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8/13/2019 The Essential Guide to Feasibility Planning and Construction Procurement for Junior Mining Companies Part 2 Detai
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FINANCIAL INSTITUTIONS
ENERGY
INFRASTRUCTURE, MINING AND COMMODITIES
TRANSPORT
TECHNOLOGY AND INNOVATION
PHARMACEUTICALS AND LIFE SCIENCES
Part 2 Detailed engineeringand constructionAn essential guide to feasibility planning andconstruction procurement for junior mining
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8/13/2019 The Essential Guide to Feasibility Planning and Construction Procurement for Junior Mining Companies Part 2 Detai
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A NORTON ROSE LLP GUIDE
AUGUST 2011
Part 2 Detailed engineeringand constructionAn essential guide to feasibility planning andconstruction procurement for junior mining
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Part 2 Detailed engineering and construction
Norton Rose Group
Norton Rose Group is a leading international legal practice. With more
than 2600 lawyers, we oer a full business law service to many of the
worlds pre-eminent nancial institutions and corporations from oces
in Europe, Asia Pacic, Canada, Africa and the Middle East. We are strong
in nancial institutions; energy; infrastructure, mining and commodities;
transport; technology and innovation; and pharmaceuticals and life
sciences. Norton Rose Group comprises Norton Rose LLP, Norton Rose
Australia, Norton Rose OR LLP, Norton Rose South Africa (incorporated
as Deneys Reitz Inc.), and their respective aliates.
nortonrose.com
The purpose of this publication is to provide information as to developments in the law. It does not contain a full
analysis of the law nor does it constitute an opinion of Norton Rose LLP on the points of law discussed.
No individual who is a member, partner, shareholder, director, employee or consultant of, in or to any constituent
part of Norton Rose Group (whether or not such individual is described as a partner) accepts or assumes
responsibility, or has any l iability, to any person in respect of this publication. Any reference to a partner or
director is to a member, employee or consultant with equivalent standing and qualications of, as the case may
be, Norton Rose LLP or Norton Rose Australia or Norton Rose OR LLP or Norton Rose South Africa (incorporated as
Deneys Reitz Inc) or of one of their respective aliates.
Norton Rose LLP NR11049 08/11 (UK)
Extracts may be copied provided their source is acknowledged.
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Contents
04 Summary
05 Introduction
07 EPC contracts
20 EPCM contracts
30 Appendix 1
32 Contacts
Contents
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Summary
The importance of a robust strategy for the procurement of a mining
project, from project inception through to construction implementation,
can not be underestimated. Full consideration of the key procurement
issues identied in this guide can often mean the dierence between
achieving a bankable project with optimal returns for the mining
company, and an expensive project failure.
Part 2 Detailed engineering and construction
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Introduction
GeneralThis is the second part of a two part guide exploring the key steps and
considerations to be made by junior mining companies (the Sponsors)
to achieve a project structure that is both bankable and able to deliver
optimal returns for the Sponsors.
On the assumption that the Sponsors have determined through a full and
proper feasibility process that the project is economically viable, they
must then consider how the project is to be delivered. We have producedseveral brieng papers on issues to be considered when looking to
secure nance for projects in the mining sector, but a key aspect of
securing such nance will be convincing lenders (or any debt repayment
guarantor in the context of a Chinese debt solution) that the structure for
project delivery is robust.
In this part two we will look at the key considerations to be made by
Sponsors in terms of achieving a construction structure that is both
bankable and economically viable.
Whilst this guide is primarily written from a western perspective, the
increasing signicance of Chinese debt solutions in this sector should
also be taken into account. This guide will therefore, as appropriate, also
oer some insight into the contrasting issues to be considered in the
procurement of mining projects in the context of a Chinese debt solution.
BankabilityWe have explained the meaning of bankable or bankability in partone to this guide. To recap, the terms are usually used to describe a
lenders view on the robustness of the project structure in terms of its
ability to secure full repayment of outstanding debt, either through
project delivery in accordance with Sponsor requirements or, in a default
scenario, through appropriate recourse against the contractor (or other
stakeholders (as appropriate)) responsible for project delivery.
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Introduction
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In the context of detailed engineering and construction delivery,
lenders will typically look for one nancially robust party to accept fullresponsibility for the delivery of the works on time, on budget and to
meet the required technical and performance specication. The key
candidates in this regard are typically large internationally recognised
engineering and construction contractors.
The identity of the contractor can certainly have an impact on the lenders
view on bankability.
The importance of achieving this single point of responsibility relates to adesire by the lenders to see the party with the deepest pockets bearing
the entire risk of project delivery. To the extent that more than one party
is responsible for delivery of the works (in terms of direct liability to the
Sponsors), lenders will be concerned that either:
there may be gaps in liability cover; or
that there may be interface issues when it comes to identifying the
party responsible for a failure; or, perhaps worst of all
that the party identied as being responsible for a failure can not be
held to account either because its liability is limited in some way under
the terms of its contract with either the Sponsors or the EPC contractor
(as the case may be) or more generally because it does not have the
balance sheet to meet the liabilities in question.
Contract structuresThe preferred option for delivery of the single point responsibility solutiondescribed above will typically come in the form of a turn key engineering,
procurement and construction (EPC) contract.
Whilst it is recognised that there are several internationally recognised
forms of EPC contract, each oering a balanced approach to contracting
risk, the hardening of the lending market in recent years (and especially
post global nancial crisis (GFC)) has seen a move away from use
of these forms, in the context of a limited recourse project nancetransaction, without signicant amendment. When procuring an EPC
Part 2 Detailed engineering and construction
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contractor, it is essential that there is transparency regarding likely lender
requirements from the outset. Raising these points post selection of thepreferred EPC contractor will place the Sponsors in a weak bargaining
position if (and more likely, when), as a consequence, the EPC contractor
proposes additional contingent risk pricing.
