Rebalancing of risk under South African EPC contracting models

While the market is evolving from traditional models to more risk-shared approaches, recent experience shows that an employer-friendly bias continues to prevail – requiring contractors to undertake proper risk awareness and assessment before signing on the dotted line.

Existing contracting models and risk allocation  

The EPC model remains very much ‘en vogue’ in South Africa across the energy and infrastructure sectors given the continued reliance on the expertise and capacity of international service delivery partners. Two notable exceptions to this approach are in the onshore wind energy and battery storage markets, where the contracting structure is often split into supply and balance of plant contracts in order to maximise the efficiencies of specialist suppliers or contractors.

Where an EPC contract is used, the market remains fairly conservative and usually adopts an employer-friendly risk regime, subject to two very important exceptions which are unique in their application to the domestic market. The first, which has been a growing trend, relates to community risk and the second is in respect of unlawful activities affecting the works.

Contractors often push back strongly against taking on the full risk relating to managing community engagement or unrest. This trend has found favour due to the recent prevalence of site disturbances stemming from unrest within the local community in which a project sits. Where a project affects multiple communities – for example, a road or rail project – those risks are multiplied, leading to greater compromise and risk sharing between employers and contractors.

Similarly, contractors have recently tended to push back when dealing with activities by individuals or consortia who hold no official role in the project yet seek to interfere with the works in order to derive an unlawful benefit from the project. This sort of activity commonly arises through the so-called ‘construction mafia’, whose influence has stretched to most regions of the country.

Are EPC contracts applied differently depending on the source of project funding?

There is a difference in approach where the project in question is being project-financed, which is the case, for example, with most renewable energy project developed in South Africa.

In this scenario, lenders in South Africa typically require additional protections which would make the EPC model in that context substantially more favourable to the employer. For instance, security packages are commonplace as a means of protecting the employer and the lender. Security packages often include, amongst other things, performance bonds or parent company guarantees - which can be ceded to the lender - or lender ‘step in’ rights, which give it the ability to take control of the project, should the contractor not be performing sufficiently or if the contractor is unable to proceed with the works after entering business rescue or being declared insolvent. Step in rights usually provide the lender with the ability to complete the project itself through appointment of a third party contractor, providing protection to the lender and giving it the ability to recover its debt by having the project generate revenue.

Amendment of provisions

There are numerous risks which can arise during construction, including in relation to the instruction of variations, delay and progress to the works, defects and liability regimes, general record keeping and notice requirements. These provisions require careful consideration during negotiations to ensure that parties do not subscribe to risks that they had not fully accounted for.

Variations

Variations are not often a highly contentious issue during negotiations with contractors generally being amenable to undertaking variations where the time and cost consequences, as well as the process for claiming, are clear. However, despite this, variations are commonly a fertile ground for dispute.

The disputes which commonly arise in relation to variations concern the scope of the variation itself, and the extent of the power to vary the scope of works and whether this is permissible in terms of the contract or common law.

As a general rule, the employer - or contract administrator on their behalf - is entitled to vary the works through instruction at any point prior to completion of the works. South African law does not permit the instruction of variations after completion of the works yet employers may seek that right in respect of, for example, the way in which defective works are remedied, or the performance of ‘punch list’ items. If those types of rights are to be ceded, it is important that they are clear in their application so that the contractor does not inadvertently sign up for a ‘perpetual’ contract whereby the employer may keep adding works after completion of the original scope. This might occur particularly in the public sector, where government procurement departments seek ways to avoid tedious re-tendering cycles. Here, contractors must be wary of indirectly breaching procurement regulations which may result in contractors operating at risk owing to the suspension and/or cancellation risk of those additional works.

The common law restricts the employer from instructing the carrying out of substantial variations. Contractors are generally reluctant to carry out substantial variations in any event without this being first agreed with the employer and it is often the case that the contract is amended to expressly restrict the size and scope of potential variations. It is important that the parameters of any sizeable variations be identified at the outset in order to avoid costly and time consuming debates about whether the contractor is or is not obliged to comply with a particular instruction.

Delay, progress and programming

‘S form’ construction contracts such as NEC4 and FIDIC, which are commonly used as the basis for EPC contracts in South Africa, contain base obligations relating to programming the works and detailing the progress on site.

For example, the FIDIC Yellow Book places an obligation on the contractor to provide monthly progress reports which set out a broad variety of information. This may include a comparison measuring planned progress against actual progress, photographic and documentary evidence showing the progress being made on site, andinspection reports and quality management programmes. In addition to specific record keeping obligations, the contractor is obliged to notify the employer should there be a deviation from the planned progress.

However, these rights and obligations are seldom sufficient in the domestic market and programming and reporting obligations are generally strengthened to account for matters such as the detail to which a programme must go, the type of programming software to be used, the requirement to identify the critical path, and the notification of potential delays, additional costs, and other aspects which may adversely affect the works.

