This article appears in our Energy Playbook: 2023 Year in Review. Download the free ebook.
Many contracts for projects in the Canadian energy sector rely quite heavily on Engineering, Procurement and Construction (EPC) contracts.
EPC contracts are centralized contracts, whereby a project owner transfers all responsibility and risk to a single contractor with a fixed lump sum price.
tracts have been the backbone of a great many energy projects, particularly those pertaining to renewable energy. Due to a number of contributing factors (described below), many contractors and project owners have found the EPC delivery model is not well suited to deliver optimal project outcomes and effectively manage risk. One potential alternative to the EPC delivery model, is a collaborative or relational approach to contracting. Collaborative delivery models focus on allowing the project owner to secure the right team for the project and enabling collaboration and a "best for project" mentality.
The EPC project delivery model
The EPC project delivery model is based around an agreement between a project owner and a single contractor. The contractor is fully responsible for the management of the project, from initial design, through procurement, and in the execution of construction. Once complete, the project is turned over to the owner in "turnkey" condition.
In exchange for certainty, risk transfer and simplicity, a project owner cedes complete control of the project to the contractor. However, such certainty and risk allocation are not necessarily guaranteed.
Contractors bid on the project prior to commencement of the engineering stage, providing a project owner with a single price for the entirety of the project life prior to commissioning by an agreed-upon date. This perceived certainty is appealing to project owners; however, in many cases, such certainty is also an illusion. A project's initial budget cannot necessarily anticipate increases in material or labour costs, shortages of raw materials, or other concerns commonly arising in modern agreements. Contractors are aware of this uncertainty and, as such, take measures to mitigate this extreme risk. For example, EPC contracts may include complex terms allowing contractors to recover excessive costs due to material shortages or other overruns outside of the contractor's control, reducing the certainty of the initial price. Further, contractors may include significant risk premiums in their initial bids, driving up the cost of a project. Instead of transferring the risk and uncertainty to the contractor, the project owner cedes control of its project without the benefits promised by the EPC model.
An alternative: Collaborative or relational delivery
A collaborative or relational contract model focuses on the relationship and collaboration between the parties. The underlying contract should encourage all parties to act in good faith in the project's best interests, sharing both the potential risks and potential gains from the project.
Collaborative or relational contracting models can take a variety of forms. Depending on the needs of the project and the parties, the agreement may be between only the project owner and a construction manager, or may include other key project participants, such as the engineer of record or the constructor.
The contractual structure of a collaborative delivery model can vary widely, although several industry standard contract forms exist on the global scale. Given the cultural shift required to move away from an adversarial model to a collaborative model, organization wide buy-in, especially at an executive level, is required to effectively implement collaborative contracts.
Key principles of collaborative project delivery models
Although the contractual form may vary, there are six key elements that define collaborative or relational contract models: (1) relationship building, (2) joint project control, (3) early participation, (4) shared risk and reward, (5) reduced liability exposure and (6) jointly developed and validated targets.
One – Relationship building
A collaborative or relational contract model involves shifting from a traditional adversarial approach to contract delivery to a model focusing on the relationship and collaboration between the parties. The contract acts as a framework for a relationship between key trusted parties, where the parties are encouraged to focus on what is best for the project, leveraging the strengths of the other party in the process. A collaborative contract is the key to establishing the relationship, and may include core values and organizational principles in addition to outlining the mechanics of the core values below.
Two – Joint project control
The majority collaborative models involve some form of joint project control amongst the key participants in the project, with fair representation and balancing of the interests of the parties in deciding issues. Given the shared risk and reward inherent to the collaborative model (see Item 4 below), joint project control ensures each party be included in the discussions that ultimately impact such risks and rewards.
This joint project control may take several forms, and is often realized through a Central Management Team (a Team). The Team represents all parties involved in the agreement with a view to the best interests of the project, including in making ongoing decisions and resolving disputes between the parties.
Joint project control does involve loss of control for a project owner, including requiring the involvement of third parties in crucial decisions. However, it is worth noting that the EPC model requires a project owner relinquish all control with minimal project owner input throughout the construction process.
Three – Early participation
A collaborative model generally includes the early involvement of key project participants, being those parties with the capability to influence project success. These parties may interact with other organizations, such as other project participants or third-party stakeholders, and therefore their early involvement has the potential to increase project productivity. Alternatively, key project participants may have knowledge that improves the effectiveness or constructability of a project design. Regardless, early participation is a crucial aspect of collaborative models as front-end collaboration during a project's planning stages generally leads to a reduction in the time and money required during later project stages.
