What is the best investment contract model for your project?

A simple contract for the completion of building works has not been sufficient for some time. It does not often fully reflect the complexity of the investment, particularly in the infrastructure and energy sectors. Hence, the right choice of contract is key for investors.

In Polish civil law, particularly as per art. 647 among others, the rules pertaining to the creation of a contract for the execution of building works are expressed in a general yet traditional manner. This is due to several historical factors and is a consequence of the institutional infrastructure responsible for the execution of building works in the past. The civil codes assume that the investor provides the plan and land, the contractor carries out the building works, and upon completion the investor takes over ownership and provides payment. Putting aside for a moment doctrinal analysis of the suitability of the regulation provided by art. 647, the question of whether the delivery of the project by the investor is a decisive element of the validity of the contract for the execution of works, the solution in which civil codes govern only one project model (e.g. ”build” model), does not accurately reflect the complexity of modern building projects, especially in the infrastructure and energy sectors.

In response to this gap, practise in the sector and templates created in international contracts (above all FIDIC standards- templates of the International Federation of Engineering Consultants) have started to introduce more flexible contract templates. They differ in the parties’ scope of responsibility, the order of tasks, structure of risk and level of involvement by the investor. The right choice of contract type has a direct impact over the course of the investment project.

Design-Bid-Build (“DBB”), the traditional “build” model

This simple, traditional investment contract model is known as “Design-Bid-Build”- also referred to as “build.” It is comprised of two distinct stages: design and execution, as well as an optional tender stage. The project design is based on the investor’s specifications, then communicated to the contractor- (or tenderers). The choice of contractor is made after the design stage, and the contractor’s scope is limited to project execution.

This model allows for a high degree of transparency and control over the project by the investor, (most often the contract engineer). The investor has full control over the design stage and the opportunity to consider a range of tenders. The tender process ensures a competitive price as well as full transparency as to building procedures.

The main disadvantage of this model is that the investor takes on all risks associated with any mistakes throughout the project, as well as any mismatch between the project and the conditions of its execution. Any uncertainty or gaps in documentation result in disputes and additional costs.

Yet the advantages of the “build” model still cause it to be one of the most popular forms of contract in the case of linear investments, such as building roads, motorways, bridges, railway infrastructure, waterways and sewers. These investments, in terms of the “build” formula, are often based on the red “FIDIC” formula.

Design-Build (“DB”)„design and build model”

The alternative to the traditional “build” model is the design-build formula, a contract model in which the scope of the contractor includes both design and execution.

The advantage of the DB model is faster project execution, as well as a lowered risk of clashes between design and execution. Thanks to the existence of a single contract and the whole project scope belonging to a single entity, the investor does not have to carry out separate processes pertaining to the designer and building contractor.

The disadvantage of DB is that the investor has a reduced capacity to continuously monitor technical solutions throughout the project. Therefore, under a DB contract, a detailed description of the project scope- including technical specifications- becomes vital for the investor. In the case of contracts for public works the investor is obligated to provide a very detailed project scope in the form of a functional-utility programme.

Aside from linear investments, (being analogous to the “build” model) the “design and build” formula is most often seen in building construction; the most common examples of which are buildings intended for public use, office and industrial construction or logistical centres and warehouses. These investments- good examples of the “design-build” formula, are most often based on the yellow FIDIC standards.

EPC (Engineering, Procurement, Construction), “on demand” model

An example of a more complex model is the EPC formula, also known as the “on demand” model. This is a type of contract for the overall execution of investment. EPC is a model in which the contractor carries out the entire process- from design to procurement, then construction and finally handing over the completed project. EPC is particularly widely used in the energy sector, such as in the construction of power stations, photovoltaic facilities, energy blocks and transmission lines. This is a result of a high degree of technical specialisation and a need for integration of different design stages.

The advantage of EPC is that it provides the highest degree of assurance and safety for the investor. Thanks to the project being governed by a single contract, the contractor is entirely responsible for the quality, timeliness and budget of the project. The investor has no need for engagement with the finer details, and the risk rests mainly with the contractor. In conformity with sub-clause 4.1 of the Silver FIDIC book, by which EPC contracts are most often governed, “the works will include all tasks which are necessary for fulfilling the expectations of the party placing the order, or that which is implicated by the contract, as well as all works which (even if they are not mentioned in the contract) are necessary for stability, or the safe and correct execution of works. Additionally, after their completion the works will be suitable for the use for which they were intended, as defined by the contract.”

The main scope of the contractor’s duties (in the EPC formula this is a general contractor) is the execution of all tasks which will ensure the safe and correct completion of the project, and result in the ability to hand over completed construction which is ready for immediate exploitation.

The disadvantage of EPC is reduced control over project solutions by the investor. If communication between the parties is insufficient, mistakes and divergent expectations are likely. Any changes to the scope of works are difficult, time-consuming and costly.

EPCM (Engineering, Procurement, Construction Management), supervision model

An example of an alternative approach is EPCM- the Engineering, Procurement, Construction Management approach. In contrast to EPC, the contractor does not carry out building works but plays a management and consulting role. This includes project coordination, preparing tenders and supervising subcontractors. This model provides a high degree of flexibility for the investor, but it also requires active engagement and the right existing background of competences. Risk and responsibility for project organisation rest largely with the investor.

The EPCM model is often chosen for projects characterised by a high degree of technical complexity that the investor wishes to maintain a higher degree of control over. This model is most often chosen for armament contracts, in chemical industry- the energy, mining and metallurgy sectors, also in investments in the pharmaceutical and biotechnology sectors.

The advantage of EPCM is a high degree of flexibility, allowing for introducing changes at the planning and execution stages, as well as continuous control over quality and budget. This model can be useful for non-standard projects, as well as projects that are carried out in stages.

The main disadvantage of EPCM is that the investor takes on a greater degree of responsibility. This model requires a high degree of management competence and active supervision. It is important to clearly establish the categories and scope of duties of the investor and contractor under an EPCM contract.

Mixed models- flexibility in practice

In the realities of big infrastructure, industry or energy investments, investors increasingly rarely choose to use a single contract model.

For example, the technological part of an investment might be carried out with an EPC model- (“on demand”), and the auxiliary infrastructure can be executed through the DBB (build) model. A common practice in the execution of public works, especially expressways or motorways, is executing the investment with the DB model (design and build), paired with investment supervision closely reflecting the EPCM approach. A mixed formula of D&B/EPC is becoming more common, increasing investor control in relation to the traditional EPC model and allowing for dividing the investment into stages. It also happens that an advisor acting on the basis of the EPCM approach can be supervising a number of EPC projects, who does not carry out works, but is responsible for coordination and supervision.

In most cases the object of the contract itself clearly shows which investment contract model is the most appropriate. For example, it is impossible to use a “pure” EPC model for works encompassing the delivery, installation and activation of an installation when the modernisation of existing parts is necessary before carrying out the investment project. The scope of the contractor’s responsibility in such a case will vary depending on the scope of works.

Concluding remarks

In summary, the choice of investment contract model is a key part of investment strategy. There is no one right answer. Each option has advantages as well as limitations. Therefore, mixed models are becoming increasingly important, allowing for the preservation of flexibility as well as the right balance of responsibility between the investor and contractor/consultant. A familiarity with the features of each model and the ability to use each one effectively are essential for investors, contractors and legal advisors who are involved in the construction and energy sectors today.