We have discussed above how the development of detailed design
at feasibility stage may undermine the Sponsors ability to achieve a
single point of responsibility solution without being exposed to inated
construction pricing, either because there is a lack of appetite in the
market to take on 3rd party design risk or because those parties willingto take on such design risk will only do so with a signicant amount of
contingent risk pricing.
In circumstances where the single point responsibility position described
above can not be achieved, the Sponsors may look for alternative
structures. In this respect, we will consider below, in the context of
bankability considerations, the fundamental dierences between the
EPC and the alternative engineering, procurement and construction
management (EPCM) contracting structures. In particular, we will
identify the likely challenges when opting to use the EPCM structure in a
hardening lending market.
EPC contracts
General
Figure 1 below demonstrates a typical EPC contracting structure underwhich lenders and Sponsors will look for the EPC contractor to accept
single point responsibility for all aspects of design and construction.
Notwithstanding the fact that the Sponsors may be able to achieve this
contractual structure, the bankability of the contracting structure will
depend also on satisfaction of certain key lender requirements under
the terms of the EPC contract. These key requirements will establish
the obligations on the EPC contractor in terms of project delivery and
importantly, the recourse available against the EPC contractor in a defaultscenario.
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Figure 1 typical EPC contracting structure
In order to gain a better understanding of the approach being seen more
recently by lenders in the mining sector, it would be helpful for us to set
out what we see as being those key commercial terms that lenders will
typically be looking for under the terms of an EPC contract.
Key lender requirementsDesign risk
As we have indicated earlier in part 2 of this guide, the lenders ideal
position will be for the party delivering the works to be responsible for
all aspects of the works, including design (whether or not produced
by the party assuming responsibility for the works). This transfer of
responsibility should even extend to mistakes in the Sponsors own
stated initial design requirements. If this design risk transfer is not
achieved, the risk to the Sponsors of cost overrun could be signicantsince there is likely to be increased exposure to claims for additional time
and money resulting from the requirement to remediate errors identied
in 3rd party design.
Since the liability for cost overruns in the circumstances described above
may be signicant, it is unlikely that this risk may be backed o fully with
the party ultimately responsible for producing the design in question. It
is more likely therefore that the residual cost overrun risk will rest with
the Sponsors. Whilst in the rst instance, this is clearly a concern for theSponsors, lenders will also be concerned to see that the Sponsors are
able to manage the potential nancial consequences.
Mining company
EPC contractor
Sub-contractor BSub-contractor A Sub-contractor C
EPC contract
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Whilst the intention of the parties may be for the EPC contractor to accept
entire responsibility for the adequacy, accuracy and completeness ofdesign, the lenders will nonetheless want to assess fully the extent to
which design risk may lter back to the Sponsors under the terms of the
EPC contract. An example of where this may happen is in circumstances
where the Sponsors accept the risk in certain sub-surface site conditions.
For instance, the Sponsors may warrant the correctness of survey
information relating to the site and accordingly the EPC Contractor will
develop its detailed design and submit its tender price in accordance
with the warranted information. However, if this information is incorrect,
the risk in the design, and in particular the impact of the changes to thedesign required to reect actual sub surface conditions, will pass back to
the Sponsors.
In practice, the lenders technical adviser will review the risk prole
proposed under the terms of the EPC Contract generally and will advise the
lenders as to the Sponsors potential exposure to cost overrun risk arising
from circumstances of the type described above. It will ultimately be for
the Sponsors to either convince the lenders that any such risk identied
may be managed by the Sponsors. Sponsors should be aware that lenders
may seek additional mitigation through equity contributions, additional
security or appropriate contractual mitigants. In the alternative, Sponsors
and/or their lenders will seek to push the risk in question back to the EPC
contractor, which may of course have pricing consequences.
Time and cost
Whilst we have discussed time and cost risk specically in relation to
design above, as a general point of principle, lenders will want to limitto the fullest extent possible the EPC contractors ability to claim for
additional time and/or money under the terms of the EPC contract. Again,
lenders will be concerned about the ability of the Sponsors to manage the
nancial consequences that will accompany these time and cost claims
and more generally the extent to which exposure to such claims may
impact on the delivery of the works in accordance with the requirements
of the EPC contract.
Many of the international forms of EPC contract contain scope for timeand money claims being made by the contractor. For instance, FIDIC
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Silver Book places time and cost risk for the occurrence of changes in
law, compliance with certain employer instructions and the discoveryof objects of antiquity at the works site with the employer. Whilst on
balance this may not appear unreasonable, the employers potential cost
and loss of revenue exposure arising as a result of accepting these risks
may be signicant. We have seen more recently lenders pushing back on
the acceptance by Sponsors of these types of risk, allowing for contractor
time and money claims only in very limited circumstances.
The key point to recognise is that the acceptance by the Sponsors of any
aspect of time and/or cost risk will undermine the xed price assumptionsought under the EPC structure. On the assumption that lenders can
get comfortable with this type of risk being retained by the Sponsors,
the Sponsors should themselves think very carefully before accepting
such risks. The potential exposure to additional costs will need to be
appraised fully by the Sponsors as will any potential impact on the
nancial model for the project. The Sponsors should ideally seek board
buy-in to any such proposals, and in particular to the commitment of
additional equity as may be required at an early stage in the project.
Parent company buy-in may also be necessary particularly where nance
guarantees will be required. We would additionally expect the sponsors
to formulate a strategy for managing any such risks. A lets wait and
see approach is unlikely to be satisfactory, since it is likely that prompt
and calculated action will be necessary on the occurrence of the risk in
question if the Sponsors nancial exposure is to be mitigated to fullest
extent possible.
Delay damagesTo the extent that the works are completed on a date later than that xed
under the terms of the EPC contract, the contract will typically include
provision for payment of liquidated and ascertained damages (LADs).
