If someone had told us a few years ago that we would be writing a note on the end of the bank-guarantee era in EPC projects, we would have laughed for a long time. But life, as usual, has its own plans.

Why is a bank guarantee no longer an effective cash-out instrument for a client in an EPC construction project — or, indeed, in any other contractual scheme, not only in Russia but, I would venture to say, anywhere in the world? Several reasons.

A vector toward national protectionism in respect of guarantor banks

Unscrupulous foreign contractors have mastered a new way of halting payment under a bank guarantee: they apply to a state court in their home country for an order prohibiting the foreign guarantor bank from paying the beneficiary (the client under the contract).

For decades the principle embedded in the legal nature of a bank guarantee held unconditionally: payment on first demand / on demand. This meant the guarantor bank paid the beneficiary first and then sorted out claims with the principal.

Under Article 19 of the Convention, there are several exceptions in which payment may be withheld, namely:

1. any document is forged;
2. payment is not due on the basis stated in the demand;
3. having regard to the type of undertaking, there are no required (sufficient) grounds for payment.

So only clear fraud could previously stand in the way of payment, including under the URDG (Uniform Rules for Demand Guarantees).

Sanctions constraints

Apart from a bad-faith contractor who obtains a court injunction blocking a guarantee payout, a situation may arise in which the client ends up on the SDN list or under secondary sanctions. In that case the guarantor bank will technically be unable to remit payment to a sanctioned person.

Such a situation requires a payment licence from the US regulator. That process is not always successful and can take a great deal of time.

What to do?

To help a Russian client in an EPC project avoid such situations, we strongly recommend moving away from bank guarantees where the contractor is a foreign entity, even one from a “friendly” jurisdiction.

A retention mechanism through escrow accounts can be built effectively into the EPC contract. Corporate guarantees are debatable: the country of incorporation of the contractor needs to be considered to assess how effective that instrument actually is in its home legal system.

Suretyship is in a similar position: neither Russian nor English law treats it as an instrument for the fast recovery of funds. If the surety refuses to pay, the client will spend a great deal of time in litigation to enforce.

In short: in today’s global circumstances, be careful.

Since the spring of 2022, when the United States sharply tightened sanctions against Russia, many Russian companies that had managed to order American equipment have had to argue their case before the US Bureau of Industry and Security (BIS).

The most important document for them is the Export Administration Regulations (EAR), which set out the procedure for issuing export licences and control the export and re-export of most commercial goods, software and technologies, including dual-use items.

The objective is to persuade the United States that the shipment to Russia of equipment from American suppliers — in most cases manufactured under contracts concluded before 24 February 2022 — poses no threat to US national security and certainly will not lead the world toward nuclear war. We are currently, for example, working with clients trying to obtain equipment for a polyethylene plant and for a cheese-making plant.

How the procedure works

The list of equipment whose export requires a licence is set out in the EAR. The American supplier completes the form on the BIS website itself, listing the equipment to be exported, identifying the manufacturer, the end recipient in Russia and how the equipment will be used — for example, stating that two evaporators will form part of an LNG plant. The form is highly technical.

After the form is submitted, BIS reviews the application and sends what is known as an Intent to Deny letter — a letter signalling an intention to refuse the licence. It bears noting that the EAR effectively builds in a presumption of refusal: all exported equipment is treated as potentially dangerous.

BIS writes that it has reviewed the export-licence application and intends to refuse it on the basis that the equipment in question may enhance Russia’s military potential and so threaten US national security. That said, BIS magnanimously gives the applicant a further 20 calendar days to provide additional arguments.

Grounds for exemptions

The American export administration rules have one redeeming feature: if an applicant is refused on one ground, nothing prevents a fresh application to export the same equipment on a different ground.

For example, the EAR allows an export licence to be granted where the supply has humanitarian purposes. The challenge is proving the humanitarian purpose, which is not straightforward. Big Brother’s cold heart is open to the plight of endangered northern fur seals off the California coast — but not exactly to the interests of Russian consumers.

For the polyethylene plant, for example, we argued that the polyethylene products it would manufacture are important for medicine and pharmaceuticals: drug packaging, single-use medical devices, patient-care items, sterilisation cabinets, test tubes and pipettes. In a comparable situation, pulling on the humanitarian heartstrings proved effective with the European regulator. With the United States it did not work — but we did not give up.

