Cost and Variation Management in EPC Contracts: MR Christopher Chuah

Cost and Variation Management
in EPC Contracts
Mr Christopher Chuah
Partner
Infrastructure, Projects & Construction
Engineering, Procurements & Construction
contracts
The EPC Contract – General Overview
– In its most extreme form, may be referred to as a Turnkey contract
• Places all design and construction responsibility on the contractor
• Reduced involvement and intervention by the Employer
• No need to identify party to attribute liability for defect as responsibility for
scope of works very broad and will fall on the contractor
• Attractive to Employers as it preserves contractor liability
• May be additional benefit of efficiency in the design and construction process
to achieve faster completion time and reduction in the price of the project
– Contractor would require broad range of experience across different
industries
• For e.g., where the scope of works encompasses civil and structural works,
specialized M&E works etc.
2
contracts
The EPC Contract – Importance of Tender Process
– The Request for Tender takes on greater importance than in
traditional construction contract
• Minimal/ no opportunity for the Employer or its Consultant to amplify or
develop the design after call for and submission of tender
• Employer to state in precision and detail its requirements in terms of
capacities and performance required of the works
• Employer to invest greater resources at tender review to ensure that
the Contractor’s proposed design meets the Employer’s requirements
and are of the requisite quality
• Contractor also to invest greater resources in tender preparation as it is
responsible for buildability of the Project
• May be necessary to carry out pre-qualification due diligence to
ascertain that the contractors are competent and capable of
performance the contract
3
contracts
The EPC Contract – Pre-tender considerations
– Determination of extent of role of the Employer/Consultant
(A) Least involved (B) Moderate (C) Most involved
(A) Minimal involvement: Employer only to turn the key after completion to
commence operation of the constructed facility.
(B) Moderate involvement: Employer/ Consultant to supervise Contractor’s
works and issue instructions or request for proposals
(C) Most involved/ Semi-Turnkey: Combination of turnkey contract in respect
of one area of works, with a traditional building contract in respect of
another area of works in the same project.
Disadvantage is risk of potential cost/ time claims where a contractor alleged poor
co-ordination between packages
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Engineering, Procurements & Construction contracts
Cost Management
Pre-tender considerations
– Employer to rationalize price of the contract
• Determine design source: Employer’s inhouse staff/ independent
Consultant/ the Contractor
– Oversight function
• Allocation of co-ordination responsibility as between:
– individual elements of the design
– management of incoming and on-site material
– inspection and testing crews belong to the Employer/ Contractor/
local regulatory authorities
• Determine party undertaking co-ordination responsibility
– Employer’s inhouse staff/ independent Consultant/ Contractor/
Management Contractor
– Determine Project duration and define milestones
5
Cost Management
The EPC Contract – Key considerations
– Risk transfer: greater amount of risk placed on the Contractor, to
the benefit of the Employer
• However, the Contractor is likely to price for the risk especially in a
low-competition environment.
• The benefit of risk transfer is likely to manifest in extra cost to the
Employer
• Ultimately, the balance of risk assumption by either party is determined
by the balance of power between the contracting parties.
– In an employer/ developer’s market, the Contractor may have to assume
greater risk without being commensurately compensated by an increase in
contract price.
– During a construction boom such as in Singapore at present, employers can
expect more resistance from Contractors in assuming additional risk.
Alternatively, the Contractors will price for such additional risks during
tender.
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Cost Management
The EPC Contract – Lump Sum Pricing
– Lump Sum pricing is generally used due to difficulties in verification
by the Employer or its consultants of valuation of interim payment
claims submitted by the contractor.
Benefits of lump sum pricing:
• Provides greater certainty in overall cost
• Provides greater certainty in timing of payments
• Minimize front loading by the Contractor
• Encourages rapid or early completion
• Facilitates financing (Lenders will have greater certainty of financial
exposure and timing of draw downs)
However, lump sum pricing does not preclude the contractor, under
certain circumstances, from claiming an increase in the contract price.
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Cost Management
Contract Structure: Semi-Turnkey

– The Employer may:
• Employ directly and separately a contractor to carry out a highly
specialized portion of the Works;
• Enter into a supply agreement directly with the supplier of any highly
specialized equipment/ machinery required for the facility.
– This structure must be harmonized by the provision of contractual

obligations on the turnkey contractor and the direct contractor to
complete the Project in mutual alliance. Care must be taken to
ensure the proper management of technical interfaces, construction
schedules and construction risk on a Project-wide basis.
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Cost Management
Contract Structure: Split EPC Contracts
– In a split EPC Project, the EPC Contract is divided into 2 separate

contracts: the “Onshore Contract” and the “Offshore Contract”.
– Benefits:
• reduced tax obligations, allow for the avoidance of local taxes on
equipment and materials purchased “offshore”.
• So that design work performed outside the host country will not be
subject to local taxes
– However, crucial to first consult and seek the advice of local tax
advisor before so doing, as the split structure and its tax advantages
may be defeated by regulations in some jurisdictions.
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Cost Management
Contract Structure: Split EPC Contracts ‘ctd

