficult for
the employer to exercise his variation power properly. He may be
distanced from the design, reducing his understanding of the
processes used and his ability to verify the need for a variation
and whether the variation proposed will affect the perfor mance of
the finished works. Where the engineer designs and co-ordinates the
construction, the employer knows at each stage how the works may
need to be altered. In the absence of the engineer, the employer's
under standing of the process of the design and construction of
the works may be diminished.
The contractor will want to execute the works within the parameters
of the employer's requirements for the least cost possible. The
contractor in a turnkey or EPC contract may be tempted to
under-design the project in order to cut his costs and save on
time. Therefore, under the turnkey or EPC model the employer will
still need to provide supervision of the construc tion, to ensure
that the contractor's performance satisfies the contract
requirements.
Indeed, where the nature of the project is such that design changes
are likely to be necessary (and yet where the contractor will not
be entitled to an increase in the contract price) the employer
should be aware that the ulti mate maintenance costs and long-term
performance of the project's structure may be negatively
affected.1o Some employers try to offset this risk by requir ing
the successful bidder to operate and maintain the facility for a
period of time after construction, thereby providing the contractor
with incentive to produce an efficient, low-maintenance product.
11
Cost of tender.12 When tendering for a turnkey contract, the
contractor 2-12 often must have a design in the advanced stages of
completion, having made sufficient tests and studies to know the
costs and the level of risk involved in the project. Under such
circumstances, the cost of tendering a turnkey contract can be
quite high. In order to counteract the expense of bidding, the
World Bank has suggested limiting the number of bids to a maximum
of six, based first on technical merit and secondly on price com
petition. 13 The employer can also offer to make a payment to those
contractors giving serious bids, but who are not chosen. This will
decrease the cost of bidding to the contractor and increase the
quality of the bidding pool. However, in practice, employers do not
often provide for such payment.
10 M.L. McAlpine, "Construction Law: Will Design-Build Contracting
Really Solve All of the Problems?" (1997) 76 M/ Bar Jnl. 522,
online: LEXIS at 557; I.N.D. Wallace, "Design-and Build: a No-No
for Owners" (1999) 4 Canst. & Eng. L. 7 at 8.
" M.L. McAlpine, op. cit. n. 10 above, online: LEXIS at 555. 12 For
further discussion of issues relating to the tendering process, see
Chap. 5. 13 G. Westring, "Turnkey Heavy Plant Contracts from the
Owner's Point of View" (1990) 7
I.C.L.R. 234 at 235.
TURNKEY AND EPC CONTRACTS
The cost to the employer of verifying the design-if such
verification is possible considering the time frame of the tender
process-may prove to be quite high. As one construction expert has
noted: " ... if a really detailed check of the design and
specification is attempted, using consultants engaged for that
purpose by the owner, the basic saving in costs by way of reduced
fees of professionals is likely to prove illusory" .14 The
temptation to under design, combined with the difficulty of
verifying the quality and efficiency of the design tendered, could
result in increased contract cost. Further, carry ing out an
effective comparison between the various tenders (due to their
individual design characteristics) will likely prove costly in both
time and money to the employer. IS
In order to avoid the temptation to accept bids based on price
rather than quality of design, the World Bank suggests a two-stage
bidding process. During the first stage contractors submit unpriced
technical proposals. It is only during the second stage that prices
are considered. A legal counsel for the World Bank suggests five
main steps: pre-feasibility, feasibility, bidding, evaluation of
bids and award of contract, and negotiation. 16 Such staged bidding
will allow the employer to look first to the quality of the design,
then only secondly at the bid price.
Cost of risks,l7 Under the turnkey or EPC contract the employer
benefits from an increased amount of the risk of the project being
placed on the contractor. However, depending upon market forces, a
contractor will attempt to increase the contract price in
accordance with the increase in risk. IS Where there is little
competition, the employer may have to assume the cost of the
increased risk placed on the contractor. Thus the employer may end
up paying a higher overall price for the project due to the degree
of risk that is placed on the contractor and the need for the
contractor to price such risk. Indeed, this is the idea behind the
risk transfer and the justifica tion for such transfer.
Whether the advantages of the turnkey contracting method will
outweigh the disadvantages will depend primarily on the nature of
the project in ques tion and the identity of the parties involved.
Naturally, the answer will also be influenced by the balance of
power in the contracting relationship. The current
employer-dominated market often results in greater risk being allo
cated to the contractor, without a commensurate increase in the
contract price to the contractor.
