ABSTRACT
Engineering, Procurement and Construction EPC contracts (“EPC Contracts” or “EPC Agreements”) are mostly preferred by both private sector investors as well as public institutions conducting large-scale tenders and construction works. In this type of contracts, contractor is responsible for the all stages of the project from designing to construction and delivery of the plant or the building and employer is responsible for the payment of the contract price. In recent years, the employment of EPC Contracts that collect the responsibility at some point become more preferable and frequently seen. In this article, EPC Contracts and especially obligation of procurement which constitutes the essence of EPC Contracts and procurement structures categorized pursuant to source of financing or purchasing of materials will be examined within the context of both Turkish Law and EPC Contracts.
1. INTRODUCTION
We witness a rapid change of innovations emerge since the beginning of early 21st century. These innovations are pre-dominantly conceivable in the construction sector, which requires machine utilization and experience, like in other sectors. Because of these innovations, companies are able to expand abroad and take up construction projects outside they territory, which generate both domestic and foreign investments and corporations Due to the nature of construction sector disputes are unavoidable to arise in this multilateral sector, which can be avoided if parties can draw a tailor made contract which suits their needs.
Turnkey contracts fill the gap that is left open in the construction sector and can briefly be described as a readyto-use immovable – construction – model, delivered to the employer by the contractor with a lump-sum price. However, turnkey contracts contain some essential components which embrace the whole risky construction procedure, form the beginning till the end. Turnkey contracts necessitate field engineering, so these contracts are standardized like the other construction contracts. These standard contract documents involve some foreseeable and negotiable constant principles and help to diverse the risk, which the construction sector faces.
Turkish companies commenced signing construction contracts from 1970’s onwards that are prepared by “Federation Internationale Des Ingenieurs Conseils” (“FIDIC”) according to the standard contract rules with international tenders. Six different contract books are prepared by FIDIC, in accordance with purposes of construction contracts. In our article, methods of procurement will be examined in the context of Conditions of Contract for EPC/ Turnkey – Silver Book prepared for the turnkey contract by FIDIC.
In this context, the general structure about turnkey contract prepared according to EPC standards and, the place of procurement of construction contracts in Turkish Law of Obligations and EPC construction contracts, and methods of procurement are explained in our article within the scope of law.
2. EPC CONTRACT IN GENERAL
The contractor has a key role in designing and making the project in EPC1 contracts, prepared for turnkey projects. In turnkey projects, liabilities of designing and making the project belong to the highest level contractor in return of an amount paid by the employer. After completing and delivering the construction, the intention is that the plant can be activated by the employer with just ‘turning the key’. Since all liability will be beard by the contractor, it is not necessary to examine whether or not a fault in these kinds of contracts belongs to the contractor. The bottom line in these contracts that the contractor is liable in case of faults, defects and deficiencies within the realm of the project which makes the construction projects appealing for employers.
EPC contracts have certain steps. The first steps include the preparation of the plans and projects of the construction, supplying and buying the materials, and completing and delivering the construction. However, liabilities on the side of the contractor does not finish upon the delivery has been made, but the liability continue after construction and covers also trial tests delivering the plant, staff procurement and educating these staff amongst others. Additionally if the contractor promises to deliver the products, a delivery contract is needed, and the contractor can receive the payment only after this process has been completed.
When we examine the contractor’s obligations within the scope of EPC contracts, the contractor, being liable for the construction from the start of the process onwards is obliged to provide the plans and projects of construction. The contractor can procure this by his/herself; or he or she can also procure via an architect. On the other hand there are examples where plans and projects are procured by the employer himself.
After completing plans and projects of the construction, the main obligation of the contractor is to complete the construction, meaning that he can start building. In this step, the contractor should plan the building site, construct the machines and the other tools, and produce according to the construction type. According to this procedure, the contractor should determine the necessary machines and construction products, the staff, which are needed for the construction and all engineering and management services required for both establishing buying relations and buying2.
Before delivering the construction, the contractor, who is obliged to comply with the requirements of the contract, should assure that the employer can operate the plant without any problem. In other words, the contractor has to make everything required to operate the plant. These duties may contain for instance, getting license for the right of technologic retention, know-how utilization license and its transfer, providing management services or educating the staff of the employer, providing technical and commercial know-how amongst others. Moreover, sometimes, engagements of maintenance of the plant or auxiliary equipment procurement contracts and long termed services can also be added as the contractor’s liabilities after the completing of the plant/construction3.
Other obligations like arranging works4, verification5 of situations and information about the substructure of the construction site or making the trial test determined in the contract belong to the contractor as well.