– The Offshore Contractor’s responsibilities would largely be
limited to supply of design and engineering consultancy
services and the supply of plant, equipment and material from
outside the host country.
– The Onshore Contractor on the other hand, will install the
equipment or machinery sourced and procured by the
Offshore Contractor, and carry out some onshore design
work, construction, testing and commissioning etc on site.
– The relationship and the overall structure should be set out
under an Umbrella Agreement
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Cost Management
Contract Structure: Split EPC Contracts ‘ctd

– Legal issues to be considered by the Employer in structuring
split EPC Contracts:
• the 2 separate Specifications must be reviewed in conjunction to

ensure the covering of the whole of the Works
• Either one of the Contractors shall assume the overall design
obligations
• Interfacing in supply/ procurement timelines and completion of
phases as between the 2 Contractors. If the LD and EOT regimes
are also split, these should be reviewed for consistency.
• Transfer of risk for equipment sourced from offshore on delivery
of equipment
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Cost Management
Provisional Sums
– There may be expenditures whose cost cannot be determined
at the time of tender and contracting, such as subcontracted
works or purchase/supply agreements that are only entered
into after the signing of the EPC contract.
– Where the actual cost exceeds the sum allowed as a
‘provisional sum’, the contract price is increased.
– Such provision may be useful insofar as it gives the Employer
some influence over the Project
– However, it is not entirely in place in an EPC contract as it
carves out areas from the absolute responsibility of the
Contract.
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Cost Management
Key contractual terms that impact cost
– Risk
• “the Contractor shall take full responsibility for the care of the Works and
materials and Plant from the Commencement Date until the [date of TOP].”
• In negotiating the lump sum price, the Contractor will incorporate a premium to
reflect the assumed risks – the quantum of such premium will be influenced by
market forces.
– Variations
• EPC contracts generally attempt to limit any opportunity by the contract to claim
for additional cost. However, the acceptance of variations may achieve a lower
contract price and impart flexibility to the contract in dealing with risks and
contingencies
– Force Majeure/ Unforeseeable Difficulties

• “the Contractor accepts total responsibility for having foreseen all difficulties and
costs of successfully completing the Works”
• “the Contract Price shall not be adjusted to take account of any unforeseen
difficulties or costs”
13
Cost Management
The Tender Process: Open Book tendering
– A “open book” method of procurement allows the Employer

and/or its Consultants to have access to project cost
information.
– The Employer may choose to enter into key orders/
agreements for e.g. the supply of specialized equipment/
machinery first. These orders are later novated to the EPC
contractor (subject to agreement on the EPC Contractor’s
contingencies and profit) to return to a more conventional
EPC contract structure. Alternatively, the EPC Contractor
may be invited to continue operations on an open book
basis.
– Benefits: more transparency, and reduce bidding and tender
review period
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Cost Management
The Tender Process: Costs associated with Tender

– Costs to the Contractor
• Cost of tender is usually very high, taking into account fact that
the Contractor must have a very advanced and detailed design
when tendering for a turnkey contract
• Employer may consider offering some payment for tendering,
to bona fide serious bidders, regardless of success of tender.
This will offset some of the Contractor’s cost of tendering and
may increase the quality of the bidding pool.
– Costs to the Employer
• Cost of verifying the design could be quite high. Extensive due
diligence required to verify quality and efficiency of Contractor’s
proposed design and specifications, to ensure no underdesign.
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Cost Management
The Tender Process: Costs associated with Tender
– Costs to the Employer ‘ctd
• Employer also to compare between respective merits of various
tenders, all of which possess pros and cons in different aspects I.e.
operating costs of completed facility; performance strengths etc.
– Two-stage bidding process
• The World Bank suggests a two-stage bidding process to avoid the
acceptance of bids based purely on price rather than quality of design.
• First Stage: Contractors submit unpriced technical proposals
• Second Stage: Price consideration
• Such a mechanism will encourage the employer to give precedence and
weight to the quality of the design, then only secondly at the bid price.
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Cost Management

Sufficiency of the Contract Price
“The Contract shall be deemed to have satisfied himself as to the correctness
and sufficiency of the Contract Price.”
– Provisions must state that the contract price is deemed to be
based on all data, interpretations, information, examination
and all relevant information
– Increases or adjustments to the contract price
– No price escalation clause:
• “The contract price shall not take into account any unforeseen
difficulties or costs, except as otherwise stated in the contract.”
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Cost Management
Key contractual terms that impact cost ‘ctd

