Unravelling the complexities and avoiding disputes in the completion phases
The fundamental principle of an Engineering, Procurement, and Construction (EPC) Contract for the delivery of an oil, gas, or petrochemical facility is that a contractor is obliged to deliver a fully operational facility to an owner. This facility must perform to the specified guaranteed levels, and all costs associated with delivering such a facility are included in a lump- sum turnkey contract price. The completion process of a petrochemical facility (a plant) necessitates the commencement of production to conduct operational and performance testing. Achieving the performance-guarantees stipulated in the contract during the normal and steady operation of a plant can be time-consuming.
Authors: Sergey Pleshakov, Associate Director, Dubai, UAE
The fine-tuning of an already-producing plant can also be a complex and prolonged task. The discovery of defects or deficiencies during commissioning and testing can extend the completion phase from several months to several years.
A typical EPC contract contains several clauses or separate articles to govern completion phases […] upon the completion of each phase, and satisfying all prerequisite requirements, a completion certificate is issued by the owner for each milestone.
Decoding the phases: a deep dive into a typical petrochemical EPC contract
A typical petrochemical EPC contract is structured around the following main phases: engineering, construction, mechanical completion, pre- commissioning, commissioning, Ready-For-Start-Up (RFSU), introduction of hydrocarbons and/or catalysts, performance tests, and initial (or provisional) acceptance of a plant. Initial acceptance occurs upon the successful achievement of minimum and/or guaranteed performance levels.
The final acceptance of a plant usually occurs after the completion of a defect liability period and releases the contractor from most of its obligations under the contract. Typically, initial or provisional acceptance is a major milestone that must be achieved within the contractually prescribed time for completion.
Achieving initial acceptance relieves the contractor from its obligation to complete the project within the agreed time and pay liquidated damages in case of delays and/or failure to achieve performance levels. The final acceptance usually takes place after the expiration of a defects liability period and might require conducting other tests such as licensor or lenders' tests, but it is not linked to liquidated damages either for delays or achievement of performance guarantees. The performance tests might also include lenders' tests and can form so-called completion tests, which are the prerequisite requirement for initial acceptance.
A typical EPC contract contains several clauses or separate articles to govern completion phases such as mechanical completion, commissioning, RFSU, performance testing, and initial acceptance. Upon the completion of each phase and satisfying all prerequisite requirements, a completion certificate is issued by the owner for each milestone.
The final hurdle: challenges at the completion stage of petrochemical projects
The completion milestones of a petrochemical project, such as commissioning, RFSU, and performance testing, are the most complex and problematic processes. The planned process of Ready-For-Start- Up, and then starting up all systems and sub-systems of a plant, can be delayed by the non-performance of some equipment, which can force the plant’s completion to a prolonged halt. In reality, after introducing hydrocarbons and chemicals into the process equipment, which enables operational testing of various systems and sub-systems, a petrochemical facility commences producing its intended product, for example, polymers, ammonia, or refined oil products. Upon starting up and beginning production, it is not always possible to easily shut down the facility without incurring significant losses. All systems should be filled with feedstock and chemicals when producing or be preserved with specific substances such as nitrogen.
An owner is usually eager to commence the much- anticipated stage of commercial production. The cyclical nature of the process means that the commercially ready product would be accumulated in storage. After a gradual start-up, a facility would need to run for several weeks to achieve conditions for conducting performance testing. The product export lines and loading facilities can only be fully tested after the plant commences production of commercially graded product. This means that commissioning and testing of a plant coincides with the commencement of commercial operation and logistics. The project lenders are normally pushing for the facility to start producing as they need to see returns on their investment. The commencement of commercial operation provides much-anticipated relief for the owner and project lenders, especially if the project was delayed.
Unresolved issues: identifying and addressing problems in petrochemical EPC contracts
Complex petrochemical projects are prone to delays. Upon reaching the Ready-For-Start-Up milestone and introducing hydrocarbons into the systems, a facility practically commences production. The bespoke EPC contracts do not always expressly provide for parties’ operation and maintenance responsibilities upon achieving completion milestones. At the same time, contractors are keen to reduce costs and demobilise staff, as at the completion stages the main focus for a contractor is to complete and leave the construction site as soon as possible. The typical EPC contract structure described above envisages achieving several completion milestones in a timely fashion. During this achievement of the final completion milestones, a facility commences production. The owner stores a product and begins to sell the product before the facility achieves initial acceptance. Normally, the EPC contracts contain a statement that the owner is entitled to retain any revenue obtained from the operation of the plant, whether before or after initial acceptance. It is quite common that a petrochemical facility can be around 99% complete but still lack all the requirements for initial acceptance. In the case of defects, such a prolonged completion stage can easily span for 2-3 years.
During this time, the multiple systems comprising the facility must be maintained and/or preserved. The owner's team de facto operates the plant upon completing the required training during the Ready-For- Start-Up commissioning. However, the contractor’s responsibility for care and custody stretches up to initial or provisional acceptance. The contractor would have to keep its operating and maintenance resources (or pay vendors and subcontractors) until the initial acceptance certificate is issued. Upon achieving RFSU and gradually ramping up production, the contractor would be looking to demobilise most of its resources.
In the case of prolonged delays to initial acceptance certification, the contractor might refuse to maintain equipment and/or refuse to provide its resources for fixing any operational issues.
The contractual care and custody responsibility does not include operational maintenance or repairs of something that was caused by operating the plant. At some point, the contractor might argue that it is more economical to shut down the plant and put it into preservation rather than continue incurring maintenance costs. An agreement is normally reached on a common understanding that the owner is producing and selling a product and therefore should take over and fully operate and maintain the plant. Contractually, this means that the contractor’s care and custody responsibility ceases before the initial acceptance certification. Common sense prevails upon contractual provisions, but both parties might still be looking to claim its costs should other matters delaying initial acceptance crystallise as a formal dispute.
Towards better contracts: enhancing clarity and efficiency in EPC contract drafting
As discussed above, a petrochemical EPC contract is typically structured around achieving certain milestones where initial or provisional acceptance serves as a major completion milestone manifesting time for completion under the contract. During the negotiation stages, it appears that the contract drafting envisages that all major milestones are achieved smoothly from one to another without delays or problems. However, in many petrochemical projects, this is not the case. Ordinarily, there is no separate contract provision that guides the respective responsibility of the parties in relation to operating and maintaining the facility/ plant during each completion phase leading up to initial acceptance. The operation and maintenance of a plant are supposed to be covered by 'care and custody' and 'loss and damage' to the works provisions. But what happens if the facility has been producing for some time, but the owner is unable to issue the initial acceptance certificate to the contractor and such a period is prolonged for a year or two? When drafting contractual clauses that guide completion phases, parties should expressly provide criteria for accepting custody and care as well as transferring operational and maintenance responsibility.
The draftsmen should carefully follow the technical side of things and prepare for any eventuality in the complex process of completing the petrochemical facility. Delays to achieving initial acceptance inevitably increase costs for both parties, and parties seek to limit their exposure to potential maintenance costs. Once the facility reaches 100% of the guaranteed production levels, the operation and maintenance obligations should be transferred to the owner.
A contract should be clear on the parties’ risk and responsibilities distribution related to the operation and maintenance of the plant prior to, during, and after achieving all major completion milestones. Specific attention should be given to the completion phase when the facility has commenced production. It is advisable to include a separate article or clause guiding the contractor’s care of the works and the process of transferring the responsibility for care to the owner, and a separate clause for the transfer of operational and maintenance responsibilities.
This article was written for issue 27 of the Diales Digest. To view the publication, please visit: www.diales.com/diales-digest-issue-27