Last Updated on 17th October 2023
An EPC (Engineering, Procurement, and Construction) Contract in the construction industry is a contractual agreement between a project owner and the contractor. The contractual framework in an EPC contract enables the owner to transfer the complete risk of design, procurement, and construction to the contractor. The contractor is solely responsible for completing the project and handing it over to the owner in a turnkey condition. This is why EPC contracts are sometimes called turnkey construction contracts or simply turnkey contracts.
Before delving into the intricacies of EPC contracts, let's start with the basics. EPC is an acronym that stands for Engineering, Procurement, and Construction. The term EPC represents almost the entire life cycle of a project. The contractor is fully responsible for the project management, from designing to procurement and then executing the construction phase.
An EPC Contract is a way to mitigate risks without getting involved much in the project management. EPC contracts are designed deliberately to shift the construction risk to the contractor. They hold the contractor accountable for all project operations from the design phase to the construction phase.
As part of the EPC contracting agreement, the EPC contractor or EPC company undertakes three important components of a project:
The EPC phase of a project is often known as the execution phase, which comes after the feasibility study and FEED (Front End Engineering Design) study phase. A FEED study encompasses the basic engineering design study, which covers the different stages and components of a project. A FEED study report is necessary for the tender and bidding stage when the project owner invites tenders from EPC contractors.
An EPC Contract is a risk mitigation and management tool in the form of a project document. In fact, EPC Contracts were specifically conceived to transfer risk to the contractor. They make the contractor responsible for all project activities from the design phase through the construction phase.
Specifically, they make the contractor responsible for all design, engineering, procurement, construction, commissioning, and handover activities of the project, leaving the owner with no responsibilities save for turning the key at project delivery.
Another reason for the widespread use and acceptance of EPC Contracts is that they are strongly preferred by project finance lenders. Project lenders are much more comfortable providing project financing when construction contracts have fixed prices and required dates for completion. Less risk to the lender means the likelihood of your project finance loan being approved increases substantially.
The project owner or project sponsor generally has little to no control over the EPC contractor once the contract is signed. However, the owner can have a presence in the project by appointing a PMT (Project Management Team) or PMC (Project Management Consultant). The PMT can have a Project Manager or Construction Manager to oversee the project proceeds as per the scope of work, and the contract is being followed. The company that conducts the feasibility study, and FEED study, and prepares the design and drawing on behalf of the owner acts as the PMT.
The Design Duties of EPC Contractors are:
The responsibilities in Procurement are:
The functions involved in the construction of a project are as follows:
By choosing an EPC contractor, the Project owner has the following advantages:
The EPC contractors have the responsibility for all spheres of construction. From designing, procuring, and constructing to commissioning and handing over the polished project. Suppose anything goes wrong during the construction of the project. In that case, the EPC contractors must take care of the liabilities. There are Construction Laws that help in the risk mitigation process. Construction law can also release the tensions related to project finance.
The EPC contractors should fix a price for their service. Any cost overrun or savings will be reflected in the contractor’s account.
EPC Contracts must be completed before the guaranteed deadline. If the contractors fail to meet the deadline, they are predisposed to pay for Delay Liquidated Damages (DLD). However, if the project owner interferes with the construction process, the contractors can claim an extension of time.
The project owner can assign detailed specifications to the construction company. It enlists all the criteria the contractor needs to meet. Nevertheless, the construction company can decide how the standards are met.
The EPC Contracts will contain certain Performance Specifications to be met by the contractors. In the event of project failure, they’re liable for Performance Liquidated Damages (PLD).
It is usual for construction contracts to include performance security. It protects the project owners from potential financial losses. The security can be in advance payment, assurance of the parent company, and bank guarantee.
The majority of the EPC Contractors would only enter the contract with limited liability. Generally, an overall liability cap of a hundred percent of the contract fee is practiced.
Generally, the project company has the right to suspend the construction contract.
The project owner usually has the right to order variations to the construction contract.
EPC Contracts can face severe setbacks from Force Majeure events such as earthquakes, hurricanes, epidemics, and wars. In such instances, both parties can excuse themselves from fulfilling their obligations.
Like any other contract, an EPC Contract also has some limitations, albeit fewer in number. The disadvantages of contracting a Turnkey Contractor are:
Construction projects under an EPC contract can be costly. This is due to the high risk faced by the construction contractor. This high cost will aid the contractor in absorbing the risk. In short, a high contract fee is a form of risk allocation. So, the project's lender or sponsor should critically analyze the risks before finalizing any tenders.
The owners of an EPC Project are essentially transferring the power and authority to their contractors. Any interference by the project company can cause costly delays. Also, the intervention by the Owners will help the contracts battle claims against delay damages.
An EPC contract is not limited to the construction industry alone. It is widely used in diverse industries, including power generation, oil and gas, renewable energy, petrochemicals, and more. In each case, the EPC contract acts as the backbone of project management, guaranteeing the successful delivery of complex undertakings.
Check out our 15 Largest Construction (EPC) companies in the world article to learn more about the largest EPC contractors in the world.
EPC contracts can get expensive, and the project owner has less control over the construction. But it is still one of the best contract types for awarding projects. So, governments and large-cap companies prefer an EPC Contract over traditional ones for their construction requirements.
A construction company or consortium of construction companies is approached by a project owner to design and build large complex structures, especially in the oil and gas, energy, power, and infrastructure sectors.
An EPC contract is one of the most widely used construction contracts, especially large and complex construction projects in industries such as oil & gas, energy, and infrastructure. They have emerged as the construction contract of choice in project financing that involves major international development projects.
EPC contracts come in various forms. However, each category can be tailored to the specific needs of the project and project owner. Some common types include lump-sum contracts, cost-reimbursable contracts, and unit-price contracts. The choice of contract type depends on the project's complexity and the risk-sharing arrangement among stakeholders.
The EPC agreement is the heart of the contract, detailing the scope of work, project schedule, quality standards, cost estimates, and the roles and responsibilities of all parties involved. It acts as a legally binding document that provides the project with a clear structure and governance framework.
EPC tenders are the initial stages of project procurement where contractors submit proposals for their EPC services.
The definition of EPCM is Engineering, Procurement, Construction, and Management. Although it sounds similar to an EPC project, an EPCM Contract differs greatly from the former.
An EPC Contract handles design, procurement, construction, and commissioning and hands the project to the end user. In comparison, the EPCM contractor is mainly concerned with the supervision of the project.
On the other hand, an EPCM Contractor is also responsible for the detailed design and the overall project management.
EPC services include designing, consultation, management, supply, procurement, and construction. Under an EPC contract, the project owner or project sponsor hires an EPC company, which then supplies its own material and manpower resources, including engineers, consultants, and suppliers. EPC contractors may even hire different types of subcontractors for specific jobs.
A turnkey contract in construction is one where the project development company or general contractor is fully responsible for every aspect of the project and hands it over to the owner in a ready-to-use state.
Turnkey contracting is an EPC contracting that always includes the complete scope of project work, right from design to construction and, often, commissioning of the facility.
On the contrary, EPC contracting may or may not include the complete project scope. It may either provide the complete service package, including design or may undertake only the construction part.
In an EPC contract, the contractor is responsible for design and technical assessment, whereas, in a lump sum contract, the project owner may consult an independent consultant for a feasibility study, FEED study, technical assessment, design, and drawings of the project. Based on the results, the owner may decide on a project delivery method and hire an EPC contractor to complete the construction part in pre-agreed terms and sum.
EPC companies work either as part of a project, such as construction, or act as project managers on behalf of the owner. However, most EPC companies work on projects right from their conception to the completion stage.