I~ Construction Contracts, op. cit. n. 5 above, p. 409. IS I.N.D.
Wallace, "Design-and-Build: a No-No for Owners" (1999) 4 Const.
& Eng. L. 7 at
8. 16 G. Westring, "Turnkey Heavy Plant Contracts from the Owner's
Point of View", op. cit.
n. 13 above at 236-238. 11 For further discussion of risk
allocation issues, see Chap. 21. 18 P.O. Marsh, Contracting for
Engineering and Construction Projects (Institute of
Purchasing
& Supply, 1988) at 252.
ISSUES IN CONNECTION WITH LUMP-SUM TURNKEY OR EPC CONTRACTS
Issues in Connection with Lump-Sum Turnkey or EPC Contracts
There are a number of key issues relating to the drafting and
negotiation of lump-sum turnkey or EPe contracts which drafters
will need to consider carefully, to ensure complete and effective
allocation of risk. The key issues include the following:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
The definition of the scope of the works l9: the parties will need
to specify carefully the scope of the works and the employer's
require ments. in order to define the contractor's liability for
design, con struction and performance.20
Use of an engineer or employer's representative: the parties will
need to decide how to make use of an engineer and his role (or the
role of the employer's representative) in the execution of the
project. Increases in the contract price: the lump-sum price is
fixed, except to the extent that the contract provides for price
increases for certain events or modifications. Due to the
contractor control over the works, the employer may want to limit
the. ability of the contractor to obtain such increases. Extensions
of time for completion: the time for completion of the works,
otherwise fixed, can be extended under certain circum stances. The
employer may want to limit the scope of the contrac tor's right to
obtain such extensions. Resp~nsibilit.y for employer-supplied
designs: the risk of employer supplied desIgns should be
specifically allocated as between the parties.21
Employer's ris.ks: the contract will need to list the employer's
risks, so as to proVIde a comprehensive allocation of such risk for
the project. Performance guarantees: the parties will need to
discuss the form and amount of the security provided by the
contractor to the employer for performance of the contract. This
security can take the form of ~ bank guarantee or other security
and/or retention money. Completion: the contract should provide a
definition of the extent and nature of completion required before
the employer takes over the works. It should identify whether any
performance tests are to be passed before or after such completion.
Defects liability: the parties will need to decide the period of
time
19 The definition of the scope of the works is found in the
employer's requirements in the Silver Book.
20 Under the Silver Book, the contractor is responsible for almost
the totality of the risk asso cIated WIth these phases of the
process.
21 Under the Silver Bo~k, the contractor is deemed to have
scrutinised the employer's require ments and therefore IS
generally responsIble for the accuracy of any designs provided in
such requIrements (SIlver Book sub-clause 5.1).
23
2-14
TURNKEY AND EPC CONTRACTS
during which the contractor will be responsible for remedying any
defect that may arise in the works.
(j) Training of staff: to the extent training of staff is required,
the parties will want to provide for a period of time during the
contract period and before the employer takes possession of the
works for the contractor to train the employer's staff.
(k) Use of a consortium or a joint venture by the contractor: a
consor tium or joint venture of contractors may prove beneficial
to the employer as they can provide more expertise as well as a
broader base of liability for the completion of the works. However,
the employer will need to ensure that the contractors agree to
joint and several liability and elect a representative of the joint
venture with sufficient decision-making power to facilitate
interaction with the employer.
(I) Regulation of labour to be used on site: including origin of
staff, facilities to be supplied and the skill and experience to be
required of such employees.
(m) The organisation of the site: including the contractor's
responsibil ities for safety and protection, as well as sanitation
and services such as water and electricity.
(n) Effect of local law and regulations including allocation of the
responsibility for obtaining permits and licences.
(0) Patent and know-how rights and licences of the technology
neces sary for the completion of the works.
The drafter of a turnkey contract will need to consider each of
these points, among others. Allocation of risk for these issues
should follow a rea sonable assessment of the ability of the
parties to bear the risk in question.
Standard Form Design-Build, Turnkey and EPC Contracts
2-15 Sectors that require a high degree of expertise and
technicality, such as the construction sector, often engender the
development of standard form con tracts.22 Such forms can be an
important factor in reducing costs for the par ticipants, as they
represent a predictable and stable basis upon which parties can
begin negotiating.23 Indeed, some attribute the sophistication and
exis tence of standard form contracts for design-build projects to
be a measure of the popularity of this project delivery system.24
When using standard form contracts, however, parties should always
keep in mind the specific ities of the project (which may make a
particular contract less suitable) as well as the particularities
of the governing law (which may denature, if not override,
sometimes key provisions of the standard form contract).