Four – Shared risk and reward
In a collaborative model, key project participants share in both risks and rewards based on the outcome of a province. Key project participants agree on project-wide targets (Targets) early in the project planning phase (see Item 6 below), ideally revisiting and revalidating such Targets as the project evolves. Crucially, the project participants work towards the Targets on a "no-fault" basis, guided by a "no blame" culture and the principle that fault is not assigned between participants.
Profit, therefore, is not a function of each party's specific work on a project, but is rather is shared based on the project's overall success. In short, potential profit is pooled and distributed on the basis of a contractually pre-determined formula. Many collaborative models contemplate that each participant's profit, or some portion thereof, is allocated to a risk pool (the Risk Pool). The Risk Pool may be augmented if Targets are met or exceeded; conversely, the Risk Pool may be used to buffer costs overruns
Five – Reduced liability exposure
Nearly all, if not all, collaborative models include a form of potential for reduced liability exposure for key participants. The free and open dialogue central to the collaborative model (see Item 1 above) would be far less likely in the absence of liability controls. Proponents of collaborative models suggest that the fear of liability customary in construction project models necessarily leads to the concealment of information, which in turn leads to reduced creativity, performance and efficiency. Liability waivers between key project participants may reduce this fear, allowing parties to focus on sharing information in a way that enhances and improves the project, instead of in reduction of individual liability
Six – Jointly developed and validated targets
As noted above, jointly developed and validated targets are often seen as central to the collaborative model. By including all key project participants in the early stages of planning and designing projects (see Item 3 above), project objectives may be jointly set by key project participants as a group. Targets jointly developed may allow for more realistic project targets to be set, as parties are incentivized to ensure realistic targets (see Item 4 above).
Suitability of a collaborative model
Collaborative models have significant benefits when properly applied. However, there are certain project and party characteristics which may recommend or discourage the suitability of a collaborative model. In considering a collaborative model, a party should consider (1) party "buy-in," (2) confidentiality, (3) risk allocation and (4) financial structure and incentives.
One – Are the parties sufficiently committed to a collaborative model?
In order to be effective, a collaborative model requires "buy-in" from the project owner, contractor and any other key project participants. Without a commitment to collaboration, the parties are exposed to the reduced individual accountability of a collaborative model, without the benefits.
This "buy-in" is particularly notable as a collaborative model requires significant involvement by the project owner, including a significant commitment of financial, staff and other resources. In the event a project owner is unable or unwilling to commit such resources, a collaborative model may not be suitable for the project.
Two – Are there concerns that would inhibit collaboration between the parties?
As discussed, the collaborative model is based on free sharing of information and collaboration between all project participants. Parties may be reluctant to fully collaborate with other participants due to confidentiality concerns or other concerns regarding sensitive information, despite non-disclosure agreements or other legal measures. In this case, or the case of other barriers to full collaboration, a collaborative model may not be suitable for the parties or the project.
Three – How is risk allocated for this project?
The reduced liability structure of a collaborative model also means that, in the event of a "blow out" of costs or schedules, the project owner has little recourse. This may further be exacerbated by the difficulties in risk allocation between key project participants.
Four – How can the project financials be structured to ensure alignment of incentives for all parties?
The Risk Pool and other financial structures under a collaborative contract must be designed to ensure that the parties' incentives are aligned. There are several items parties should consider in designing the financial incentives for a project. In the event (a) the Risk Pool is insufficient for the cost overruns of the project, or (b) the parties can earn significant profit during the project outside of the Risk Pool, there may be insufficient incentive to achieve project objectives, including the Targets. The reduced liability exposure inherent to collaborative models means individual participant's exposure to poor outcomes is limited to the Risk Pool. Notably, the quantum of the Risk Pool must be significant enough to ensure the project owner and contractor(s) are aligned, as contractor markup may outweigh the Risk Pool as the project progresses.
Further, although there are a variety of cost structures available under collaborative contracts, project owners may have reduced cost certainty, especially in the event of a cost reimbursement structure. In this event, the project owner must rely on the shared Risk Pool to ensure the alignment of incentives among project participants.
In the event the Risk Pool is tied to targets which are subject to adjustment (such asforce majeure, unforeseen site conditions, changes to the project scope or owner caused delay), a collaborative model may not suitably adapt to these changes. A contractor may be inclined to pursue a claim for target adjustments, thereby reverting the parties to positional or adversarial behaviour, no longer pursuing collaboration. Additionally, an adjusted target may not be in line with the operational needs of a project owner. As such, parties should consider if adjusted targets are required for their project, and if there are operational requirements which would not be best met by a collaborative target structure.
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