NEC4 provides for a collaborative approach between the project manager and the contractor in managing delays. Early warning notice regimes are a particular feature of the NEC, however, they are now commonplace in other forms of contract too, and are often strengthened even further particularly where bank funding is involved.

Rights to an extension of time and prolongation costs generally follow accepted norms, however certain sectors often offer broader rights of recourse for contractors. One example is in the case of force majeure, which is typically a ‘neutral’ event entitling the contractor to an extension of time only, however in the private sector renewable energy market it is not unusual to see the contractor being entitled to additional cost here too, albeit subject to extensive and onerous pass-through notice regimes.

Given these strengthened rights and obligations, contractors should maintain good recordsto ensure that they maximise their recovery of compensable delay events.

Defects and liabilities

Generally, well-drafted EPC contracts in South Africa will include provisions making the contractor liable to rectify any notified defects as well as latent defects. This will take the form of a defects liability period. During this time, the contractor can be notified of any defects which may arise, but is also independently obliged to seek out and correct defects of its own volition.

The extent of the defects liability period is subject to negotiation. However, this generally falls between one and two years. It is also common for contractors to retain liability in respect of so-called latent defects - those defects which are not readily ascertainable at the end of the defects notification period. Here, the notification period commences on the expiry of the defects notification period and generally falls between a further three and five years, again subject to negotiation. This is in line with the common law rights which the employer would in any event have in respect of latent defects where the Prescription Act affords a claimant a period of three years from the date on which it reasonably became aware of its rights to claim. Where the defect is hidden, liability can thus extend significantly into the future, and for that reason the employer’s contractual rights in respect of defects are often stated to be its only rights, thus book-ending the contractor’s liability to the end of the latent defects period.

In renewable energy projects, provision would also generally be made for serial defect liability for specific critical components of the works. This typically includes solar panels, inverters, trackers and turbine blades. The serial defects notification period usually aligns with the defects notification period and where any such defects are identified and notified, the contractor is commonly required to conduct a root cause analysis and, where found to be defective, replace all components, or a manufactured batch of components where an agreed percentage of the components installed exhibit the same defect.

During the course of the project itself, obligations will also be placed on the contractor in respect of quality management and testing to ensure compliance with the contactor’s specifications, employer’s requirements, or legal standards.

Similarly, keeping a record of compliance of the required tests will prove useful in assisting a contractor to defend any claims in respect of alleged defect work which may arise after the completion of the works.

Contract administration

Contract administrators are widely used in South Africa and have a great deal of expertise and acumen in the management of construction projects.

A contract administrator’s powers will be limited to those delegated to it under the terms of the relevant contractual regime, but the extent of those powers is often a source of debate and confusion.

It is widely understood that contract administrators cannot be regarded as ‘independent’ in the legal sense, given that they are appointed and paid by the employer. However, both common law and relevant industry ethical guidelines impose an obligation to act fairly and make impartial determinations. Some contracts make this inherent duty express.

A common area of difficulty arises in respect of deviations to the strict contract machinery where, for example, one party requests an indulgence or waiver, or an amendment to cater for contraventions of contractual processes. In those situations, unless the contract provides that the contract administrator may approve amendments to the contract, parties must remember to follow the amendments clauses in the contract which typically provide for all amendments to be in writing and signed by authorised representatives of the parties.

Claims and disputes

Time bar provisions are commonly used in EPC contracts in South Africa, and their efficacy is upheld by the courts where the drafting of the requirements is clear and it is plain that a failure to comply results in a sacrifice of rights. It is common for the ‘normal’ condition precedent-type clauses to be strengthened further, for example through the application of a time bar to not just the initial notice of claim, but the subsequent provision of particulars of claim as well. Where pass-through mechanisms apply, the contractor will usually be required to ensure that notice and particulars are given ahead of time so as to enable the employer to comply with its reciprocal obligations of notification under its head agreement, such as a power purchase agreement. Where compliance with any one of those obligations fails, the contractor will typically lose its rights, so it is imperative from a contract drafting perspective that both the form and timing of contractual notices is both realistic and clear.

Amendments to the dispute resolution mechanisms in contracts are commonly made to account for local law considerations and the parties’ preference for adjudication or nominated arbitration bodies. However, these amendments would not substantially alter the multi-tiered dispute resolution mechanisms as provided for by the contract.

The final determination of any claims will normally be dealt with by arbitration and will not be subject to appeal. However, in terms of the Arbitration Act, there are limited instances where a decision can be taken on review, using the court system. It is common to preserve the ability of a party to approach the court for urgent relief, for example in relation to interdictory relief. A common reason where such an exclusion is relied upon is where the employer seeks to make a demand on performance security which the contractor resists. However, given that arbitration rules and international practice are more flexible than court jurisprudence in this particular area, consideration might be given by contractors to the use of emergency measures under applicable arbitration rules, such as the Arbitration Foundation of Southern Africa International Rules, instead.

While these processes may be broadly familiar to those experienced by contractors internationally, it remains important to be wary of the local context and approach to these common issues in South Africa.