22 C. Pedamon, "How is Convergence Best Achieved in International
Project Finance?" (2001) 24 Fordham Int'/ L.}. 1272, online: LEXIS
at 1294.
23 ibid. at 1298. 2~ M.L. McAlpine, op. cit. n. 10 above, online:
LEXIS at 553.
24
STANDARD FORM DESIGN- BUILD AND TURNKEY CONTRACTS
Over the past few years a number of standard form design, build,
turnkey and EPC contracts have been published. These include:
(a) the ENAA Model Form International Contract (1992); (b) the ICE
Design and Construct Conditions of Contract 2nd Ed.
(2001); , (c) the DBIA (1998); (d) the AlA Contract Form A191
(1996); (e) the AGC 415 (1994); (f) the EIC Contract (1994); (g)
the FIDIC Orange Book (1995); (h) the FIDIC Silver Book (1999); (i)
the FIDIC Yellow Book (1999); (j) the FIDIC Red Book
(1999).25
The above list is by no means exhaustive. A brief introduction to
each of the listed contracts is set forth below.
The ~~AA Contract Model Form, The Engineering Advancement 2-16
Assocl~tlon of Japan (ENAA) is a non-profit organisation that was
estab- lished 10 August 1978 and supported by the Ministry of
Economy, Trade and I~dustry.of J~~an and by various other national
and local government agen- Cies, UniverSIties and research
organisations. The Association has the support of numerous
specialists from member companies as well as various experts in
their respective fields.26 ' . This book. refers .to the second
edition of the ENAA model form published 10 1992, which reVised the
first edition issued in October 1986. Volume 1 of the EN~A Model
~orm for Process Plant Construction is reproduced in the appendl~es
of thiS book. The remaining four volumes, Samples of Appendices
(Volume 2), Guide Notes (Volume 3), Work Procedures (Volume 4) and
Alternative Form ~ithout Process Licence (Volume 5) are not repro
duced. T~e form contract IS meant for use in connection with the
design and construction .of process plants using the turnkey
approach.27 In 1996 the ENAA published a standard form relating to
Power Plant Turnkey Cont~a~ts. That edition consisted of three
volumes: Agreement and General Condlt1ons (Volume 1), Samples of
Appendices (Volume 2) and Guide Notes (Volume 3). It has not been
reviewed for the purposes of this book.28
The ICE Design and Construct Conditions of Contract. This model
contract 2-17 :-vas drafted by the Conditions of Contract Standing
Joint Committee which IS the permanent joint committee of the
Institute of Civil Engineers (ICE), the
25 l':I0te that, although not a turnkey contract, for comparison
purposes this book will also con. SIder the terms of the Red
Book.
~; jay~es, ".Turnkey Contracts: japan's Model Forms" (1993) 10
I.C.L.R. 251 at 253. Engmeermg Advancem~nt Association of japan,
Model Form International Contract for
28 Process Plant ConstructIOn, Volume 3 Guide Notes (1992), p. 1.
T~es~ fo~ms m~y ~ obtained by contacting the ENAA at GECIENAA, CYD
Bldg. 1-4-6, NIshI Shmbashl,. Mmato-ku, Tokyo 105-0003, japan;
telephone +81 35024441; fax +81 3502 5500; emaIl
[email protected].
25
I
TURNKEY AND EPC CONTRACTS
Association of Consulting Engineers and the Federation of Civil
Engineering Contractors. This drafting body has a long history in
and experience of tra ditional forms of contract, including, most
recently, the ICE Minor Works 3rd edition (2001) and the ICE
Conditions of Contract, 7th edition (2001).
The ICE Design and Construct Contract 2nd edition, referred to here
as the ICE Contract, is based on the traditional form contracts of
the ICE and adapted for use in connection with the design and
construction of civil engineering works. The second edition of the
ICE contract reflects certain changes made in light of "leg
islative change and [ ... 1 evolution of working practice".29
2-18 The DBIA Agreement Between Owner and Design-Builder-Lump Sum.
The Design-Build Institute of America (DBIA) was founded in 1993 in
order to promote the design-build project delivery process
throughout industry and government in the United States.30
In 1998 the DBIA published Document No. 525, Standard Form
Agreement Between Owner and Design-Builder-Lump Sum. This form is
examined in this book, along with Document No. 535, a Standard Form
of General Conditions of Contract Between Owner and Design-Builder,
which complements this document.
