the essential guide to feasibility planning and construction procurement for junior mining companies...

8/13/2019 The Essential Guide to Feasibility Planning and Construction Procurement for Junior Mining Companies Part 2 Detai

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Part 2 Detailed engineeringand constructionAn essential guide to feasibility planning andconstruction procurement for junior mining


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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

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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.


04 Norton Rose LLPAugust 2011


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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.

Norton Rose LLPAugust 2011 05

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




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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.


EPC contracts


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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


EPC contracts


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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


EPC contracts


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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,


EPC contracts


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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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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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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

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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

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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.

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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.

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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.

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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



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


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



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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