– Completion delays and acceleration
• Provisions that the Employer may consider:
– Attach the Contractor’s submitted programme to the contract and
specify that this shall not be modified without the employer’s
approval.
– Require that the critical path be described in the main programme
– Suspension attributable to the Contractor: no entitlement to claim
for time/ cost
– Bonus for early completion
• Lenders may require programme updates with periodic
progress reports or verification by an independent engineer.
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Cost Management

– Completion delays and acceleration ‘ctd
• Provisions that Contractor may consider:
– Bonus payments for early completion
– Right to receive increase in contract price for costs incurred arising
from delays occasioned by the authorities
– Specify, in reference to the programme, what constitutes
acceleration. This is necessary as the employer’s minimal
involvement would also mean it may not recognize accelerative
measures.
– Costs arising from any suspension or Stop Work Order which is
not attributable to the contractor.
» “The Contractor is entitled to seek an adjustment of the Contract Price
and/ or time if its cost or time to performa the Work has been
adversely impacted by any suspension of stoppage of work by
Owner.”
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Cost Management
– Foreign exchange fluctuation
– Material fluctuation
• “The contract price shall not take into account any unforeseen
difficulties or costs, except as otherwise stated in the contract.”
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Cost Management
Value Engineering
– FIDIC Silver Book: Cl 13.2(1)
The Contractor may submit to the Employer a written proposal at
any time, which will, if adopted:
• Accelerate completion
• Reduce maintenance and operating costs to the Employer
• Improve the efficiency or value of the completed works
– Orgalime Turn Key: Cl 8.2
The Contractor may inform the Purchaser of possible variations
which the Contractor considers to be in the interest of the
Purchaser
– Under both standard conditions, the Contractor holds control of
value engineering since it is restricted to his opinion on the matter.21
Variation Management
Variation/ Change Orders generally
“The Contractor may request and the Owner may order changes in the Work
within the scope of the Contract Documents …. “
The Employer may vary the works during construction by

either altering the criteria specific in the Employer’s
Requirements, or by directly altering the design submitted by
the Contractor. Limitation can be placed on the extent of the
Employer’s power to order variations. Contractor may specify
that all ordered changes, unless accepted by the Contractor,
are at the risk of the Employer.
Contractor generally not permitted to alter the Works without

the Employer’s consent.
22
Minor Changes not constituting Variation
“The Contractor may make minor changes in the design and construction of
the Project consistent with the intent of the Contract Documents which do not
involve an adjustment in the Contract Price …and do not materially and
adversely affect the design of the Project… “
The Conditions of the EPC contract should provide flexibility to

the Contractor to exercise its discretion to make minor changes
so long as the design of the Project as awarded is not
compromised.
The Contractor must be required to inform the Employer of the
changes in writing and to keep a record of all such minor
changes.
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Limit / Prohibit drastic Variations
– The Contractor may desire the limitation of excessive

Variations which may radically expand/ reduce the scope of
the Contract Works or alter the nature of the project
– See, Engineering Advancement Association of Japan

Model Form: Cl 39.7
• “The Contractor may object to any Change … where the aggregate
effect of compliance therewith and with all other Change Orders which
have already become binding …. would be to increase or decrease the
Contract Price as original set form in [Contract Price] of the Agreement
by more than fifteen per cent (15%) …”
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Costs due to preparation of variations
– FIDIC Silver Book: Cl 13.2(2)
• The party initiating the proposal for variation prepares it at his own cost,
i.e.
– Contractor bears cost of Contractor-initiated proposal.
– The Employer prepares any variation instruction at his own cost
– the Contractor is not entitled to any payment for responding to a request
– Orgalime Turn Key: Cl 8.6
• Where a variation is requested by the Purchaser, the Purchaser shall
reimburse the Contractor any costs incurred in examining the
consequences of the variation
• Silent on which party is to bear the cost of preparation of variations in the
event of Contractor-initiated proposals
– Recommendation:
• The costs in this respect should be expressly agreed upon and stated in
the EPC contract, especially when detailed and expensive design is
involved.
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Determination of costs arising from variations
The various standard form contracts set out the method(s) for the
determination of costs of variations. The provisions describing the
methods of valuation range from the broadly-worded to very
specific, regimented approaches.
In ascending order of specificity, the variation cost determination

clauses in the various standard forms are as follows:-
1) Orgalime Turn Key: Cl 8.5