A series of conference calls with the American vendors allowed us to formulate new bases for an export-licence application. For instance, if an American vendor intends to wind up its operating activity in Russia, BIS may grant an export licence for the “final shipment”.

Across most US federal statutes, “operating activity” covers acquisition, development, maintenance, ownership, leasing, renting and operation of equipment, facilities, personnel, products, services, personal property and real property.

American counsel pushed back, saying that this basis applies only if the company had a Russian office that it now intends to close. We reminded our US colleagues of the Fourteenth Amendment to the US Constitution, which provides that “no State… shall deny to any person within its jurisdiction the equal protection of the laws.”

Indeed, how lawful is it for BIS to act against American companies that have manufactured unique equipment, want to sell it and walk away from the Russian market, but cannot obtain an export licence simply because they had no formal Russian office at the time of application?

Is it really to be the case that the equipment ends up in a scrapyard for that reason — and that everything is a matter of luck? It was in exactly that logic that we drafted a new submission to BIS, and we are now awaiting the response with interest.

This is about a frequent misconception among our clients regarding the moment at which title to equipment passes in EPC projects — and in cross-border supply more generally.

Project after project, we explain the same point: the earlier title passes to the client, the fewer risks the client and its project lenders bear.

At the same time — it goes without saying — the risk of accidental loss should pass to the client as late as possible. That the moment of transfer of title to equipment and the moment of transfer of risk of loss can — and should — be separated, under both Russian and English law, is something we routinely remind the client’s commercial division.

The classic “non-bankable” wording

Here is a typical wording from an EPC contract for DAP-basis deliveries:

What is wrong with this wording? In most cases the project lenders will tell you that this clause is non-bankable. In plain language: a lender will not provide financing for an EPC project on these title-transfer terms. Why? Let us reason through it.

How much of the total contract price will the client have paid by the time the equipment is delivered at the delivery point — say, at the site? Of course it depends on the specific project and its commercial terms, but plainly, by the time the equipment arrives at the site, the client will typically have paid the supplier more than 70% of the equipment price.

The supply cycle for the equipment — from placing the order with the vendors, through manufacture, factory testing, shipment, intermediate transhipment, to delivery to the final destination — takes a long time (six months and up), especially for long-lead items in petrochemicals or in mining.

Three negative scenarios

What can happen while the equipment is en route? Let us consider the most likely negative scenarios.

1. Attachment of the supplier’s assets. The supplier has breached obligations to another counterparty under another contract, and that counterparty has gone to court seeking interim relief in the form of an attachment over the supplier’s assets — which, by sheer coincidence, may include the equipment that is travelling to your delivery point. You never know how conflict-of-laws rules will play out in different jurisdictions. The probability is significant and entirely outside the client’s control.
2. Insolvency of the supplier. Insolvency or compulsory liquidation proceedings have been opened against the supplier. The equipment may end up in the bankruptcy estate or its local equivalent in the supplier’s jurisdiction. Handing it over to the client becomes, to put it mildly, complicated.
3. Sanctions risk. A friendly foreign supplier has manufactured the equipment and is shipping it to the client, but somewhere along the route OFAC clerks send the supplier a chilling letter about secondary sanctions, payment blocks, the arrest of executives in any country in the world (except Russia, of course) and their extradition to the United States for assisting a Russian company in evading sanctions.

What matters to project lenders?

That the project be delivered on time. A plant built on schedule means lenders repaid on schedule. Equipment manufactured over six months to a year that fails to reach its destination for any of the reasons described above means a serious slippage of the project schedule to the right. Nobody wants that. And that risk can — and must — be managed in the EPC contract or supply contract.

The solution

Title to the equipment should pass to the client on the earliest possible date.

• If the EPC contractor places manufacturing orders with the equipment fabricators, title can pass to the client on the date the equipment is shipped from the fabricator to the EPC contractor — i.e., in transit.
• On CIP-basis deliveries, title should be discussed as passing on the date of handover to the first carrier.

The earliest possible date of title transfer should, of course, be defined separately for each contract, taking into account the delivery basis and the insurance requirements.

For the client, declining to take title until the equipment arrives at the delivery point — while having already paid nearly all of its price — is dangerous.