These LADs will typically be paid at a daily rate to cover anticipated lost
revenue and costs (including debt service costs (as applicable)) during
the period of delay. It would be unusual for the EPC contractor to accept
unlimited exposure in this regard and any liability sub-cap agreed will
typically be sized to the level of LADs payable up to the construction
long stop date. Whether or not any such sub-cap will fall within thecontractors overall liability cap is likely to be an area of debate between
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lenders and the EPC contractor. This issue will tend to be considered by
lenders in the context of the EPC security package as a whole and we willdiscuss this point in further detail below.
Performance liability
Following completion of construction and the handover of the works, the
Sponsors and the lenders will be keen to ensure that the plant is able
to achieve certain performance guarantees. These are required in order
to provide both parties with a degree of comfort that projected project
revenues can be achieved by the completed plant over a sustained
period. It is usual therefore for the EPC contract to also document therequirement for a post completion testing regime.
To the extent that the required performance guarantees can not be
achieved for a sustained period of operations, the EPC contractor will
typically be liable for payment of performance liquidated damages up to
an agreed liability cap. The damages will usually be sized according to
the loss of revenue and/or prot occasioned by the performance shortfall
for a nite period of time.
It would be extremely unusual for the Sponsors to achieve a life of mine
performance guarantee and, as such, it would be usual for the liability
cap in relation to performance damages to be capped at the Sponsors
loss of revenue and/or prot for a specically negotiated period. Whilst
residual liability will be a Sponsor risk, it would be usual for Sponsors to
manage this risk by building headroom into the nancial model for the
project.
The pre and post handover testing regime will be subject to scrutiny
by the lenders technical adviser. If, for instance, it is apparent prior to
handover of the works that the plant is not going to achieve the lenders
base case performance/output requirements, the lenders would typically
expect to see a right to reject the plant in its entirety with full recourse
against the EPC contractor for debt outstanding. For obvious reasons, EPC
contractors will tend to resist any such position. They may, for example,
look for an extended period of additional testing in order to rene the
plant and to achieve the required performance levels. If this is permitted,time and cost impact of this additional testing will tend to be at the EPC
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contractors risk and the lenders will typically seek to retain the right to
reject at the conclusion of any such repeated testing, if a required level ofperformance is not demonstrated.
Again, where detailed process design is not provided by the EPC contractor,
it may be more dicult to require this party to accept performance risk in
full, particularly in circumstances where the technology is more complex
in nature. Carving out these types of risks from the EPC contractors
liability under the terms of the EPC Contract is however likely to make
potential lenders nervous for the reasons discussed above. Whilst
lenders may accept the interface risk in this liability gap being lled bythe designer itself (whether under the terms of a design contract with the
Sponsors or under the terms of a collateral warranty), it is often the case
that the party providing the detailed process design is either unwilling or
unable to accept the type and extent of liability for design failure that
would usually rest with an EPC contractor under the terms of the EPC
contract. If this is the case, lenders may require additional security from
the Sponsors to bridge the liability gap.
Limitations on liability
As indicated above, a key consideration for lenders when considering
lending into a mining project will be the extent to which they will have
recourse against the EPC contractor for debt outstanding in an EPC
contractor default scenario.
There is, as may be expected, a tension between the lenders requirement
for full coverage of debt outstanding from the EPC contractors security
package and the legitimate requirement of a contractor to limit its liabilityexposure. It is not unusual however for lenders in the current market to
look for an aggregate liability cap of up to 100 per cent of the contract
price, especially where the works include an unproven technical solution.
The lenders may however accept a lower liability cap of say 60-80 per
cent of the contract sum in these circumstances on the basis that liability
for certain key risks is excluded from the aggregate liability cap. It is not
uncommon for instance for lenders to seek to exclude liabilities that are
the subject of a sub-cap, such as delay or performance liquidated
damages, from the aggregate liability cap.
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The appropriate exclusions from the aggregate liability cap will be
negotiated on a project specic basis by the lenders following adviserinput. The list of exclusions will typically include those liabilities that
are not able to be limited at law (and this will require local law advice),
those liabilities that are uninsurable and those liabilities that are not
quantiable at the date of contracting.
Security package
As we have discussed above, to the extent that the EPC contractor fails
to deliver the works, the lenders and, in the rst instance, the Sponsors,
must have direct recourse against the EPC contractor to recovertheir losses. The lenders will ultimately control this process through
restrictions placed on the Sponsors in the nance documentation. For
instance, the lenders will not allow the Sponsors to use (and ultimately
deplete) the EPC security package to replace a defaulting EPC contractor
in circumstances where such replacement is unlikely, in itself, to secure
delivery of the project. It is more likely in these circumstances that
the lenders will look to call a default under the terms of the nance
documentation, trigger its security over the project documentation and
access the EPC security package to recover debt outstanding.
The security provided by the EPC contractor in respect of its potential
liabilities will typically be formed, in part, by a form or forms of liquid
security.
Liquid security and bonding
When we talk of liquid security, we are talking about forms of security
that should be as good as money in the bank for the Sponsors. TheSponsors should be able to claim any such monies by simply serving
a demand on the party providing the security on behalf of the EPC
contractor. Typical forms of liquid security are performance bonds,
retention bonds and letters of credit, all usually provided by international
banks with lender approved credit ratings.
Leaving retention bonds to one side for the time being, the lenders in
the current lending market will typically require the EPC contractor to
procure performance security (ie, performance bonds and/or letters of
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credit) with a value no less than 15-20 per cent of the contract sum, but
this may vary on a project specic basis. The lenders are however likelyto permit a step down in performance security coverage as the works
progress to reect reduced risk in the project for the lenders. Typically,
the level of performance security coverage may reduce by 50 per cent, for
instance, following the completion of operational testing and will usually
be discharged completely upon expiry of the defects liability period (ie,
12-24 months post handover of the works).
