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Dispute in EPC Contracts

Introduction to EPC contract:

Usually, the construction industries are known to use different types of contracting modules based on different factors such as the scope of work, costs and timelines etc. Older models such as packaged based contract, design-bid-build etc. where the owner/employer had the responsibility of both the project management and also the incidental risk involved in it.

In older models, either designing of the project or procurement or maintenance work were the responsibilities of the owner/employers. With the advancement of technology, there are huge demands for modern constructions such as power plant, high-quality bridges, airports etc.

This modern construction comes with more complexities and too risky for the owner/employer. In such situations, EPC module emerged as a best modern modality of contracting for the owners, since in EPC module, the ouns of the project management is shifted from the owner/employer to the contractor.

The use of EPC module is not restricted only in infrastructure & construction industry but are used in many other industries such as thermal power project, renewable energy, oil and gas, railways etc. In the EPC module, a contractor is responsible for the design, procurement and construction of the project.

The contractor has to handover the project to the owner in running stage which means that the owner/employer will come and directly turn the key and start using the project. Broadly, the EPC contract consists of three components i.e. detailed engineering design of the project (E), procurement of raw materials (P), and construction of the project (C) as per the specifications.

The whole process of the EPC module can be summarized in different stages. After successfully bidding the project, the contractor has to start with designing work and get it approved from the owner. Once the contractor receives the approval from the owner, he as to initiate the procurement process of all required raw materials either from his organization or through subcontractors.

Once the raw material is at the site, then he needs to start with the construction works as per the terms and conditions mentioned in the contract. Lastly, he has to commission the project, i.e. he has to show the owner the desired output as mentioned in the contract, once the commission stage is approved then the contractor is said to have executed the project. The person who carries out the contract under EPC module is called as EPC Contractor. In India, we have some major EPC contractor like L&T, Hindustan Construction Co.ltd, Punj Lloyd Ltd etc.

What are the key elements of an EPC contract?

  1. Contractor's Sole Responsible:
    Under an EPC contract, an EPC contractor will be solely responsible for the execution of all the contract works awarded to it by the client except for few activities which the client has to perform. In practice, an EPC contractor will subcontract a certain part of the contract works with the other contractors then to the EPC contractor will be responsible for the subcontracted work to the client. In the tender documents, the employer may also put certain qualifications which a subcontractor has to satisfy before the work is subcontracted to it. Through the tender documents, an EPC contractor shall be deemed to have obtained all necessary information as to risks, contingencies and other circumstances which may influence or affect the Works. By accepting the Letter Of Award (LOA), the Contractor acknowledges that it has foreseen all the difficulties and costs required for completing the tendered works.
     
  2. Milestones:
    Since an EPC contract is an end to end contract arrangements, the works of EPC contractors will be measured on the milestone basis. Total contract works will be distributed into the various sets of activity and such activity will be linked to the particular milestone and such milestone will be linked to the major contract work under an EPC contract. The EPC contractor will raise its bill once a particular milestone is completed and it is approved by the employer.
     
  3. Defined period:
    Time is the essence is an integral part of all EPC contracts. This principle is included in all EPC contracts because of long gestation period and complexity involved in such project it is utmost required that all the activities mentioned in the contracts are to be completed on or before mentioned timelines. Hence, the employer includes stringent deadlines for each activity in the contract and when the contract is signed by the contractor, it is deemed to be known to the EPC contractor that it has to adhere to such timelines unless it is contrary to the contract. It is also the contractor's responsibility to complete the activity and raise the bills to the client on the fixed time mentioned in the contract. In case an EPC contractor fails to adhere to such timelines then it may have to pay liquidated damages unless the contractor shows there was a bonafide reason for the delay.
     
  4. Higher degree of control:
    Practically, an EPC contractor will not have complete control over the project because there are few critical activities, which if the employer does not perform then the whole project can be jeopardized. For example, in the EPC contracts such as metro construction, the employer has to remove all the existing public utility from the site, it has to get clearance from all relevant regulatory bodies beforehand, it has to acquire the land from the owners.
     
  5. Limited risk for the employer:
    In an EPC contract, the client's risk can be minimized by taking few financial guarantees such as performance bank guarantee (PBG) which is at the rate of 10% of the contract price, bank guarantee for defect liability period (DLP) which varies from 5 to 10% of the total contract price and few other warranties from the contractor. This helps in reducing the financial risk of the client whereas it increases the financial burden of the EPC contractor.


What are the types of disputes in an EPC Contract?

Disputes arising out of an EPC contract are distinctly different from the disputes involved in other types of contracts. The EPC contracts disputes are highly technical and complex by nature and require urgent resolutions. Ascertaining, the liability of a party in a group of parties requires a thorough understanding of responsibility and obligation of each party, nature of omission or commission of an act by each party, any breach of obligations by any party etc.