Living in hope of a bank guarantee that supposedly covers the risks listed above is also possible. Or rather, was possible until February 2022. Today, a bank guarantee from a foreign bank is no longer an effective instrument for securing proper performance by a counterparty, much less an effective tool for a quick cash-out.

And remember: even a “cashed-in” bank guarantee cannot bring back the time that matters so much to every participant in an EPC project — time that can be lost through a single ill-drafted clause.

During the performance of EPC contracts, clients pay particular attention to placing on the contractor the responsibility for the successful completion of tests and the achievement of the guaranteed performance figures of the equipment supplied or of the production line as a whole.

To secure performance of those obligations, clients often tie part of the contract payments to the successful completion of such tests. In some cases they include a right of unilateral termination in the contract, demanding a full refund of all sums paid and damages.

It is important, however, to bear in mind that achieving the guaranteed performance figures is the product of both contractor obligations and the reciprocal obligations of the client. One of the key reciprocal obligations is the supply of quality feedstock.

Supply of feedstock as the client’s reciprocal obligation

Achieving the stated operating characteristics of the equipment and the production line is impossible without the client providing feedstock and utilities of proper quality. Even minor deviations in feedstock characteristics (composition, moisture, structure, presence of impurities) can lead to the following consequences:

• damage to or contamination of the process equipment (pumps, filters, pipelines, etc.);
• loss of equipment performance or equipment failure;
• inability to achieve the planned product quality.

To address these risks, we recommend a clear provision in the EPC contract that securing the supply of quality feedstock and utilities is a reciprocal obligation of the client. Breach of that obligation should relieve the contractor of liability for failure to achieve the guaranteed figures, and should give the right to revise the testing schedule.

Responsibility allocation matrix

For effective risk management at the commissioning and testing stage, the parties should agree a responsibility allocation matrix. This matrix should form an integral appendix to the contract.

Client’s responsibility

• supply of quality feedstock in the required volume;
• timely and sufficient provision of utilities (power, water, compressed air, etc.);
• feedstock sampling and proper sample storage for later analysis in case of dispute.

Contractor’s responsibility

• configuring equipment operating parameters in line with the stated feedstock characteristics;
• organising and conducting the production-line tests;
• maintaining documentation of the test results.

Technical aspects

Effect of feedstock quality on test results. Proper feedstock quality is one of the most significant factors for successful testing. To ensure the reliability of testing, the contractor needs the ability to verify the feedstock both before and during the tests. We recommend including in the contract:

• mandatory laboratory analysis of the feedstock before testing;
• recording of feedstock parameters (chemical composition and physical properties, moisture, sizing) and provision of test certificates;
• agreeing the storage format for feedstock samples for possible future verification.

Stability of utility supply. The operation of the production line depends on a stable supply of utilities (electricity, gas, water, steam, compressed air). We recommend recording:

• requirements for the parameters of the utilities;
• installation of back-up power sources;
• the client’s responsibility for monitoring supply stability against demand.

Tuning equipment to feedstock characteristics. If the feedstock supplied by the client does not match the parameters set by the design, the contractor should have the right to review the equipment settings and/or the characteristics of the product. This covers:

• adjustment of equipment operating parameters (pumps, compressors, heat exchangers and other system elements);
• additional tests to minimise the risk of equipment damage.

Verification of automated control systems. Before start-up of the production line, full testing of all elements of the control system (SCADA or equivalent) is recommended, including a preliminary alternative verification of all systems, instruments and sensors, in order to rule out failures during the “hot” tests.

Financial aspects and compensation

Attempting tests with unsuitable feedstock or in conditions outside the design requirements can result in significant costs for the parties. We therefore recommend that the contract record:

• determination of the contractor’s compensation. The client shall compensate the contractor for documented and pre-agreed costs where failed tests were the client’s fault;
• deployment of specialists, accommodation, meals and travel expenses;
• additional commissioning costs and re-diagnostics of equipment where required;
• procedure and conditions for compensating the contractor’s costs;
• recording of penalties for breach of obligations.

Penalties should be provided for late delivery of feedstock or for non-conformity of its characteristics with the design requirements.

Embedding the client’s reciprocal obligation to supply quality feedstock, the procedure for verifying it, and agreeing the responsibility allocation matrix will:

• reduce the likelihood of disputes and disagreements;
• ensure transparency at commissioning and testing;
• improve the overall efficiency of project delivery.