In the UK domestic market, there has been a shift in recent years in
the surety market away from providing performance bonds of the typedescribed above. This is not to say that such bonds are not available,
however procuring them can be prohibitively expensive. Instead the
UK has increasingly seen use of conditional bonds under which the
beneciary must rst establish the right to make a claim and the
quantum of any claim before a call is made on the bond. Whilst a
fraudulent claim under an unconditional bond of the type described
above can be challenged, a conditional bond is more akin to a form of
guarantee and for the reasons set below will be less attractive to both
Sponsors and lenders.
It is usual for lenders to also require that a xed amount of any payment
being made to the EPC contractor is retained and held by the Sponsors
as security for the remedying of defects subsequently discovered in the
works. Unlike the performance security which secures more general
performance by the EPC contractor under the terms of the EPC contract,
retentions are held for a specic and dened purpose. However, in reality
this is somewhat of a falsity as lenders generally view retentions as partof the wider security package available to the Sponsors, and ultimately
the lenders, as security for non-performance by the EPC contractor.
The level of retention required by lenders will vary but typically will be
between 3-5 per cent of the contract sum. Instead of a cash retention
being made on any payment to the EPC contractor, and to assist the
EPC contractors cash ow, lenders will usually instead accept a form of
retention bond as an alternative which will provide security for monies
that would have otherwise been retained. Any such instrument should bein the same form as the performance bond discussed above, ie, provided
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by an international bank with an approved credit rating and permitting
claims for payment upon the presentation by the Sponsors of a demandfor payment. Again, any such bond should be as good as money in the
bank for the Sponsors.
To the extent that any advance payment is made to cover the cost of
the ordering of plant and materials or mobilisation, lenders will expect
the Sponsors to secure such payments by requiring the contractor to
procure an advance payment bond. Again, any such bond should have
the characteristics of the performance bond and the retention bond
described above.
Illiquid security and guarantees
Outside of liquid forms of security, lenders will typically require a
guarantee from the ultimate parent of the EPC contractor. The ultimate
parent is usually a requirement as a shell holding company, for instance,
with limited or no assets will not be acceptable to the lenders.
In practice, lenders will carry out their own due diligence on the parent
company proposed to ensure that it is suciently robust to meet its
potential liabilities under the guarantee.
Unlike the forms of liquid security described above, a guarantee of
this kind will usually rst require the establishment by the Sponsors of
liability against the EPC contractor, which the EPC contractor has failed
to discharge. Furthermore, the Sponsors will run the risk that any claim
made under the guarantee will be subject to challenge by the guarantor.
Far from being akin to cash in the banks, the pursuit of a claim undera parent company guarantee can be a lengthily process which is why
claims under the liquid forms of security will usually be the Sponsors
rst port of call.
Termination
Lenders will tend to have certain minimum requirements in terms of the
circumstances where they will expect the Sponsors to have the right
to terminate the EPC contractor and access the EPC security package
to either replace the defaulting EPC contractor and secure projectcontinuance or bring the project to an end. As we have indicated earlier,
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Part 2 Detailed engineering and construction
the lenders will control the actions of the Sponsors in this regard through
the restrictions imposed on the Sponsors under the terms of the nancedocumentation.
It would be usual for lenders to look for the EPC contract to contain a right
to terminate the EPC contractor in circumstances where recourse against
the EPC contractor may be limited in some way or where key requirements
relating to performance are not achieved. Lenders will typically look for
advance warning of any problems relating to the works so that armative
action may be taken before the circumstances become critical.
Lenders will be especially concerned to see that the losses recoverable
on termination will (to the fullest extent possible) cover amounts
outstanding under the terms of the nance documentation (ie, principal,
interest and fees). The ability of lenders to recover these losses tends to
be very dicult for the uninitiated to understand and accept this, but this
is part and parcel of limited recourse project nancing where the lenders
security is limited to the project and those responsible for delivering it.
EPC contracts in a Chinese debt contextAs we discussed in part one of this guide, the focus of project scrutiny in
the context of a Chinese debt solution will typically dier from that under
a western project nance solution. The nature and extent of security
typically required by Chinese lenders from the State of the Sponsor or its
parent company (as the case may be) will tend to mean that the lenders
themselves will be looking less closely at the project structure.
Whilst the bankability requirements discussed above will not tend to bepressed by Chinese lenders, the Sponsors should themselves be looking
to secure these positions and indeed this is likely to be a requirement of
the relevant guarantor.
In the context of a Chinese debt solution, Sponsors and guarantors must
together take on an almost lender due diligence type approach towards
the project structure and ensure that appropriate mechanisms are in
place to secure completion of the works on time, on budget and to meet
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Norton Rose LLPAugust 2011 17
a required performance and technical standards. Consideration of these
issues in isolation and without lender support is often a new dynamic forsponsors.
In the context of an Export Credit Agency (ECA) backed Chinese debt
solution, we considered in part one to this guide the typical Chinese
content requirement under the Sinosure policy. To recap, Sinosure is
the ocial ECA for China and will provide lenders with political and
commercial risk cover to support exports of Chinese goods and services.
It will however be a condition of providing such cover that the export
contract (for instance, an EPC contract with a Chinese contractor) has aChinese content of at least 60-70 per cent.
It should be noted that whilst a breach of this requirement may
have consequences for the Sponsors under the terms of the nance
documentation, it would actually be unusual for Sponsors to ever have
sight of the policy and hence be aware of the specic details of the
Chinese content requirement. If the EPC contractor is a Chinese entity and
has itself or through its agents procured the debt solution (as is often the
case in this context), it is likely that the EPC contractor will have visibility
on the specics of the Chinese content requirement and can therefore
develop its design, procurement strategy and price accordingly. In these
circumstances, any failure to meet the Chinese content requirement
should be an EPC contractor risk under the terms of the EPC contract.
There is a strong argument that the EPC contractor will be best placed to
manage this risk in any event.
We have set out above the key requirements that lenders are likely toseek under terms of the EPC contract in the context of a western debt
solution, but it is recognised that these requirements may not always be
achievable.
