India: Infrastructure and Energy Quarterly - Vollume III: Issue IV - April/May, 2015

Last Updated: 9 October 2015
Article by DSK Legal

Engineering, Procurement and Construction:

Contemporary Challenges in Engineering, Procurement and Construction Arrangements

Engineering, Procurement and Construction (EPC) forms the soul of project development across various sectors, which is critical for sustaining the robust growth of the Indian economy. The success of any project is directly dependent on the successful implementation and completion of EPC. EPC contracts are the tool to achieve this purpose. In this article it is our endeavor to highlight some of the challenges involved in an EPC arrangement  from the perspective of the project developer and the contractor.

The two critical components of project development are time & cost. The parties would always seek to avoid delay in project completion and cost overrun.

The roles and responsibilities of the project developer and the contractor are agreed to in this context (i.e. cost and time) having due regard to the risks involved in a specific project. Thus, principally, the EPC contract is all about efficient risk management by the project developer and the contractor.

Risk management involves the following aspects:

a) Identification of risk – It is imperative to identify the risks under various categories that are associated with the specific project including by way of reference to and extensive analysis of the pre-feasibility and feasibility study/ies conducted for the said project.

b) Risk analysis – Determination of the nature of risk and its likely impact to enable the parties to decide on the party that is best suited to take the risk.

c) Risk allocation – Risk is allocated to create an efficient environment for the parties involved in the project such that the party who gains the maximum for taking the risk or is in the best position to manage the risk, will take the said risk.

d) Managing the Risk- Upon the risk being allocated to a party the said party has the ability to manage the risk appropriately by sharing the risk or the consequences of the risk with a third party.

Types of Risks

For the sake of brevity, we have categorized the contemporary risks that we intend to deal with in this article under the following heads: (a) Financial Risks; (b) Regulatory/Policy Risks; and (c) Other Risks.

Financial Risks

Interest Rate and Exchange Rate

Every project requires huge capital investment, bulk of which is raised in the form of debt where the interest rate has been spiraling up. According to recent market trends, many projects are being funded by way of external debt in foreign currency. Such external debts come at floating interest rate being benchmarked to the LIBOR, an acceptable benchmark under the ECB Regulations prescribed by the Reserve Bank of India. Further, the unprecedented change in exchange rate, more particularly the rising value of the United States Dollar against the Indian Rupee, has adversely impacted costs of such borrowing. The profitability of any project is impacted to a large extent by these factors. The commonly accepted method to address the interest rate and exchange rate fluctuation is entering into of hedging contracts by the party taking the risk on price of the project.

Inflation Rate

Another major financial risk is the rate of inflation which has a huge impact on the commercial dynamics of the project as it affects the pricing of the material inputs for the project. The rate of inflation in past few years has been growing in unwarranted manner. By way of illustration, the price of cement which is an essential raw material for most projects has risen sharply in past few years.

The different formulae linked with various indices are prescribed under the Model EPC Agreement for determination of price adjustment. However, it is essential to ascertain whether these formulae are close to the contractor's procurement model as prices may differ from region to region. Further, the indices used for benchmark prices may not be realistic thereby creating serious risks.

Regulatory/Policy Risks

The recent decision of the Supreme Court whereby the coal blocks allocations made since 1993 were cancelled has created a sense of fear amongst project developers that the project, after being awarded, could still be affected by the courts based on factors to which the contractor may not be privy. It is seen that such risks are not specifically identified and allocated in the EPC Agreements as these are project risks inherent to the role of the project developer. However, the implication of such risk does not remain confined to the project developer but has trickling effect on others including the contractor. These risks could be mitigated by the contractor inter alia by way of consequential loss insurance policy being obtained by the contractor or by seeking a security from the project developer. But for the project developer, the only practical risk mitigation remedy seems to be obtaining consequential loss insurance policy. Thus, it is important to assess if cancellation of the grant of the project of the impact on a project due to a court order/regulatory action can be insured under consequential loss insurance policy and the cost of premium for such policies as it has direct impact on the profit margin of the project developer.

As far as environmental clearances/consents are concerned it is always advisable to ensure that the project has received such clearances/consents before the commencement of EPC work. Further, in an EPC contract, the responsibility to obtain local permits and clearances are sought to be shifted to the contractor. The process for obtaining local permits and clearances may be cumbersome and may delay the project. EPC contractors should factor this risk and seek suitable protection by way of adjustment of time and price.

Another important policy risk is uncertainty with regards to fiscal incentives offered by the Government (Central, State and local). Many projects across different sectors enjoy various fiscal incentives pertaining to income tax, excise duties, custom duties, stamp duties etc. These are fiscal policies of the Government and are subject to change in future on account of the social, economic and political conditions prevailing at the relevant time. Withdrawal of such incentives has bearing on the cost of development of the project. Therefore, the price for the project should factor all incentives that can be categorically identified and variation in these incentives should be allowed as factor for price adjustment.

Other Risks

There has been a rising trend of consortium bidding. Consortium bidding was considered beneficial from taxation point of view as supply of capital goods by foreign bidder to the owner, being import of equipment was not considered to give rise to payment of income tax by foreign supplier under Income-Tax Act, 1961. However, Income Tax Act applies to income derived by an association of persons in India. Recent rulings on the subject suggest that such consortium will be treated as an association of persons and therefore, income from offshore supply becomes taxable in India. The Authority for Advance Rulings (AAR) in its ruling in 'Alstom Transport SA' on June 7, 2012 applying the 'look at' approach of Supreme Court in Vodafone case, held that a contract for design, manufacture, supply, installation, testing and commissioning of signaling/train control and communications systems is a composite contract and income from offshore supply was taxable in India, even though property in such goods was transferred outside India. Earlier in the case of 'Linde AG' on March 20, 2012 in case of consortium bidding, AAR had reached a similar conclusion based on facts of that case. Therefore, it is imperative that due care is exercised in structuring the EPC contracts in case of consortium bidding, taking the potential tax exposures into consideration.

