The legal nature of construction and engineering agreements

1. CONSTRUCTION
& ENGINEERING
SEMINAR
DEON GRIESSEL

2. > Common law (Roman Dutch law)
> Locatio conductio operis faciendi
distinguished from
> Purchase and Sale
2
LEGAL NATURE OF CONSTRUCTION
AND ENGINEERING AGREEMENT

3. > There is no intention to sell
> Parties: contractor & employer
> Contractor is commissioned to deliver a finished product
of work for remuneration
> Contractor’s core obligation: handing over the works
> Employer’s core obligation: payment of contract price
> To these are added ancillary provisions stemming from
either:
> the common law re locatio conductio operis (implied
terms); or
> the terms of the contract between them
3
LOCATIO CONDUCTIO OPERIS FACIENDI
(LETTING & HIRING OF WORK)

4. > If the contractor designs, he takes design responsibility
> Vis major & casus fortiutus serve as an excuse for late
completion
> Contractor must execute work in proper and
workmanlike manner
> Materials used must be of sound quality & fit for
purpose
> Damages for breach of contract: the cost to have the
work remedied or completed by someone else
> Contractor bears risk during construction phase
> Employer bears risk as soon as he approves the
works/takes over the works
4
LOCATIO CONDUCTIO OPERIS FACIENDI
(LETTING & HIRING OF WORK)

5. > contractor has a lien for:
> enrichment enjoyed by employer
> moneys owing to contractor by owner
> employer must give occupation of the site for works to
be carried out
> accessio: if the plant is affixed to the land it
automatically belongs to the owner
5
LOCATIO CONDUCTIO OPERIS FACIENDI
(LETTING & HIRING OF WORK)

6. > Very different common law basis
> There must be an intention to sell
> Could be for sale of things not yet in existence eg a
machine yet to be manufactured
> Common law remedies
> Actio empti if there is a contractual warranty which is
breached (powerful remedy)
> cancellation
> damages
> Aedilian actions (lesser remedies) where there is no
contractual warranty
> price reduction
> restitution
6
PURCHASE AND SALE (DISTINGUISHED
FROM LOCATIO CONDUCIO OPERIS)

7. > Risk passes from the seller to the purchaser as soon as
the sale is perfecta, in other words as soon as
agreement is reached on price, the thing sold and the
intention to buy and sell
> Avoid combining agreements for “works” and
agreements for “supply” into one contract as this does
not recognise the differences in the common law basis
of each
7
PURCHASE AND SALE (DISTINGUISHED
FROM LOCATIO CONDUCTIO OPERIS)

8. > EPC (fixed price turn key) not re-measurement, not
EPCM
> bankability of agreement (FIDIC Silver Book plus more)
> delay liquidated damages sized with reference to
obligations under funding documents
> performance liquidated damages (sized with reference
to obligations under funding documents)
> accompanied by O&M agreement
> pass-through provisions
> EPC agreement subject to Financial Close and Equity
Close
8
REQUIREMENTS OF BANKS IN
PROJECT FINANCE MATTERS

9. > parent company guarantee by contractor
> advance payment guarantee
> performance bond by contractor
> compliance with technical standards
> should the performance bond reduce on completion?
> Supervisory Control and Data Acquisition (SCADA)
software clause (for power generation plants, fabrication
plants, etc)
> unforeseeable difficulties clause
9
REQUIREMENTS OF BANKS

10. > Schiffren clause (absent in FIDIC)
> Conventional Penalties Act and liquidated damages
clause
> Typical security arrangements (advance payment,
advance payment guarantee, performance bond,
retention moneys)
> Design clause regulating design responsibility and
design liability
> Employer’s requirements (scope document)
> Section 37(2) of OHS Act and mandatary agreement
> Pass-through provisions (REIPPP)
> Site data clause
10
TYPICAL CLAUSES IN EPC
CONTRACTS

11. > Intellectual property rights (technology not to infringe
IP rights of third parties)
> Warranties re design, workmanship and materials
> Performance warranties relating to yield of plant
> Early warning clause (absent in FIDIC)
> Termination for convenience by Employer
> Testing & completion
> Insurance (broker’s input required)
> Dispute resolution
11
TYPICAL CLAUSES IN EPC
CONTRACTS

12. > An advance payment by employer to contractor
> Reducing advance payment guarantee given by
contractor to employer
> Performance bond given by contractor to employer:
may or may not reduce on completion of plant and valid
for defects liability period
> Retention amounts withheld by employer from
payments to contractor
> Parent company guarantee by contractor
12
TYPICAL SECURITY ARRANGEMENTS
(MITIGATES THE RISK OF BREACH OF
CONTRACT/INSOLVENCY OF THE COUNTERPARTY)

