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Japan – EPCM Contracts: A More Sophisticated Procurement Methodology?

31 July, 2012

 

Legal News & Analysis – Asia Pacific – Japan – Construction & Real Estate

 

In construction projects with an international dimension, the debate about which procurement model is most appropriate for your Client and the project as a whole is usually very short. The Client has heard that a "turnkey" solution will meet his every need: a fixed completion date, performance guarantees, and certainty on price. He normally concludes that a suitably amended FIDIC Silver Book form of Engineering, 
Procurement and Construction ("EPC") contract will fit the bill, with the contractor undertaking responsibility for integrating all the elements of design, construction and procurement and assuming the solvency risk down the supply chain. He goes out to tender on this basis, careful to include his form of contract in the tender pack, and sits back whilst bidders compete to offer the best terms and fall over themselves to agree to the proposed terms of contract.
 
In the current global economic uncertainty, this model has continued to flourish where contractors are keen for work and are therefore prepared to accept a risk profile which benefits the Client and is bankable to financiers. However, where the pool of contractors actually capable of undertaking the sort of mega-projects associated with the petrochemical, oil and gas and mining sector is small and becoming more so following consolidation amongst project participants, the negotiating position of contractors is becoming stronger. Clients therefore need to be much more aware of other procurement models which will perhaps suit their needs better. 
 
What is EPCM?
 
One such example is what is known as EPCM contracting, where the "M" stands for Management. Only under this form of procurement, the EPCM contractor does not actually undertake any construction at all. Instead, he is required to manage the design and construction process on behalf of the Client in a professional services capacity. Those with knowledge of projects in the UK will be familiar with equivalent procurement methodologies developed relatively recently known as 'construction 
management' (and to a lesser extent 'management contracting'), which share the same philosophy as EPCM contracting. Under this form of procurement, the construction manager, or EPCM contractor, acts as agent for the Client in assisting the Client to enter into and manage the individual works packages and specialist trade/sub-contracts relating to the project. Separately, other design contracts with professional consultants are also entered into directly with the Client.
 
Advantages and disadvantages
 
The key advantages of using a structure like this are as follows: 
 
(i) design and construction can in theory progress more quickly and in parallel with each other as works contractors are instructed as and when required by the Client. In addition, the works contractors are less likely to be able to get away with minimum compliant standards of design as the EPCM contractor can review and monitor such designs to ensure that effective solutions are developed; 
 
(ii) the EPCM contractor may charge a fixed fee for his role, rather than a percentage of the total construction price, so costs can be contained and built-in cost contingencies prevalent in EPC contracting should not be needed; and 
 
(iii) the project can proceed more flexibly, which is particularly useful oncomplex projects where programming of the works is challenging and specialist works contractors are the norm. This in turn should minimize the need for variations and the time and cost consequences of these.

 

 

However, some disadvantages with EPCM contracting include: 
 
(i) there is potentially an uncertain construction period if the EPCM contractor is not able to manage the works contractors properly; 
(ii) the construction price is unlikely to be a fixed lump-sum, and therefore a strong, experienced EPCM contractor is required to manage cost issues across a number of individual packages of works; and 
(iii) there is no single point of responsibility that is otherwise inherent in the EPC model as responsibility for both design and construction will be diluted between the EPCM contractor, professional consultants and works contractors. On the other hand, insolvency and performance failure risks are spread.
 
The primary concern of the Client in EPCM contracting is likely to be the extent of the EPCM contractor's responsibility. This will ordinarily only amount to breach or negligence in the performance of its duties to prepare the cost estimate properly, manage the procurement process and co-ordinate the design and construction elements of the project as a whole. The Client will almost always find it very difficult to attach any liability to the EPCM contractor if the project is late or over budget, since complex construction projects can simply take longer than expected or cost more, however negligent the EPCM contractor may have been. Contrast this with the notionally straightforward guarantee of recovery (either in monetary terms or by requiring re-performance of the works) against an EPC contractor, in the event that a defect arises.
 
Operating EPC and EPCM in tandem
 
Before the already short procurement debate winds up and the Client reverts to proceeding with EPC contracting, perhaps further consideration could be given to engaging an EPCM contractor alongside or overarching the EPC contractor. This might prove beneficial to the Client on complex projects to assist its already stretched in-house project management function. From a legal perspective, the Client might also be able to have the best of both worlds. He can now secure a single point of responsibility against the EPC contractor (particularly if any early basic or front-end engineering design or works packages are first transferred by novation to sit under the EPC contractor), whilst also acquiring an extra layer of expertise on the project by means of an EPCM contractor, who should be able to review and confirm that the performance requirements and specifications are being met, as well as exercising a degree of cost control. 
 
Ultimately, therefore, the decision on what procurement model should be adopted needs to take account of the individual skills of the Client and its appetite for risk, together with balancing the time, cost and quality components of any project. EPCM contracting can offer considerable benefits to both sophisticated Clients and those that require additional expertise.  On the other hand, the lower risk associated with EPCM contracting compared to EPC contracting is generating considerable interest amongst contractors looking to explore new ways to reduce their exposure on projects.
 

 

For further information, please contact:

 

Peter Godwin, Partner, Herbert Smith

peter.godwin@herbertsmith.com  
 

 

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