The client is building a plant — say, a chocolate factory; why not. The client engages an EPC contractor to give the project turnkey liability, i.e. end-to-end responsibility sitting with the EPC contractor.

First, because that is convenient; second, because project lenders are not always willing to provide financing where the plant is built on a multi-lot basis, i.e. with many contractors. Why? Because for project lenders — the banks — that means risk: the more contractors in the project, the higher the probability that one of them will miss deadlines or fail to perform other contractual obligations, which in turn increases the risk of late commissioning of the chocolate factory and, behind it, the risk of borrower default.

Designing the chocolate factory

Several vectors are possible on the design side. Let us examine each of them under both Russian law and English law as applied to the EPC contract.

Vector 1 · Designing in-house. The EPC contractor designs the project with its own resources. This is rare but does happen. The EPC contractor does not subcontract a design institute; its staff includes designers. This is the ideal scenario for all parties to the EPC contract, because if the EPC contractor makes a calculation error in developing the FEED or design documentation, and the plant therefore fails to reach the guaranteed figures either during the 72-hour tests or by any other date set by the EPC contract, the responsibility lies entirely with the EPC contractor.

Vector 2 · The EPC contractor engages designers. In practice, this is the most common picture: the EPC contractor enters into subcontracts with one or more designers.

Depending on the technological complexity of the EPC project, the designer (usually foreign) may develop only the FEED package (front end engineering design), i.e. basic or preliminary design with the production technology built in, and the EPC contractor itself adapts the basic package to Russian design norms in line with Resolution 87 of 16 February 2008, “On the Composition of Sections of Design Documentation and the Requirements for Their Content.”

Alternatively, the EPC contractor subcontracts a Russian designer to adapt the basic design to Russian design norms, and receives back a package of design documentation that complies with the Russian standards.

Vector 3 · The client supplies FEED documentation as input data. Cases occur where the client signs the basic-design contract directly with the licensor (the technology holder) and then passes the FEED package across to the EPC contractor as input data, to be incorporated, in adapted form, into the Russian design documentation.

What rely upon and non rely upon information mean in a project

Sometimes the EPC contractor does not want to bear responsibility for the technological decisions “sitting” in the design. Take our chocolate factory. The EPC contractor is most often not the licensor: it knows how to build the factory but does not know which technological decisions need to be designed in so that the factory produces chocolate with specified characteristics.

So the EPC contractor engages a licensor — the party that holds the technology to produce chocolate with the required characteristics. The licensor delivers pre-FEED or FEED design, and the EPC contractor adapts the basic design to the Russian norms.

What to do with this

Whether any given input data is rely upon information or non rely upon information is, in most cases, a matter of commercial negotiation. There are also a number of technical aspects on which it is hard to influence.

This topic is particularly sensitive — and important — for EPC contractors at the moment of accepting input data from the client before the project starts. The EPC contractor needs to understand clearly, and to record in writing in the EPC contract, which input data delivered by the client the EPC contractor is to verify and which it is not.

• Non rely upon information — information that cannot be relied on and that must be verified.
• Rely upon information — information that should be relied on and that need not be verified.

Why is this needed? Any error in the input data from the client, discovered during project execution, can lead to a significant extension of the construction period for that chocolate factory. And if the EPC contractor has not recorded in the EPC contract which input data it is to be liable for the accuracy of, then de jure it will be liable for everything — especially if English law applies to the EPC contract.

Example: an ancient settlement beneath the foundations

Say the client hands the EPC contractor the results of surveys (geology, geodesy) carried out by a separate contractor. When construction works begin, the EPC contractor discovers an ancient settlement that the survey contractor did not find.

What does this mean for the project? Correct: a suspension of works of up to a year. These are so-called subsurface risks. But who is liable for the construction delay if the EPC contract says nothing about whether the EPC contractor must verify input data for accuracy? In the example, the EPC contractor finds itself in a very bad position.

When we represent the EPC contractor on a project, we always sit down with its technical team and explain why we need an appendix clearly demarcating which input data is to be verified by the EPC contractor and which is not. For example, all survey results we treat as rely upon information. So if pile-driving uncovers an ancient settlement, the EPC contractor is not liable for the delay and does not pay the client delay liquidated damages.