2-19 The AlA Form A191. The American Institute of Architects (AlA)
is a national association of architects whose form contracts for
design-build pro jects are a standard in the construction industry
of the United States.3! AlA contracts are particularly well suited
for architectural projects.32 The AlA A191 Standard Form of
Agreement Between Owner and Design/Builder is for use where the
employer contracts directly with one entity for both design and
construction services. 33
The AlA A191 is a two-part agreement, developing the project and
the design through two separate agreements, one for preliminary
design and budgeting and one for final design and construction.34
This structure and the guiding concepts of this form are markedly
different from the approaches of the other standard forms examined
in this book.
2-20 The AGC Document 415 Standard Form of Design-Build Agreement
Lump Sum. The Associated General Contractors of America was formed
in 1918 with the intention, amongst others, to adopt standard form
construc tion contracts "which would equitably divide
responsibilities and risks and assure fair competition for works".
35 In response to a renewed interest in the
29 Online: The ICE
http://www.ice.org.uklnavigationlindex_news.asp?page=/newsI
pressarchive.asp
30 Online: The DBIA http://www.dbia.org/aulindex.html(date
accessed: August 16, 2001); online: The DBIA
hrrp:/lwww.dbia.org/aulmission.html(date accessed: August
16,2001).
31 R.J. Smith, "Risk Identification and Allocation: Saving Money by
Improving Conrracts and Contracting Practices" (1995) 12 I.C.L.R.
40 at 58.
32 M.L. McAlpine, op. cit. n. 10 above, online: LEXIS at 558. 33
American Institute of Architects, Form A 191 Instruction Sheer at
1. 34 J.E Butler, "Protecting Owner with Conrract Clauses" in R.E
Cushman & K.S. Taub (eds),
Design-Build Contracting Handbook (Wiley Law Publications, New
York, 1992),253 at 255. 35 T.J. Stipanowich, "Reconstructing
Construction Law: Reality and Reform in a Transactional
26
STANDARD FORM DESIGN-BUILD AND TURNKEY CONTRACTS
design-build method of contracting, the AGC first published a set
of stan dardised design-build contracts in the early
1990s.36
In 1999 the AGC published the standard form contract AGC 415 to be
used as a follow-on document to the 1999 edition of AGC 400. Unlike
its predecessor, AGC 415 is not intended as a stand-alone
agreement, but rather assumes that schematic design documents plus
a preliminary esti mate and schedule (i.e. the work product of AGC
400) is part of the owner's program provided in AGC 415. The
revision of AGC 415 was developed with the advice and cooperation
of the AGC Private Industry Advisory Council which council is
comprised of a number of Fortune 500 owners' design and
construction managers who meet with AGC contrac tors to discuss
issues of mutual concern.37
The European International Contractors Turnkey Contract. The
European 2-21 International Contractors (EIC) is associated with
the FIEC (Federation de l'Industrie Europeenne de la Construction)
and the CICA (Confederation of International Contractors'
Associations). Its membership includes 15 con struction industry
federations in 15 different European countries.38
The FII~IC Design-Build and Turnkey (Orange Book). Created in 1913,
the 2-22 Federation Internationale des Ingenieurs-Conseils (FIDIC)
represents national associations of consulting engineers. It
maintains its seat and secre- tariat in Lausanne, Switzerland. The
first FIDIC conditions of contract were published in 1957 with the
aid of the Federation lnternationale du Batiment et des Travaux
Publics (FIBTP).
The (1995) Orange Book represents the fifth FIDIC form of contract.
It is intended for use with international design and construct
contracts.
The FIDIC Plant and Design-Build (Yellow Book). The (1999) Yellow
Book 2-23 (first edition) is based both on its predecessor (the
(old) Yellow Book) and on the Orange Book.39 The Yellow Book is
intended "for plant and for build- ing and engineering works
designed by (or on behalf of) the Contractor where, nonetheless,
the Employer may have executed some design".4o
The FIDIC Construction (Red Book). The (1999) Red Book (first
edition) is 2-24 based on its predecessor (the (old) Red Book) and
is intended to be "suitable for building and civil or other
engineering works designed by the Employer or by his
representative, the Engineer" .4!
System" (1998) Wis. L. Rev. 463, online: LEXIS at 485 n. 74 citing
in turn Booth Mooney Builders (or Progress 6 (1965). ' ,
~; M.L. McAlpine, op. cit. n. 10 above, online: LEXIS at 553. AGC
Document 415 Instruction sheet.