There can be disputes related to bank guarantees, the wrongful invocation of bank guarantees, fraud in tenders etc. If such kind of dispute is raised then it means a non-defaulting party to the contract raises a claim against the defaulting party. If you go through the definition of a claim it says a request, demand, or assertion of rights by a seller against a buyer, or vice versa, for consideration, compensation, or payment under the terms of a legally binding contract, such as for a disputed change1.

Time is the essence in every construction work, yet the most frequent disputes arise out of delays in completion. A variation in the scope of work, materials, could result in additional costs, losses, delays or claims for extension of time. While there are different type of disputes arising out of an EPC contract, in this article we will focus on two major issues namely delays and variations and also its remedies available.

Below are the few types of claims raised in the EPC contracts:

Time Related
  1. Compensation for delay in work by the contractor.
  2. Delay in work due to details, approvals not timely provided.
  3. Suspension of work by client.
Cost Related
  1. Related to payments of Running Account (RA) bills/refunds.
  2. Escalation of rates.
  3. Deviation in quantities/specifications.
  4. Job carried out at risk and cost.
  5. Related to deduction of penalties/recoveries.
Quality-Related
  1. Differences in interpretation of Bill of Quantities (BOQ).
  2. Work not conforming to specifications.

Two Major disputes in the EPC contracts
  1. Delays:
    As we already know, that in every EPC contract, the contractor has to complete the project on time but if the time is not stipulated in the contract then it has to be done within a reasonable time. Completion of any construction activity involves two critical parts i.e. practical or substantial. Based on facts and interpretation by a legal expert, it can be ascertained whether the completion of any activity is practical or substantial.

    Most of the EPC contracts have either a penalty clause or liability clause which means that if there is a delay in any activity due to reason attributable to the contractor then the contractor shall be liable to pay the damage as defined in the contract. Any delay due to the default of the contractor, the employer can claim the damage through the liquidated damage clause, which is pre-determined by both the parties usually at the rate of 0.5 to 1% of each milestone.

    Even after paying liquidated damages, the errant contractor keeps on defaulting then the employer has no other choice but to terminate the contract. However, the contractor shall not be liable to pay for any damages to the employer, if the delay is due to the reason attributable to the employer or due to any reason beyond the control of the contractor. In such a case, the contractor has a right for extension of time, claim costs if any incurred such as machinery costs, labour costs etc.

    There are a plethora of cases decided by the Supreme court of India, where the employer was held responsible for the delay and the contractor was granted reasonable costs. In General Manager, Northern Railways v. Sarvesh Chopra, AIR 2002 SC 1272, the SC agreed that since the delay was due to the reason attributable to the employer, the contractor would be entitled to claim of damages which were provided at the time of acceptance of ‘extension of time' for the performance of the contract.

    Now, it is important to know that a delay can arise in an EPC contract due to any factor, for example, a delay could be due to breach of contract either due to the employer or due to the contractor or by its subcontractor, it can also arise due to any unforeseen circumstances such as act of god, war, strikes etc.

    There is one more type of delay known as a concurrent delay, which means that there can be two or more events of delay occurring concurrently and in parallel during the lifecycle of the project, were one event happened due to the default of the contractor and the other due to default of the employer. For example, if there is a delay of 60 days at the start of the project because the employer did not provide the site for the construction and during this 60 days, the contractor did not mobilize its resource.

    1. Delay and Indian Contract Act,1872:
      Under section 55 of Indian Contract Act,1872 (ICA), a party who has promised to do a certain thing at a specified time, fails to do it at or before that time, the contract becomes voidable at the option of the promisee, when time is of the essence in the contract.

      Time may be specified by fixing a date or time or fixing a period for the performance. But if the intention of the parties reflects otherwise, then the contract is not voidable, however, the promisee is entitled to the damages for loss caused to him by such failure.

      According to section 46, if no time is specified then it has to follow the principle of ‘reasonable time', which means that the contract should be completed within a reasonable time frame. And in the subsequent sections 47-50 it deals with proper place and time of performance when it is no explicitly mentioned in the contract.
       
  2. Variation dispute in the EPC contracts
    A variation clause is incorporated in an EPC contract so that, the employer can have the power to alter or modify any works which are already defined in the pre-existing construction contract. Variations may be required for diverse reasons such as latent site conditions, design defects, changes in the law, instructed changes to works and value engineering.

    It is usually invoked by the employer in almost every construction works depending upon the length, nature and complexity of the project. But to invoke the variation clause it is important that such a clause is expressly mentioned in the contract.

    To protect the interest of the contractors, such variation clause usually accompany with compensation provisions i.e. to adjust the contract price, the schedule of the payment etc. These provisions enable parties to smoothly administer works and avoid disputes.