The criterion of reasonableness and common sense is also important here. In theory, the contractor could verify the survey results by re-excavating the site, but that is not reasonable — which is why, in international EPC practice, the so-called subsurface risks sit with the EPC client as the site owner.

From the client and lender side

When we represent the client in an EPC project, the rely upon information question also plays an important role — for the client and for the project lenders. Often the client company’s shareholders are not aware that they have selected an EPC contractor who, after several months of negotiations, casually mentions over a coffee break that it is only responsible for its part of the design, the Russian part. The basic design package produced by the foreign licensor — whom the EPC contractor itself engaged — the contractor is not going to check.

So if the chocolate factory produces less chocolate than was agreed in the technical specification, and an expert review concludes that the error “sits” in the FEED package that “underpins” the Russian design documentation, there will be no one from whom to recover the performance liquidated damages for failure to reach the guaranteed figures.

Direct contract between client and licensor for the FEED package

There are cases in which the client engages the foreign designer directly to develop the basic design package and then hands that package to the EPC contractor for adaptation to Russian design norms. If, on that model, the EPC contractor states that it will not verify the FEED package because it lacks the expertise, the client can in such a case pursue the foreign designer for damages.

This route, however, will not be liked by lenders and is commercially poor for the client, because the foreign designer’s liability cap will be calculated from the price of the contract with that designer — which, by definition, will be lower than the EPC contract price. The client will therefore recover a smaller amount of damages than it could from the EPC contractor.

To sum up: before spending months preparing and negotiating EPC terms, include in the tender package or the term sheet a clause addressing which input data the EPC contractor is, in the client’s view, to be responsible for the accuracy of — paying particular attention to verification of the basic design from the licensor.

Increasingly, we are receiving requests from our clients to prepare a notice of termination of contract for breach (notice of termination of contract for breach) under an English-law agreement on the basis of a counterparty’s breach.

We are sent the correspondence with the counterparty for review, which includes claim letters asking the counterparty to cure its breaches of contractual obligations. As we dig into the substance of the dispute, the following picture often emerges: the client asks the counterparty to cure the breach within a particular period and threatens to terminate the contract if the requirement is not met.

Time passes; the counterparty tearfully promises to fix everything, just later; the client’s heart softens, and the contract continues to be performed until the counterparty annoys the client with a fresh breach.

In practice, however, a client–counterparty relationship of the “today I love you, tomorrow I don’t” kind, under a contract governed by English law, generates the following risks for the client where certain reservations are absent from the correspondence.

Affirmation of a contract

English law has the concept of affirmation of a contract (refusal to terminate the contract) and, as a consequence, the loss of the right to terminate it on previously stated grounds.

As a matter of fact, the client does not, of course, consciously waive the contract. In practice, this risk plays out almost always on the same pattern, of which the client is often unaware:

1. the counterparty commits a breach of contractual terms giving the right to terminate — for example, supplies defective equipment;
2. the client writes a claim asking for the defect to be cured within the period set by the contract, or threatening to exercise its right to terminate;
3. the counterparty does not cure the defect, and the client does not terminate either: they meet, they talk; the client expresses displeasure, the counterparty promises to fix everything later;
4. the contract continues to be performed by the client through acceptance of works and payments — meaning the client, by its subsequent conduct, has in effect accepted the breaches.

Then the parties fall out again, and several months later the client asks for a termination notice to be served on the counterparty relying on that same uncured equipment defect. Here is the point: termination on the above ground is no longer available — the right will, with a high degree of probability, be treated by the English courts as having been lost.

The price of the mistake: epic fail

A reminder: in English law there is nothing worse than a termination notice served on the wrong ground. The party that has served such a notice will itself be regarded as having materially breached the contract — i.e. as being in repudiatory breach — which is a direct ground for the counterparty in turn to recover damages and terminate the contract itself. Epic fail, in short.

Withdrawing a termination notice is also not possible under English law; a new contract will need to be concluded.

A protective formulation

To avoid such an exceedingly unpleasant situation, please remember to add to your correspondence with the counterparty a disclaimer in the following terms — particularly where the correspondence concerns non-performance by the counterparty of contractual obligations:

The price can be too high. Are the beneficiaries ready to pay it?