Each project will see dierent positions that the EPC contractor will
look to push back on, usually because it has not adequately priced for
the risk in question. Whilst the obvious answer would be for the EPC
contractor to price every risk, the real concern will be the extent to which
EPC contracts
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Part 2 Detailed engineering and construction
unknown risks can be priced sensibly without an unacceptable amount
of contingent. Whilst the EPC contractor may be willing to oer a singlepoint of responsibility, the price on oer may not be acceptable to the
Sponsors. In these circumstances, the Sponsors must consider how they
will provide lenders with reassurance that the risk or risks in question can
be managed by the Sponsors themselves.
In the alternative, the Sponsors may wish to consider use of a dierent
contracting structure, and we will consider this option in further detail
below.
Bribery Act new legislation for companies with UK linksWhilst not an issue that will directly aect the nancing of a mining
project or more generally its economic viability, Sponsors incorporated
in the UK or carrying out business or any part of their business in the
UK should be considering very carefully the requirements of the
Bribery Act 2010 (the Act).
The Act will make it a criminal oence, for persons to whom the Act
relates, to bribe another person or to be bribed, but perhaps most
signicantly it also introduces a new criminal oence for corporates
of failing to prevent bribery.
Corporate entities can be guilty of this oence if an associated person,
which given the scope of this denition is likely to include any EPC
contractor or operator, carries out an act of bribery when acting on their
behalf. It is important to recognise that the associated person does
not need to be incorporated in the UK or indeed have any businessconnection with the UK.
The only defence for an entity being prosecuted for failing to prevent
bribery is to show that it had adequate procedures in place designed
to prevent bribery being carried out on its behalf. Whilst the precise
meaning of adequate measures is not clear, the UK Government
has made available guidance as to the key principles to be followed.
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Given the signicant scope and extraterritorial reach of the Bribery Act,
it will be extremely important for Sponsors to rstly ensure that they haverobust internal policies in place to guard against bribery and secondly
to ensure that its supply chain members have robust anti-corruption
compliance programmes and are subject to appropriate due diligence
and monitoring.
Specic advice should be sought by Sponsors having any particular
concerns about the scope and implications of the Act.
EPC contracts key point summary In terms of delivery of the detailed engineering and construction
phase of a project, Sponsors should, and lenders will, look for one
nancially robust party to accept full responsibility for the delivery of
all aspects of the works on time, on budget and to meet the required
technical and performance specication. In achieving this single point
of responsibility position there will be reduced risk that:
there may be gaps in liability cover;
there may be interface issues when it comes to identifying the party
responsible for a failure; or
the party identied as being responsible for a failure can not be held
to account either because its liability is limited contractually or more
generally because it does not have the balance sheet to meet the
liabilities in question.
If the single point of responsibility position can not be achieved,
and on the assumption that lenders accept this, the Sponsors must
consider how they will themselves manage the risk(s) in question
and in particular the concerns identied above. The Sponsors should
at an early stage plan for the management of the relevant risk(s) and
obtain board approval to the provision of additional security (as may
be necessary) and the nancial support that may be required upon
materialisation of the risk(s) in question.
EPC contracts
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The lenders will have key requirements in terms of:
the obligations on the EPC contract to deliver the works on time,
on budget and to meet a required technical and performance
specication; and
the recourse available against the EPC contractor to the extent that it
fails to discharge its obligations under the terms of the EPC contract.
The preferred EPC contractor should be procured on the basis that these
key requirements will be included in the form of EPC contract eventuallysigned. This will allow for certainty of EPC price at the conclusion of EPC
procurement process and will mitigate the likelihood of price escalation
following EPC contractor selection.
EPCM contracts
GeneralThe acronym EPCM is commonly mentioned in the same breath as the
EPC structure described above. However, from both a structuring and risk
allocation perspective, the two contracting solutions are fundamentally
dierent. The confusion would appear to come from the shared use of the
work construction in their titles. It is important however to recognise
that an EPCM contract is (amongst other things) essentially a design and
construction management contract and that no physical construction will
actually be carried out by the EPCM contractor.
The EPCM structure has been used extensively in the mining sector,
especially in the years leading up to the global nancial crisis (GFC)
where the lending market became more contractor friendly in terms of
both risk allocation and pricing. However, post GFC the lending market
has hardened and the liquidity gap has meant that lenders are now
increasingly risk averse and far more selective about the projects they are
willing to back.
For the reasons set out below, the EPCM structure has tended to be lessattractive to lenders in the form typically employed in the mining sector
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and so more challenging to achieve a project nancing. We will however
consider below what the writers see as the likely requirements neededto bring an EPCM solution to market and importantly to attract project
nance.
The EPCM structureIn contrast with an EPC contract (and as mentioned above), the EPCM
contractor does not undertake primary responsibility for delivery of the
construction works. The EPCM contract is essentially a professional
services contract under which the EPCM contractor will typically carry out
the following services:
Engineering services the EPCM contractor will typically be the party
producing the basic design at feasibility stage or will be appointed
post feasibility under the terms of the EPCM contract to complete the
basic design developed by or on behalf of the Sponsors. The EPCM
contractor will typically be responsible for overall co-ordination of
design for the project to ensure that the completed works meet the
required technical and performance specication (but note Appendix 1
descibing the limited liability typically accepted by EPCM contractors in
this regard).
Procurement services the EPCM contractor will be responsible for the
overall procurement strategy and will source contractors, consultants
and the necessary plant and equipment in accordance with the
Sponsors requirements and the assumptions established at feasibility
stage. The EPCM will advise on the timing of the letting of the relevant
packages and will advise the Sponsors on the terms available and willnegotiate the contract packages on the Sponsors behalf.
Construction Management services the EPCM contractor will
typically be responsible for overall management of the carrying out
and completion of the works. This will include the co-ordination
of the works and services being procured on the Sponsors behalf
to achieve completion of the works in accordance with the project
schedule, the project budget and to meet the required technical and
EPCM contracts
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performance specication (but again, note Appendix 1 and the limited
liability typically accepted by EPCM contractors in this regard). Theconstruction management services will also typically include the
management of health and safety at the site, the establishment of
quality assurance systems and the management of the remedying of
defective works and or services provided by other parties.
