Assessing the risk
JONATHAN HOSIE TAKES A LOOK AT HOW CHANGES IN THE LAW CAN AFFECT BOTH CONTRACTOR AND OWNER IN TRADITIONAL EPC CONTRACTS FOR OIL & GAS PROJECTS
The world remains hungry for energy and the prevalent contribution of hydrocarbons to the energy mix will not change overnight. When participants in the sector start to plan for a future of rising oil prices, mothballed investment decisions will be dusted off and re-assessed. One factor in that process will be to consider the type of contract structure required for the delivery of the project. In the oil & gas sector, there are many examples but at the core is the traditional EPC model, where an owner engages a contractor to undertake the engineering, procurement and construction of a facility in return for payment of a lump sum price.
The completion risks that are allocated to the contractor under this EPC model are generally those which impact on the cost and time to complete the completed facility. Many factors will impact the management of these completion risks. This article focuses on just one but important such risk, being the risk of a change in law.
How do EPC contracts allocate change in law risk
The EPC contractor will be required to comply with the law when delivering the project, in return for payment of a lump sum price. However, this imports a potentially large risk as the law may include legislation of central government and other state agencies, as well as associated codes of practice and guidance and the interpretation of this legislation and guidance by local courts. There is a keen commercial tension between the allocation of change in law risk and the price payable for it; the negotiation of such provisions is amongst one of the key commercial issues in large energy sector EPC contracts.
There is no one ‘market approach’ in the oil and gas sector for the allocation of this risk. The outcome will depend on the type of project, duration of the construction period and the jurisdiction where the project is being carried out (as well as the negotiating strength of the parties and the skills of their lawyers). However, there are a number of approaches that will commonly be encountered and which will shape the final deal. Some of these factors are listed below:
- There is a school of thought that change in law should be an owner risk in large strategic energy projects as the owner is likely to have the closest relationship with the government but this view is not shared universally.
- Changes in law in the host country which come into force after the effective date of the EPC contract tend to be at the owner’s risk; the EPC contractor cannot be expected to take account of such unknown risks in assembling its tendered prices.
- Conversely, it is frequently the case that changes outside of the host country will be at the contractor’s risk, regardless of when they happen.
- A hybrid situation is where there is a change in the laws of the host country but this is only implemented to comply with some international requirements; such changes may not be accepted as constituting a qualifying change in law.
- The owner may also wish to exclude certain circumstances from its liability for an increase in the contract price, for example changes in tax law which affect only the contractor’s profit and loss.
- Parties may consider sharing the risk that eventuates from a change in law, albeit when this happens, the liability will often be capped to allow the contractor to price the risk.
- Any properly drafted change in law provision will provide that the change needs to affect the contractor’s performance of his obligations under the contract in order to qualify. Even then, the owner may seek to impose a qualifying threshold test of materiality.
- To the extent the owner retains any change in law risk, the EPC contract will frequently include express provisions to the effect that if and to the extent that any such change gives rise to the requirement to make a modification to the work or the schedule, manner or sequence of execution of the work, the contractor shall notify within a defined period of it becoming aware of the change and shall provide details so the owner may evaluate the effect of the change.
- Such notice provisions may be elevated to the status of a condition precedent. If the contractor fails to provide a compliant notice or the required particulars within the time limits, it forfeits all entitlement to extra time or money arising from the change in law.
- In addition, the owner may want to discuss or disagree with the contractor’s position on the change in law and may even want the option to terminate the EPC contract where the change in law renders completion of the project uneconomic.
As will be appreciated, there are many issues to be considered (and negotiated) when agreeing change in law risk provisions in EPC contracts. However, by analysing how an EPC contract can be used to allocate and manage the treatment of this risk, contracting parties can develop appropriate strategies in relation to the tendering, negotiation and award of EPC contracts.
Once the oil price recovers from its current 20-year low point, oil and gas producers and refiners will be re-assessing their investment case decisions and thinking about how best to structure the EPC contract to implement their projects. Change in law risk should be an important consideration in that process.
Jonathan Hosie is Partner in Mayer Brown’s international construction team. Mayer Brown is a distinctively global law firm, uniquely positioned to advise the world’s leading companies and financial institutions on their most complex deals and disputes.
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