• “The Contractor shall, without undue delay … notify the Purchaser
whether it is possible to carry out the variation and, if so, specify the
manner of execution and the effects of the variation on the Contract
Price, the Main Time Schedule and other terms …”
• No constructive guideline as to method of determination of cost or
valuation of the effect o the variation on the Contract Price.
26
Determination of costs arising from variations ‘ctd
2) European International Contractors Conditions of Contract:

Cl 11.1.2
• “Within 28 days of receipt of the [variation order] from the
Owner the Contractor shall inform the Owner of the cost of
such Variation(s) including a reasonable cost break down in a
form of mutually agreed indicating adjustment of the Contract
Price …”
• No constructive guideline as to method of determination of cost
or valuation of the effect o the variation on the Contract Price.
27
3) FIDIC Silver Book: Cl 13.3(4), 3.5
• If no agreement reached following the Contractor’s proposal, the
Employer shall proceed to determine adjustments to the Contract
Price and the Schedule of Payments
– Adjustments shall include reasonable profit, and take into
account the Contractor’s submissions regarding value
engineering
• Silent on compensation on delay arising from variation
4) Engineering Advancement Association of Japan Model
Form: Cl 39.5, 39.8
• Cl 39.5: Adjustment of Contract Price shall as far as practicable be
calculated in accordance with the unit rates. If the unit rates are
unavailable or inequitable, the parties to agree specific rates for the
valuation of the Change
• Cl 39.8: If parties cannot agree within 60 days of the variation
instruction, either party may refer the dispute to an expert
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5) AGC Doc No. 415 Standard Form: Cl 8.4

• 3 methods for determination of increase/ decrease of Contract
Price:-
– 1) based on unit prices set forth in the Contract
– 2) mutually accepted, itemized lump sum
– 3) if cannot agree, the adjustment in the Contract Price shall be
“determined by the reasonable expense and savings of the
performance of the Work resulting from the change.”
In order for the latter provision to work, crucial that the Contract provides
that the Contractor shall maintain a documented, itemized accounting
evidence the expenses and savings.
29
6) Design-Build Institute of America Standard Form: Article 9.4

• 4 methods for determination of increase/ decrease of Contract
Price:-
– 1) based on unit prices set forth in the Contract
– 2) mutually accepted, itemized lump sum
– 3) Costs, fees and any other markups set form in the Contract
– 4) if cannot agree, the adjustment in the Contract Price shall be
“determined by the reasonable expense and savings of the
performance of the Work resulting from the change.”
In order for the latter provision to work, crucial that the Contract provides
that the Contractor shall maintain a documented, itemized accounting
evidence the expenses and savings.
30
– Recommendation:
• If any variation order/ work change directive issued by the
Employer cannot be agreed upon, and the Contract does not
provide a specific guideline, there is a risk of the Contractor
proceeding with the instruction to carry out the works and
commence claim in quantum meruit thereafter.
• The Employer should be cautioned against imposing expensive
variations on the contractor without affording sufficient
compensation even if the EPC contract allows the same. The
Employer’s interest in the long-term performance and efficiency
in operating/ maintenance costs of the facility may be
adversely impacted by poor design decisions.
31
Thank You
Christopher Chuah, Partner

Email: christopher.chuah@wongpartnership.com.sg
DID: 6416 8140
32

Cost and Variation Management in EPC Contracts: MR Christopher Chuah

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Cost and Variation Management

(A) Least involved (B) Moderate (C) Most involved

Contract Structure: Semi-Turnkey

– This structure must be harmonized by the provision of contractual

Contract Structure: Split EPC Contracts

– In a split EPC Project, the EPC Contract is divided into 2 separate

Contract Structure: Split EPC Contracts ‘ctd

Contract Structure: Split EPC Contracts ‘ctd

• the 2 separate Specifications must be reviewed in conjunction to

– Force Majeure/ Unforeseeable Difficulties

– A “open book” method of procurement allows the Employer

The Tender Process: Costs associated with Tender

Key contractual terms that impact cost

Key contractual terms that impact cost ‘ctd

Key contractual terms that impact cost ‘ctd

Key contractual terms that impact cost

– Foreign exchange fluctuation

The Employer may vary the works during construction by

Contractor generally not permitted to alter the Works without

The Conditions of the EPC contract should provide flexibility to

– The Contractor may desire the limitation of excessive

– See, Engineering Advancement Association of Japan

In ascending order of specificity, the variation cost determination

1) Orgalime Turn Key: Cl 8.5

2) European International Contractors Conditions of Contract:

5) AGC Doc No. 415 Standard Form: Cl 8.4

6) Design-Build Institute of America Standard Form: Article 9.4

Christopher Chuah, Partner

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