Many mining clients are adopting a slight variant to the EPCM
arrangement which is essentially a split EP & CM structure. Under this
variant the Sponsors will appoint a rm generally with greater expertise
in engineering design and, possibly procurement, as the EP Contractor.Sponsors then appoint a specialist construction management rm
to appoint and manage the trade contractors and the rest of supply
chain (including the engineering designer). This assists getting lenders
comfortable that an appropriate party will be in place having expertise
in procurement to ensure the best chance of success and avoiding cost
overruns.
Whilst the EPCM contractor will negotiate the terms of the contract
packages, whether for delivery of works, services or the provision of plant
and equipment, it is the Sponsors that will enter into direct contractual
relations with the relevant third parties and assume the rights and
obligations under the relevant contracts. For reference, we have set out
below the typical EPCM structure.
Mining company
Contractor BCcontractor A Contractor C
EPCM contractor
EPCM contract
Figure 2 typical EPCM contracting structure
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It should be noted that we have structured arrangements for clients
where the EPCM contractor actually enters into all of the trade contractoron behalf of the sponsors. The reasons being for particular project
specic ECA coverage reasons. However, the EPCM contractor will, if well
advised, insist on back to back protection for all liabilities under the
trade contracts.
As we have indicated above, the EPCM structure may be considered by
Sponsors where the single point of responsibility EPC structure can not
be achieved or is not attractive for one reason or another. This may be
because:
The securing of the single point of responsibility EPC solution may
expose the Sponsors to inated pricing which may have an impact on
project aordability and which may not be considered by the Sponsors
to oer value for money;
There may be a general lack of appetite in the market to take on the
project in question on a turn key EPC basis;
The Sponsors have a good track record in project delivery and have a
large internal management resource and as a result prefer to adopt the
EPCM structure to signicantly reduce overall outturn cost and increase
equity returns.
In the context of a mining project, the EPCM contractor will typically be
the party developing the basic design at feasibility stage. This party will
then be retained to develop the nal design and to provide the otherrelevant EPCM services for the construction phase of the project. This
structure will obviously generate continuity in design responsibility
throughout works planning and implementation and will typically allow
for greater employer inuence in design evolution than would otherwise
be available under the EPC structure.
In considering the use of an alternative structure (and on the assumption
that an EPC structure is otherwise achievable) the Sponsors will typically
EPCM contracts
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balance, amongst other things, the increased cost and reduced equity
return that is likely to accompany use of the single point of responsibilityEPC solution against the corresponding key benets, namely, price
certainty for project delivery and the increased likelihood of securing
project nance. If the negatives of the EPC solution outweigh the
positives, Sponsors may be inclined to consider use of an alternative
contracting structure.
EPCM and bankability
The fundamental point for the Sponsors to consider will however be
the extent to which the EPCM solution may be considered bankable bypotential lenders.
A key dierence between the EPC and the EPCM solutions is that the
EPCM solution does not oer a single point of responsibility for delivery
of the works. There will be multiple interfaces which must be carefully
managed by the EPCM contractor and the Sponsors and there will remain
a risk that there may be gaps in liability or that a party identied as be
liable for a failure will not, on its own or collectively with other culpable
parties, be willing to accept the measure of liability typically recoverable
by Sponsors when using the EPC structure.
The provisions of the EPCM contract, in terms of both scope (as identied
above) and liability for the services provided, will dier fundamentally
from the terms seen in a typical EPC contract. To illustrate these
dierences, we have provided at Appendix 1 to this guide a comparison
between the key lender requirements under the EPC structure and the
corresponding terms and risk allocation typically achieved in the contextof an EPCM structure.
The reader should note that the summary at Appendix 1 provides only
a high level overview for the purposes of comparing the risk allocation
typically seen under the EPC and EPCM structures. There will of course
be exceptions to these positions on a case by case basis. To provide a
more detailed picture, we provide our clients with EPC and EPCM risk
matrices that essentially show the positions taken on the key risk issues
on recent projects closed in the mining sector. These invaluable tools
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allow us to quickly identify the market position on any given risk and
more particularly show how a particular risk allocation has been banked(if at all).
From the high level summary at Appendix 1, it is apparent that the usual
risk prole under the EPCM solution is far less favourable from the
Sponsors (and ultimately the lenders) perspective when compared with
the position typically secured by Sponsors under the EPC structure.
It is easy to see why lenders prefer the certainty and security that comes
with the EPC solution and also why many of the key principles underthat solution should gain support from the Sponsors. However, whilst
risk allocation considerations are very important, Sponsors will also
be looking at the commercial imperative of (a) bringing a project to
market where, for instance, the EPC structure is not achievable and, (b)
maximising equity returns from the project by securing a signicantly
lower construction cost.
EPCM key requirements
We will consider below the more robust Sponsor approach to risk transfer
typically adopted in other sectors, such as the petrochemicals sector,
where the EPCM solution remains a popular contracting structure for
project delivery (although not always on a project nance basis). On
the face of it, there would seem no reason why a similar more Sponsor
friendly approach to risk transfer should not be pursued in the mining
sector.
If the EPCM solution is to be considered, it will be important for theSponsors to rst satisfy themselves and ultimately the lenders that the
proposed solution can oer a robust structure for project delivery. The
following requirements will, in the writers view, be key to demonstrating
a robust EPCM structure best equipped to secure project delivery:
The selected EPCM contractor should be a robust experienced
organisation with a strong track record of securing project delivery on
an EPCM basis in the mining sector. The terms of the EPCM contract
should reect an appropriate risk transfer to the EPCM contractor.