When EPC Contract necessitates the constructions of big plants, after completing the construction, the contractor must provide the staff in respect of the obligation of providing equipment and material6. Not only is contractor obliged to provide for the operation of the plant, he is also obliged to provide the necessary training of the staff as well. These trainings can contain during the procession of the plant or a technical trip to the other similar plants7 8.
In EPC Contracts, the contractor should also provide the substructure works of the construction and also water and electricity services of the plant9. According to this procedure, technology transfer provides that the contractor fulfills his/her obligations arising from the contract and the employer can obtain maximum benefit from the plant10. Also, the contractor should consider the technology license required for completing the construction, patent and know-how rights11.
The nature of EPC contract requires that the obligation of the contractor does not end with merely fulfilling the duty of payment, but includes also other duties, which goes along with operating the construction plant. The examples of his/her obligation for both before and after completing the construction can be summarized as getting the necessary permissions for the construction, a building license, permission from the administration/ government or private person or to make a contract with them to provide water, energy or gas to the plant; to get permission from the administration and customs for imported materials and equipment, which are used in the construction, by being in a cooperation with the contractor; if the turnkey construction is a production plant, the employer should provide raw material need and to deliver the product after the production.
3. THE OBLIGATION OF TOOLS AND EQUIPMENT AND MATERIAL PROCUREMENT AS REGULATED IN THE LAW OF OBLIGATIONS
Contractor’s obligation regarding the tools, equipment and material procurement is regulated in Article 471 and Article 472 of the Turkish Law of Obligations (“TCO”), and a more specified regulations can be found in Article 20 of the General Specifications for the Construction Affairs (“GSCA”) regulating the obligations on tools-equipment and Article 31 on obligations regarding material.
With regarding the construction work, tools (and equipment) and facilities present in the providers ownership, benefited in the course of the construction and excluded from the content of the construction work and separable from the work even if they are worn out after the construction work is completed. Small tools used by the constructors or workers are called appurtenances12.
Material term can be explained as objects or facilities that are included in the content of the construction work or integrated with it or the integral parts of it13 14.
3.1. Procurement of Tools and Equipment
According the last Paragraph of Article 471, the contractor provides the tools and equipment and material for the construction work to be built unless other customary usage or an agreement is available. However, contractor does not have any obligation on manufacturing these tools and equipment15 16. Yet, for the proper performance of the work, the contractor determines (unless otherwise provided in the contract) to what extent hand labor or tools and machines will be applied17 18. The provision on providence of tools and equipment by the contractor regulated under the Article 471 last paragraph of the TCO take the form of regulatory provision due to the expression “unless customary usage or an agreement is provided”. Therefore, parties can agree that employer will provide the tools and equipment.
Tools and equipment refers to things that can be separated from work and recollected by the contractor after the construction work is completed. Necessary tools and equipment in a construction site may entail construction machinery, engines, cranes, concrete blocks, machinery replacement parts, scaffolds, sheds, temporary power lines, appurtenances used by the workers and the constructors. Contractor, unless otherwise provided in the contract, has an obligation of not only providing these tools and equipment, but also has an obligation of maintaining and preserving them as well as covering the operation expenses. Besides, after the completion of the construction work and the delivery made to the employer, he has to remove the tools and equipment from the construction site. For instance; contractor must, remove scaffolds, dismantle scaffolds, remove unused concrete blocks and construction machinery off the construction site. These operations are included in the scope of the contractor’s delivery obligation19 20.
Unless otherwise provided in the contract, it is not possible to add expenses related to the contractor’s obligation of providing tools and equipment to the contract price. Commercial practices are also formed in this direction21 22.
Contractor who is responsible since the signing date of the contract due to the nature of the Turnkey Projects, cannot ask for an additional fee for neither providing the tools and equipment nor removing them after completing the construction work. As the expenses on providing tools and equipment lies with the contractor, tools and equipment expenses are calculated prior to the contract price agreed as lump-sum fee. Removing the tools and equipment after the performance is contractor’s responsibility23.
Tools and equipment which are provided by the contractor need to be appropriate for the construction, both quality and quantity wise. In order to speed up the construction, contractor cannot apply any extra or expensive tools and equipment that goes beyond reason and it is not expected of him to provide tools higher than the quality of the construction. Likewise, avoiding expenses by using insufficient and inappropriate tools constitutes a breach of obligation as well. As a result, if the construction is delayed due to the insufficient and featureless tools and equipment used by the contractor or there is a defective construction in question, contractor is responsible against the employer24.