13. > Purpose: to back up project company
> Content (general overview)
> BEE obligations
> Economic development obligations
> Anti-corruption clauses
> Commercial Operation Date (COD) arrangements
> Reporting obligations and giving of notices
> Minimum acceptance capacity of facility
> Performance testing
> Commissioning of facility
13
PASS-THROUGH PROVISIONS
(REIPPP)

14. > Compliance with the Codes
> Compliance with Power Purchase Agreement (PPA) and
Implementation Agreement (IA)
> Personnel clauses
> Termination points
> Granting DoE access to information
14
PASS-THROUGH PROVISIONS

15. > In international project finance deals a subsidiary of the
offshore parent is often also the contractor
> In many instances the engineering/technology comes
from overseas
> Large parts of the plant are often imported and make
up a big part of the cost of the plant
> With planning, one could capture profit in a low tax
jurisdiction depending on transfer pricing and the
shareholding structure
> One can reduce taxable income of the local contractor
subsidiary
> Could charge the local project company for engineering
and the major supply from offshore
15
STRUCTURING ISSUES:
INTERNATIONAL EPC CONTRACTS

16. > Project company still pays the same price
> EP (offshore) vs C (local)
> Bank/Employer on the horns of a dilemma:
> the risk of split responsibility vs fully wrapped EPC
> Performance warranty: who gives?
> Split EPC structure has been approved by an off-shore
funder in REIPPP project
16
STRUCTURING ISSUES:
INTERNATIONAL EPC CONTRACTS

17. > details: scenario A
17
EXAMPLES TYPICAL OF ON-SHORE
OFF-SHORE EPC STRUCTURES

18. 18
OFFSHORE
Offshore Parent
Low tax jurisdiction
subsidiary
Project Company
local contractor
subsidiary
Minority/BEE
Minority
Shareholder
Shareholding
Shareholding
Co-Ordination
Agreement
Minority
Shareholder
Construction
contract
Offshore
Engineering
and Procurement
contract
Offshore
Onshore

19. > details: scenario B
19
EXAMPLES TYPICAL OF ON-SHORE
OFF-SHORE EPC STRUCTURES

20. Construction contract
20
Offshore Parent
Offshore
Contractor
Company
registered in SA
as an
External
Company
Offshore
Onshore
Shareholding
Project Company
Minority
shareholder
Offshore
Engineering
and
Procurement
contract
Construction contract

21. > Where external company is used, no co-ordination
agreement is necessary because it’s the same legal
entity
> Because it is the same legal entity, the bank’s risk is
reduced
> Don’t have risk of supplier blaming construction
company and vice versa because it is the same entity
> Must have separate agreements: one for offshore
supply and engineering, one for local construction
> External company structure has been approved by local
bank, albeit not in REIPPP context
21

22. > Currency and Exchanges Act No 9 of 1933
> Exchange Control Regulations 1961
> Treasury delegated authority to SA Reserve Bank
> SA Reserve Bank delegated certain functions to local
banks
> Rulings and circulars are issued by SARB to authorised
dealers (banks)
> Local resident may not pay an off-shore party without
exchange control approval: many standing
exceptions/arrangements
22
EXCHANGE CONTROL

23. > A project company may receive a parent company loan
in foreign currency. It may need to pay an off-shore
supplier (eg a sister company or third party) abroad in
the same foreign currency
> Normally when foreign currency comes into SA, it is
converted to ZAR
> Normally a local resident must use his Rands to buy
foreign currency in order to pay a non-resident
> To avoid double currency conversion, the SARB allows
the project company on application and depending on
the merits, to keep the foreign currency in a CFC
account and to pay the off-shore supplier from the CFC
account in foreign currency
> Without SARB approval this is not allowed
23
EXCHANGE CONTROL

24. > No currency conversion
> Need SA Reserve Bank approval
24
CLIENT FOREIGN CURRENCY
ACCOUNT
CFC Account
Local (project) company
Receive foreign currency
(eg shareholder loan)
Pay in foreign currency
eg pay for engineering done
offshore and/or for imported
elements of plant

25. > One must be aware of:
> the common law roots of a construction and engineering
agreement because this is the backdrop against which our
courts interpret these contracts and the common law
governs where the agreement is silent
> typical clauses normally encountered in a construction and
engineering contract so as to assess what is missing when
presented with a draft agreement and what banks will be
looking for if the project is funded
> structuring issues when dealing with cross-border
transactions
> exchange control rules and opportunities available if the
appropriate consents are obtained
25
CONCLUSION

26. THANK
YOU
Legal notice: Nothing in this presentation should be construed as formal legal
advice from any lawyer or this firm. Readers are advised to consult professional
legal advisors for guidance on legislation which may affect their businesses.
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