EPCM contracts
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In view of the more limited liability typically accepted by an EPCM
contractor under the EPCM structure, the Sponsors should appointa full time experienced and well resourced internal team to monitor
and manage the execution of the project in order to ensure that the
Sponsors key requirements are being achieved and to permit early
identication of issues that may impact on project delivery. There
should be developed a clear internal strategy for the management and
resolution of all risks retained in part or whole by the Sponsors.
The contractors, service providers and equipment and plant suppliers
should also be robust entities with experience and a track recordof project delivery in the mining sector. Where possible, these
contracts should be nalised on a xed price basis with any limits on
liability and security requirements being appropriately determined in
accordance with the role assumed by the relevant party.
The Sponsors should identify possible interface issues and put in
place an appropriate mechanism to co-ordinate the completion of
the works and to address the allocation of risks that may impact
on delivery of the work. This mechanism should provide for prompt
resolution of the relevant circumstances in a manner which does not
detract in any material respect from project delivery.
Whilst the points identied above will be important in developing
robustness in the structure for project delivery, there is little doubt that
potential lenders will seek from the Sponsors security for the residual
risks that may be retained at Sponsor level under the EPCM solution. The
nature and extent of this security will really depend on the lenders viewon the robustness of the project structure.
Provided Sponsors are comfortable with the robustness an EPCM
structure and the key requirements listed above can be achieved, the
contracting freedom under a Chinese debt solution may make this
nancing option more attractive, especially where security requirements
for delivery of an EPCM and an EPC solution may not be substantially
dierent.
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A more robust view on EPCM risk transfer
As Sponsors and contractors operating in the mining sector are usuallylarge sophisticated entities, it is perhaps surprising that the approach
taken to risk transfer in the context of EPCM solutions has remained
relatively simplistic in nature when compared to the approach taken in
other sectors.
Given that the role of an EPCM (or EP&CM) contractor will be
fundamentally dierent to that adopted by an EPC contractor and given,
as a consequence, the signicantly lower price paid for EPCM services
when compared with that payable under a typical EPC contract, thewholesale transfer of risk from the Sponsors to the EPCM contractor will
not be appropriate.
However, use of more innovative ways to transfer risk to the contractor,
without necessarily seeing a dollar for dollar pricing consequence,
deserve more serious consideration in the mining context. Whilst use of
these solutions will not, in themselves, secure a bankable position for
the Sponsors, they will however create a more robust EPCM structure
by ensuring that the EPCM contractor has skin in the game and is
further motivated to secure project delivery in accordance with Sponsor
requirements.
Incentivisation
The key aspect of the EPCM risk allocation in other sectors is the concept
of incentivisation.
Although sometimes seen in the mining sector, the nature and extentof its use is not of the order of that seen in other sectors. It is not really
apparent why this is the case and the writers would simply put this down
to Sponsors and contractors following approaches used previously. With
no international standard form EPCM contract, there has previously been
no real impetus to shift away from market practice. However, given the
liquidity gap and the bankability issues discussed in this guide, it is
perhaps clear that this approach requires a re-think.
EPCM contracts
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Incentivisation provisions will typically provide for EPCM contractors
accepting nancial risk and reward in the achievement of key projectrequirements, including, completion of the works within the agreed
project budget, completion of the works in accordance with the project
programme and the nal works achieving key performance and other
quality requirements. Again, we produce for clients risk allocation
matrices demonstrating in more detail how key risks are allocated
through incentivisation provisions under the EPCM structure in other
sectors.
Whilst these risks are not passed to the EPCM contractor in full, the EPCMcontractor will be accepting a degree of liability in the relevant risk, so
will be more motivated to manage it. The key point to understand is that
the EPCM contractor will be responsible for the nancial downside of the
incentivisation provisions irrespective of whether it has used reasonable
skill and care in managing the risk in question. There is therefore a clear
imperative for the EPCM contractor taking ownership of the management
of the risk in question from that date of contract to secure project delivery
in accordance with the Sponsors requirements.
There would ordinarily be concerns that the EPCM contractor will simply
price the risk in question on a contingent basis, and this will of course
not oer value for money for the Sponsors, particularly if the risk never
materialises. These concerns however tend to be mitigated by the fact
that the EPCM contractor s risk in the project will be limited to its agreed
prot margin on which there should, in theory, be absolute transparency
beyond the actual agreed cost for providing the EPCM services.
Conversely, there will also typically be a bonus structure under which
the EPCM contractor will receive additional payments for meeting and
surpassing key project delivery requirements.
EPCM key points summary An EPCM contract is essentially a professional services contract under
which the contractor will accept no primary responsibility for the
carrying out of the works.
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The EPCM contractor will be responsible for:
completion of detailed engineering;
the procurement of contractors, service providers and plant and
equipment suppliers on behalf of the Sponsors; and
management of the carrying out and completion of the works on
behalf of the Sponsors.
The contracting structure under an EPCM solution is fundamentallydierent to that adopted under a typical EPC solution. Unlike the
EPC solution, it will be the Sponsors, not the contractor (but see our
comments above where this can be an option), that will enter into
contractual relations with the contractors, service providers and plant
and equipment suppliers responsible for delivery of the works.
The risk prole under an EPCM solution is substantially more onerous
from a Sponsor perspective when compared with the EPC structure. In
order to attract project nance Sponsors will need to:
demonstrate an allocation of risk between the Sponsors and the
EPCM contractor appropriate in the post GFC lending market; and
demonstrate to potential lenders how the risks retained by the
Sponsors will be managed. It is likely, in any event, that Sponsors
will be required by any potential lenders to provide additional
security in respect of these risks.
Given the level of risk retained by the Sponsors under the EPCM
structure, it is likely that the level of security required by lenders from
the Sponsors will be signicant. The level and nature of the security
required from the Sponsors will be determined on a project specic
basis and will depend on lenders view as to the robustness of the
EPCM structure procured by the Sponsors.