3.2. Procurement of the Material
Material is the substance of the construction work. According to Aydemir, material consists of all necessary stuff for the existence of the construction that becomes a part of it by being used like brick, tile, wood, rock, sand, cement, pebble, lime, plaster, glass, paint, electricity cables, all kinds of mine, plastic or concrete pipe and all components s that facilitate the elevator, heater, natural gas, water, electricity, telephone forms the material. Although some of these facilities are removable, being an integral part of the construction makes their ownership belong to the employer. Material can be raw or semifinished. Sand and rock is raw material. Materials used in the construction like iron, cement, pebble are semifinished materials. While some writers argue that lands and plans are not counted as material in this sense, article 472/II of the TCO can also be applied by analogy to these25. Even though contractor is obligated to use and deliver the material, he is not obligated to manufacture it.
The obligation of providing material is regulated for both the contractor and the employer, is regulated in article 472 TCO, which the parties can agree in a contract. Construction contract divided into two as “common construction contract” and “construction work delivery contract” in terms of providing the material. In the ordinary construction contract, obligation of providing the material lies with the employer, while in construction work delivery contract, the contractor has to provide both the material and creates the construction work. Construction work delivery contract can also be considered as a construction contract regarding the quality26. This law provisions, related to construction work delivery contract, also apply to Turnkey contracts. This is why obligation of providing material regarding the construction work delivery contract will be discussed hereunder.
4. MATERIAL PROCUREMENT STRUCTURE
Procurement methods, which can be considered within the scope of EPC Contracts, differ for the provider (contractor in general) as regards to the volume and the type of the work performed under the Project. The basic principle of commercial relations, high profit with less expense, is also applicable for these contracts. Therefore, the procurement methods used in EPC Contracts differ mostly because of the financial concerns.
There are also other reasons of the differentiation of the procurement methods. For instance, the new investment incentive policies that are brought to agenda in the last years in Turkey is specifically designed for encouraging investments, which have potential for decreasing the import addiction of intermediate goods, which are important for Turkey’s strategic sectors. Employers, who have the right of benefit from these incentive policies, can undertake the procurement works of the EPC contract.
Through successful supply chain and a well-organized procurement, customer satisfaction increases, while operational loss of time, expenses and product defects decrease. If a well-organized procurement can be provided, demand uncertainty decreases and companies do not have to stock unnecessarily. With this method, cash remains in the company.
4.1. Offshore Procurement – Onshore Procurement Distinction
In the search for financial sources to cover major projects it might be money saving to separate the construction contract into two parts as onshore and offshore contract in terms of not only tax reduction but also other jeopardized commercial benefits.
Difference between the responsibilities of Onshore Contractor and Offshore Contractor can be explained as follows: Offshore Contractor is only responsible for design supply and offshore (where the project is located) engineering services and supply of offshore plant, equipment or/and materials. Notwithstanding, the Onshore Contractor shall deal with (i) the installation of the above offshore Equipment when it comes inshore; (ii) supply of Equipment within the boundaries of host country; and (iii) other inside activities besides construction, testing, commissioning including potential onshore design and engineering service.
But, despite this money-saving structure of splitting the contract into two pieces this system broke the main logic of signing an EPC contract. The core meaning of signing an EPC contract is to gather responsibility around a secluded contractor. Hence, in case of a situation that hinders the performance of the contract, the problem can be solved swiftly by one contractor. Therefore, signing the contract with two different contractors is completely against the logic of signing of an EPC contract.
To avoid such unintended consequences of tax reduction and despite all other benefits of the agreement, mostly named Co-Ordination Agreement or Wrap Around Guarantee (WAG) are signed. These agreements are regulated to wrap the obligation to one Project Company to cover any gap in responsibility situation.
Parties, in these types of contracts are Project Company and Offshore Contractor or its parent company. By doing this, not only tax reduction gained but also stable responsibility chart which is probably the most important case about loan negotiations with Banks.
It is necessary to express the methodology lies under the idea of splitting the contract and how it reduces taxes. The split structure is designed to reduce the exposure to local taxes on offshore Equipment, or any design work performed outside the host country, becoming subject to local taxes. The classes of taxes, both direct and indirect, that an EPC Contractor and a Project Company may be exposed to in the host country include: value added taxes, withholding taxes, technology transfer taxes, import and stamp duties, local construction and property license fees and duties, and onshore income or profit taxes.
Splitting EPC Contract’s procurement obligation into two pieces does not always result in a desired way. Indeed, in some jurisdictions a mere reference in an Onshore Contract to an Offshore Contract (or vice-versa) can defeat the tax advantages that the split structure is intended to achieve. This scenario may normally be avoided through careful drafting. Appropriate local taxation and legal advice should always be sought before deciding whether to split an EPC contract into two or more contracts to take advantage of taxation savings and other commercial benefits.
Although a reduction in contract resulting in tax savings appears as commercially beneficial to a Project Company, this reduction must be weighed against the costs and risks involved in splitting the EPC contract. A split structure can be initiated at any time prior to execution of the project documents.