38 Dr J.J. Goudsmit, . "The EIC (European International
Contractors) Turnkey Contract 39 (Co?dltlons for DeSIgn and
Construct Projects)" (1995) 12 I.C.L.R. 23.
Online: FIDIC http://www.fidlc.org/resources/contracts/courses.asp
(date accessed, April 4 2001. . ,
41 ibid. at 2. ' .
TURNKEY AND EPC CONTRACTS
2-25 Due to significant changes between the two versions of the
Yellow and Red Book contracts, FIDIC issued the new contracts as
first editions.
The FIDIC EPC and Turnkey Projects (Silver Book), The Silver Book
(1999 first edition) was issued for EPC Turnkey Projects and is
suitable for BOT projects as well as process plant projects (such
as E&M, or electrical and mechanical, projects).42 The Silver
Book provisions arguably reflect industry practice at the expense
of FIDIC's traditional even-handed approach.43
Under the Silver Book, the contractor takes a higher degree of risk
and, therefore, the construction time and cost are more
certain.44
42 ibid. at 5. 43 ibid. at 4; see generally C. Wade, "The Silver
Book: The Reality" (2001) 18 (3) I.C.L.R. 497. 44 Online: FIDIC
www.fidic.orglresources/contracts/courses.asp (date accessed: April
4, 2001).
28
Introduction
Over the past 40 years, the Federation Internationale des
Ingenieurs- 3-01 Conseils (FIDIC) has developed an unparalleled
reputation as the leading body for the development of model
standard form contracts for use in the international construction
industry.
In September 1998, FIDIC published four new or revised standard
form contracts comprising new editions of two existing forms-the
Red Book2 and the Yellow Book3-and two completely new forms-the
Silver Book4 and the Green Book.s Definitive editions of these
contracts were published in 1999.
Previously, FIDIC had in place two contracts that were based on the
nature 3-02 of the works: broadly speaking, the Red Book (fourth
edition)6 dealt with civil engineering works and the Yellow Book
(third editionj7 with electrical and mechanical works (in both
instances, the employer and/or the engineer either supplied the
design or played a central role in producing it). FIDIC pre- pared
the Orange Book (first edition)8 to provide a contract where the
contractor supplied the design and took single-point completion
responsibil- ity. The Orange Book, unlike the old Red and Yellow
Books, contemplates the use of an employer's representative and
does not use the term "Engineer".
The new Red and Yellow Books have shifted this perspective to
contracts based on the relationship between the parties,
particularly with reference to which party takes responsibility for
the design.9 The revised Red Book is now primarily focused on those
situations where the employer will supply
1 A previous version of this chapter (in anticipation of the
publication of this edition) first appeared in (1999) I.C.L.R. 27
and was co-authored by Joseph A. Huse and Jonathan Kay Hoyle.
2 Conditions of Contract for Construction (for Building and
Engineering Works Designed by the Employer) (1998).
J Conditions of Contract for Plant and Design-Build (for Electrical
and Mechanical Plant and for Building and Engineering Works
Designed by the Contractor) (1998).
• Conditions of Contract for EPC Turnkey Projects (1998). S The New
Short Form of Contract (1998). 6 Conditions of Contract For Works
of Civil Engineering Construction (1992). 7 Conditions of Contract
for Electrical and Mechanical Works (1998). S Conditions of
Contract for Design-Build and Turnkey (1995). • See also the
comments of Christopher Wade in his paper "History and Scope of The
Three
Major New Books" in FIDIC's New Standard Forms of Contract, IBC
U.K. Conferences Limited.
29
FIDIC DESIGN-BUILD, TURNKEY AND EPC CONTRACTS
the design (and an engineer will be used) and the new Yellow Book
on those situations where the contractor supplies the design (and
an engineer will be used). By contrast, the Silver Book is intended
to deal with something entirely new in FIOIC's scheme: an EPCIO
turnkey contract where the contractor takes responsibility for
design and the contract is on a strictly two-party basis (that is
to say, there is no intermediary such as the engineer).
3-03 The new FIOIC contracts are harmonised around the same basic
format: that of the Orange Book. Therefore, the new Red, Yellow and
Silver Books are now all structured in the same way: the 20 clauses
of the Orange Book taking account of the particulars of each
contract. This harmonisation has extended to the language of the
contracts. Much of the basic Orange Book language has been retained
in the three contracts.
The author welcomes, for the most part, the specific drafting
changes to, for example, the new Yellow Book (as comp