EPCM contracts
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Appendix 1
Note: the reader should note that this summary provides only a high level
overview for the purposes of comparing the risk allocation typically seen
under the EPC and EPCM structures. There will of course be exceptions to
these positions on a case by case basis. To provide a more detailed picture,
we provide our clients with EPC and EPCM risk matrices that essentially
show the positions taken on the key risk issues on recent projects closed
in the mining sector. These invaluable tools allow us to quickly identify
the market position on any given risk and more particularly show how a
particular risk allocation has been banked (if at all).
EPC riskallocation
Typical EPCM position EPCM riskallocation
Risk typicallytransferred tothe contractor
EPC EPCM
Contractor to beresponsible forcompleting the
works on time.
The EPCM contractor will not usuallyguarantee delivering the works on timeand will therefore not usually have
responsibility for the payment of delayliquidated damages in this regard.
Any damages recoverable from othercontractors, who are identified asbeing responsible for delayedcompletion of the works, will nottypically be of the order recoverableunder the EPC structure (eitherbecause of quantum or cappingarrangements agreed).
Nominal delay liquidated damages maybe payable by the EPCM contractorto the extent that the design, or otherdeliverables for which the EPCMcontractor is responsible, are deliveredotherwise than in accordance withthe project programme.
The EPCM contractor will be responsiblefor managing the overall worksprogramme and any failure to usereasonable skill and care in doing sowill give rise to liability. Any suchliability will usually be restricted to acontractual damages claim and willbe subject to the limitations onliability identified below.
As the delaydamagesrecoverable
from the EPCMcontractor,and any othercontractorsidentifiedas beingresponsiblefor delayedcompletionof the works,will not besufficient
to cover theSponsorspotential lossin revenueand debtservice costsoccasionedby such delay,the financialrisk of delayedcompletionof the workswill ultimatelyrest with theSponsors.
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EPC riskallocation
Typical EPCM position EPCM riskallocation
Risk typicallytransferred tothe contractor
EPC EPCM
Completionof works for alump sum fixedprice.
The EPCM contractor will not usuallyguarantee the overall outturn cost ofthe works.
The EPCM contract will provide forthe EPCM contractor setting thebudget and managing adherence tothe budget. Any failure by the EPCM
contractor to use reasonable skilland care in doing so will give rise toliability. Given the limits on the EPCMcontractors liability typically agreedunder the terms of an EPCM contract(see below), it is unlikely thatliability for any significant costoverrun will be recoverable from theEPCM contractor.
In procuring the works, servicesand plant and equipment supply
packages on behalf of the Sponsors,the EPCM should attempt to procuresuch packages on a fixed pricebasis. However, this is not alwayspossible. Notwithstanding the factthat fixed price solutions may beachieved, the multiple interfaceswill however widen the scope fortime and money claims by the thirdparty contractors which will be aSponsor risk to the extent that theliability giving rise to any such claimcan not backed off fully with othercontractors.
Payments to the EPCM contractorfor services performed are typicallymade on a monthly basis based onactually costs incurred at agreedrates. The parties will usually agreea target final contract price witha capped sharing mechanism forsavings and any cost overrun.
The Sponsorswill ultimatelyaccept the riskof anymaterial costoverrun.
Appendix 1
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EPC riskallocation
Typical EPCM position EPCM riskallocation
Risk typicallytransferred to
the contractor
EPC EPCM
EPC contractorto provideperformanceguaranteesin respect ofthe completedplant.
The EPCM contractor typicallyaccepts full responsibility for thefinal design and for it meeting therequired technical and performancerequirements and will typically beresponsible for coordinating thedesign produced by other parties.
Establishing that a performance
failure has resulted from the designproduced by the EPCM contractorand not from the implementationof such design by other contractorsmay not always be straight forward.
The liability of the EPCM contractorfor design failure will however belimited as set out below.
Due tointerfaceissues relatingto identifyingthe partyresponsibleforperformancefailure and themore limitedliabilitiesaccepted byparties underthe EPCMstructure,it is morelikely that themajority of theliability for anysubstantive
performancefailure willretained bythe Sponsors.
Any limit onliability toprovidesufficientcoverage forrecovery of
amountsoutstandingunder the termsof the financedocumentation.Appropriatecarve outs to beagreed inrespect ofwhich the EPCcontractorsliability will be
unlimited.
The EPCM contractors liability willtypically be limited to anythingfrom 50-100% the EPCM contractprice (which will typically be US$5-10m) or, as is more common in themining sector, re-performance of the
services.Carve outs from the liability cap areusually limited to those liabilitiesthan can not be limited at law.Sums recoverable from the othercontractors in the aggregate (onthe assumption that the partiesresponsible can be held to account)are unlikely to be of the order ofsums recoverable from an EPCcontractor under the EPC structure.
The Sponsors(andultimatelythe lenders)recoursefor recovery
of debtoutstandingand otherlosses in aproject defaultscenario willbe limited.The residualliability inthis regardwill ultimatelybe a Sponsor
risk.
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EPC riskallocation
Typical EPCM position EPCM riskallocation
Risk typicallytransferred tothe contractor
EPC EPCM
Securitypackage toinclude liquidperformancesecurity,retentionsand parentcompany
guarantees.
Whilst parent company guaranteestend to be procured, it would be lessusual for EPCM contractors in themining sector to provide other liquidforms of security.
The EPCM position in this regardis symptomatic of the nature and
extent of liability being accepted bythe EPCM contractor.
The nature and extent of thesecurity package obtainable fromcontractors, services providers andplant and equipment suppliers willbe determined on a project specificbasis.
Sponsorsaccept cashflow riskduring theperiod inwhich a claimis establishedagainst
the EPCMcontractorand sumsfor whichthe EPCMcontractoris liable arerecovered.
/
Appendix 1
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Contacts
For further information, please contact:
Mark Berry
PartnerNorton Rose LLP
Tel +44 20 7444 [email protected]
Matthew Hardwick
Associate
Norton Rose LLPTel +44 20 7444 [email protected]
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