4.2. Direct Procurement - Indirect Procurement Distinction
Procurement is becoming more and more important every day for the largest companies in the world because it became an essential in the face of managing astronomic operational costs. This is the result of the idea to consider the purchase as a strategic implementation rather than a basic step in supply chain. The fundamental difference between direct and indirect procurements is essentially related to the product that is bought.
As the name implies direct procurement connotes the operation of raw material directly instead of buying it operated and stems from the idea of manufacturing. Direct procurement is the best possible cost, quality and reliability option for any case in supply chain management.
Nevertheless, subject of indirect procurement denotes basically that buying things you need to keep your business alive but you cannot manufacture such as services or suppliers. Those can be identified by checking whether it is about the main business topic or not. For example, if Samsung purchases fiberglass or copper to generate board circuit then it is direct procurement; however, if Samsung calls for a technician to check the main fuse then it is indirect procurement.
5. CONCLUSION
Trade requires an alternative dispute settlement mechanisms, which ensures to settle disputes regarding construction projects quickly and on the construction site if possible especially on the international construction projects. A modern procurement system should begin with an efficient pre proficiency assessment for the applicants and continue with a procurement procedure based upon high quality procurement documents and with balanced terms of a contract, which distributes the possible future risks fairly between the employer and the contractor.
EPC Contracts come upon as detailed regulations that provide solutions for these kinds of problems faced in the developing construction sector. By courtesy of this, the context of the responsibilities and risks are clearly determined of which either the employer or the contractor undertake.
Procurement line, which is the most important line of the EPC Contracts consists of engineering, procurement and construction, differs both financially and physically with regards to risks and responsibility. In order for the employer and the contractor to sign a construction contract at global standards and to carry out the project sturdily they need to draw up an EPC Contract, by choosing the most suitable procurement method for the project volume.
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DİPNOT
1 EPC contracts, the contractor is liable from the design of the construction, operation of Works and making the construction. That’s why, in FIDIC Grey Book, “EPC/Turnkey” words are used together; it means that “EPC/Turnkey” words have same meaning and they are interchangeable. (Hosie, 2007: 2).
2 Ergin, D. A. 2003. The Turnkey Contract according to the Code of Obligations, Unpublished Post Graduate Thesis. Ankara.
3 Ergin , D. A. 2203. The Turnkey Contract According to the Code of Obligations, Unpublished Post Graduate Thesis. Ankara.
4 Huse, Joseph A. 2002. Understanding and Negotiating Turnkey and EPC Contracts. Sweet and Maxwell, London.
5 Huse, Joseph A. 2002. Understanding and Negotiating Turnkey and EPC Contracts. Sweet and Maxwell, London.
6 Huse, Joseph A. 2002. Understanding and Negotiating Turnkey and EPC Contracts. Sweet and Maxwell, London.
7 Dayındarlı, K. 1998. The Consulting Engineering Contract in The Construction Sector. Ankara.
8 Boon, J. A./ Goffin, R. 1987. Les Contrats “Clés en Main” 2. Édition. Masson.
9 Huse, Joseph A. 2002. Understanding and Negotiating Turnkey and EPC Contracts. Sweet and Maxwell, London.
10 Boon, J. A./ Goffin, R. 1987. Les Contrats “Clés en Main” 2. Édition. Masson.
11 Huse, Joseph A. 2002. Understanding and Negotiating Turnkey and EPC Contracts. Sweet and Maxwell, London.
12 Aydemir, E. 2009. The Contract of Work and the Construction Law. Ankara.
13 Aydemir, E. 2009. The Contract of Work and the Construction Law. Ankara.
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18 Uygur, T. 1998. The Construction Law with Explanation and the Legal Precedent, Volume 1-2. Ankara.
19 Dayındarlı, K. 2008. Default of the Employer and the Contractor in the Contract of Work. Ankara.
20 Tandoğan, H. 1987. Law of Obligations Private Liability Relations. Ankara.
21 Duman, H. İ. 2008. The Construction Law with Explanation and the Legal Precedent. Istanbul.
22 Karataş, İ. 2004. Contracts of Work (Construction), Ankara.
23 Duman, H. İ. 2008. The Construction Law with Explanation and the Legal Precedent. Istanbul.
24 Duman, H. İ. 2008. The Construction Law with Explanation and the Legal Precedent. Istanbul.
25 Tandoğan has the opposite opinion; he does not determine the working equipment, the land of the construction and plans belonging to both the employer and the contractor as materials.(Tandoğan, 1987:104)
26 Eren, F. 2001. “The Contractor’s Obligations and the Reasons of Defaulting these Obligations in the Construction Contract (II)”, The Construction Contract (The Common/Mutual Seminar for AdministratorOperator Engineers and Legal Experts/Lawyers), p. 69. Ankara.
