Built to Last: Ensuring quality in EPC contracts

Built to last:

Ensuring quality in EPC contracts

We often see disputes between principals and contractors regarding the quality of works, and most notably where quality has the potential to materially impact the productivity, useful life and overall economic viability of the relevant asset. Here are 8 ways to manage that risk and ensure quality projects are delivered.

1. Compliance with law, good industry practice and standards

In engineering, procurement and construction (EPC) contracts, requiring (and regularly checking) adherence to law, good industry practice and relevant standards is critical for ensuring quality.

Whilst compliance with law is expected at a minimum, good industry practice, provided it is sensibly defined, can put both the principal and contractor at ease in delivering the best outcomes. Further, clear reference to standards (such as AS, NCC, BCA, IEC and ISO) can serve to align the expectations of the parties.

2. Conformance to designs

This is a cornerstone of managing quality in EPC projects. Ensuring that construction reflects approved designs, specifications and other contract documents prevents time-consuming and costly rework.

Design integrity is preserved through a series of reviews, approvals and coordination meetings between clients and relevant contractors and consultants. Establishing clear procedures for approval of designs, and deviating from approved designs, is essential. 

3. Practical completion

Practical completion is a critical milestone in EPC contracts that signifies substantial completion of the project to a point where it is fit for (including safe to) use, though minor defects may still exist.

Tying material milestone payments and release (or even partial release) of contractor-provided security to achievement of practical completion, in conjunction with the prospect of freedom to focus on the next job, can significantly motivate contractors to tick off practical completion requirements, which will often include procurement of certifications required for the intended use of the relevant asset (such as an occupation certificate or approval to commence operation from a utility). 

4. Defect rectification

A defects liability period (DLP) is a designated period after practical completion during which the contractor is (usually much more explicitly than at general law) responsible for rectifying defects. During the DLP, which can range from several weeks to several years depending on the nature of the project, contractors are required to repair or replace any defective work or materials within a prescribed period (or at least  promptly) after the relevant defects are notified, at no additional cost to the principal. This helps ensure that the project meets design, performance and quality requirements long after handover.

Release of the balance of contractor-provided security is often tied to expiry of the DLP, and principals may insist on having the right to conduct defect rectification works where the contractor has failed to respond (at all or in a timely manner) as well as the right to ‘back charge’ the contractor the costs of such rectification works. The two levers work in tandem to incentivise contractors to honour their defect rectification obligations

In addition to during the DLP, principals may insist on having the right to direct rectification of issues at any time prior to practical completion.

5. Inspection and testing

Meaningful inspection and testing are integral to ensuring quality throughout the lifecycle of an EPC project. Inspections are performed at various stages – during design, procurement, construction and commissioning as well as during the DLP, when the asset is in operation – to verify that work conforms to approved designs, specifications and other contract documents and complies with law, good industry practice and relevant standards.

Critical hold points ensure that key tasks, such as structural work or equipment installation, are reviewed before proceeding. This way, quality issues can be promptly addressed along the way so that the parties are not left with significant non-conformances (i.e. a mess) at the end.

Factory acceptance tests (FATs) help ensure that equipment is in good working order before it leaves the factory and site acceptance tests help ensure equipment is in good working order when it is delivered to site, while other on-site inspection and testing protocols (ITPs), including operational performance and safety checks, help confirm that systems function as they are intended to function where they are intended to so function.

6. Performance liquidated damages and bonuses

Performance liquidated damages are damages payable by the contractor to compensate the principal for underperformance by the contractor. The quantum of such damages is calculated using a pre-agreed formula to reflect quantifiable and quantified underperformance from a pre-agreed benchmark (such as the volume of electricity to be exported by a plant over a given period). Conversely, performance bonuses may be paid to reward the contractor exceeding performance targets.

These mechanisms should motivate contractors to get the design and engineering right, use top-shelf suppliers and subcontractors and follow good industry practice. Contractors may seek to manage their exposure by negotiating a cap on performance liquidated damages as a percentage of the contract price.

7. Serial defects obligations

Serial defects regimes usually stipulate that contractors must replace all equipment, components or materials of the same type (or all equipment, components or material of the same type from the same manufacturing batch, shipment or order, or within the same phase, stage or portion of the project) if more than a pre-agreed percentage of such prove defective. Naturally, a lower threshold favours the principal and a higher threshold favours the contractor.

Since the replacement cost of the relevant equipment, components or materials, together with removal, reinstallation, shipping and other related costs, can be considerable, these provisions are often hotly contested at the negotiation stage.

8. Key personnel controls

Principals may also insist that specified key personnel of the contractor are (and continue for the duration of the job to be) engaged in prescribed roles and (other than in exceptional circumstances) will not be replaced other than with the principal’s consent. This helps to ensure the team that wins the job does the job.

Contact us

For tailored advice on managing and ensuring quality in EPC contracts, reach out to our team.