    1. Variation valuation clause:
      If the price for any variation works is not pre-agreed between the parties, then the employer provides a clause having a certain methodology or procedure or formula which helps in determining the variation values. Such clauses are either included in General Condition of Contract (GCC) or Particular Condition of Contract (PCC).

      In some turnkey contracts, there is also a provision whereby, the contractor is required to immediately highlight the impact of requested variation on the project cost. The contractor is also required to inform the employer whether the timelines of the milestone will be affected severely due to the variation request. This mechanism helps in cost impact analysis of the variation, allow the employer to take an educated decision whether to withdraw, modify or cancel the variation order.
       
    2. Reason to dispute in variation clause
      Most of the time the scope of variation is bone of contention between the employer and the contractor. Whenever any variation request is made by the employer, it is very important to ascertain whether the request made by the employer for a variation is an actual variation request or whether such variation order is above the agreed variation percentage in the contract.

      Likewise, it is utmost important for the employer to identify whether the contractor's request for extension of time and/ or whether the contractor's claim of additional cost for carrying out additional work is at the applicable rates. In National Fertilizers vs Puran Chand Nangia on 17 October 2000, SC held that the employer's variation demand was way above the agreed +/- 25% variation work. Hence, allowed the contractor to claim costs for additional work above agreed percentage at market rate.

     
Remedies:
  1. Under Indian Contract Act, 1872:
    Section 73 and 74 deals with compensation for breach of contract. Section 73 deals with actual damages on the occurrence of a breach of contract and the injury arising out of such breach which is not pre-determined in the contract. In such cases, the court assesses the quantum of damage and provides reasonable costs to the aggrieved party to the contract.

    Whereas, section 74 deals with liquidated damages which widely used and incorporated in most of the EPC contracts. In liquidated damages, the parties have already estimated the costs which need to be paid by the defaulting party to the non-defaulting party.

    In ONGC v. Saw Pipes (2003) 5 SCC 705 it was clarified by the SC that it is pertinent to note that the amount stipulated as liquidated amount or penalty is the upper limit beyond which the court cannot grant reasonable compensation.

    There are catena of cases where supreme court has concluded that even if there is pre-determined sum agreed by both the parties as liquidated damages, courts will have to consider certain other factors such as mitigation of losses, reasonability of the sum and other facts and circumstances of the case.

    In SNL v. Reliance Communication Ltd. (2011) 1 SCC 394, SC has allowed that in the absence of such proof (as mentioned in the above paragraph) or honest estimation by the claimant, the court shall award damages which are below the stipulated liquidated damages. And while awarding damages, it should take into consideration a reasonable assessment of the consequences of the breach of contract.
     
  2. Specific Relief Act,1963:
    With the recent amendment to the Specific Relief Act (2018 Amendment) has brought certain remarkable changes which are as follows:
    It has made the specific performance of the contract as a mandatory remedy at the discretion of the party filing the suit. It has replaced old common law rule where the specific performance being remedy at the discretion of the court where the aggrieved party has to prove that monetary damages would be inadequate.

    If the aggrieved party does not want the defaulting party to perform the contract, then it can opt for substituted performance. A substituted performance is a new addition to the relief of the aggrieved party, where he can ask any third party to execute the remaining work of the defaulting party and all the costs and expenses will be borne by the defaulting party.

    Under Section 20A of Specific Relief Act, that the act bars courts from granting an injunction in the infrastructure contract like transport, energy, communication etc in case if an injunction is granted would significantly delay the project and also impact the progress of the project.
     
  3. Alternative Dispute Mechanism
    Alternative Dispute Mechanism (ADR) is always opted by the parties in the EPC contracts depending upon the nature and type of the project. ADR is used because its focus is to ensure that in minimum time and in a cost-effective way the issue is resolved.

    Since the EPC contracts are dynamic by nature and involve many variable factors the parties prefer to have multi-tier dispute mechanism. These mechanisms consist of Dispute Adjudication Boards (DAB), Mediation and Arbitration. Once this multi-tier dispute mechanism fails to resolve the issue then and then only the parties approach court for the resolution.

Conclusion
Over the year, infrastructure industries have developed in an organic way where it learned from its own mistake and adopted necessary changes. Fundamentally, every party to the contract will try to avoid any kind of dispute arising between them. But through this article, we have seen that in a contract like EPC contract which involves longer execution period, higher-level of complexity, a lot of variable factors and ever-changing circumstances would always find a way to throw new issues.

Dispute minimization will always be an ongoing process since no matter how robust the contract is drafted. Parties can avoid disputes if they have effective and reliable records, communication and awareness. If there is any potential dispute arising between the parties then such disputes should be identified and resolved at the earliest stages itself using effective dispute resolving mechanism such as Multi-tier dispute resolving mechanism.

End-Notes:
  1. https://dictionary.cambridge.org/dictionary/english/claim

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