Different governing laws and jurisdictions in different contracts for same project may pose unnecessary risks for a project. For example, in case of consortium bidding, the consortium partners enter into a consortium agreement to govern their inter-se relationship. If the consortium agreement is governed by laws of a foreign country and EPC contract is governed by Indian laws, this may cause serious problem as to interpretation of responsibilities of partners and enforcement of contract.

Further, while it is common to have mediation mechanism being resorted to before invoking arbitration, creation of multi-layered structure for dispute resolution in pre-arbitration stage may cause substantial delay. Further, institutional arbitration is expected to scores better than leaving appointment of arbitrator to the discretion of parties under an ad-hoc mechanism. Qualification of arbitrator and their integrity is essential for an efficient and fair adjudication. Selection of arbitrator in an ad-hoc manner may adversely affect this process. Therefore, parties should consider opting for institutional arbitration wherein arbitrators are to be selected from a panel of arbitrators.

Conclusion

In view of the above, it is important to upfront identify and suitably address all the risks so identified in relation to a specific project with prudent risk management and appropriately worded contracts. It is in this context one may note that the disputes in relation to EPC contracts currently pending are reported to involve Rs. 1 Lakh Crores.

Augmenting Grid Connected Solar Power Capacity in India:

Scheme for addition of 15,000 MW Grid Connected Solar PV Power Capacity under the National Solar Mission

The first phase of India's National Solar Mission (2010 – 2013) had set a target of adding 1100 MW grid-connected solar power generation capacity. However, a total of 1685 MW grid-connected solar power generation capacity was added during this time under various schemes in India. To further augment and tap solar power in India, the Government of India had laid down a scheme for setting up of 15,000 MW grid-connected solar PV power projects in India under the National Solar Mission.

The Ministry of New and Renewable Energy (Grid Solar Power Division) vide its Notification dated March 5, 2015 has notified the assent of the President of India for the implementation of the scheme (Scheme) for setting up of 15,000 MW of grid connected solar photovoltaic power plants (Project) under the National Solar Mission (Solar Mission). The aforesaid grid connected solar photovoltaic power plants are proposed to be set up under the Solar Mission through project developers from the private and/ or public sector over a period of 5 (five) years from the financial year 2014-15 to 2018-19 and the National Thermal Power Corporation Limited and the NTPC Vidyut Vyapar Nigam Limited shall be implementing agency for the Scheme.

The Scheme proposes to achieve the said capacity augmentation in 3 (three) tranches as under:

(1) Tranche I (2014-15 to 2016-17): 3000 MW under mechanism of bundling with unallocated coal based thermal power and fixed levellised tariffs;

(2) Tranche II (2015-16 to 2017-18): 5,000 MW with some support from the Government to be decided after getting some experience while implementing Tranche – I; and

(3) Tranche III (2016-17 to 2018-19): Balance 7,000 MW without any financial support from the Government.

Tranche I of the Project, which will comprise of Batch II of Phase II of National Solar Mission, is envisaged to augment 3,000 MW solar photovoltaic power capacity to the national solar grid. Tranche I of the Project is proposed to be based on bundling of solar power with unallocated thermal power in the ratio 2:1. The 1,500 MW of unallocated thermal power which shall be required for this purpose has already been made available by the Ministry of Power. The solar power projects under Tranche I shall be developed by private and/or public companies selected through international competitive e-bidding. Under Tranche I, the solar power plants shall have a minimum capacity of 10 MW.

Out of the total 3,000 MW capacity under Tranche I, 1,000 MW capacity solar power projects shall be developed in the State of Andhra Pradesh, where land has already been identified for the purpose of setting up of a solar park.

While the Ministry of New and Renewable Energy's Notification dated March 5, 2015 sets out the mechanism to be adopted for the setting up of solar power projects under Tranche I, the mechanism for the Tranche II and Tranche III of the Scheme has not been devised yet. The Ministry of New and Renewable Energy proposes to devise suitable mechanisms for the Tranche II and Tranche III of the Scheme, in which minimum support will be provided to the project developers by the Government, after gaining experience from the implementation of the Tranche I of the Scheme.

Other aspects of the Scheme:

(1) Like the previous projects under the National Solar Mission, the Projects to be developed under the Scheme shall have certain portion of the total capacity earmarked to be set up using Domestic Content Requirement (DCR).

(2) The DCR shall be technology agnostic and shall be applied to both crystalline silicon technology and thin film SPV cells/ modules technology.

(3) State nodal agencies appointed for the purpose shall be responsible for: (a) grid connectivity; (b) land acquisition; (c) water availability; (d) monitoring of progress of projects; (e) commissioning; and (f) related activities.

Ensuring bankability of the Power Purchase Agreements (PPAs): A payment security mechanism/ working capital fund has been proposed to be set up with a total estimated corpus of Rs. 2,300 Crore for ensuring 3 (three) month's payment for the bundled capacity of 4,500 MW (3,000 MW solar power capacity together with 1,500 MW coal based thermal power). The aforesaid fund shall ensure the bankability of the PPAs which shall be entered into for the Projects under the Scheme.

The Mines and Minerals (Development and Regulation) (Amendment) Act, 2015

Removing discretion in grant of mineral concessions and making auction the sole method for allotment

The Mines and Minerals (Development and Regulation) (Amendment) Act, 2015 (MMDR Act, 2015) which amends certain key provisions of the Mines and Minerals (Development and Regulation) Act, 1957 (MMDR Act, 1957) has finally been passed by both the houses of the Parliament.

Amending the MMDR Act, 1957 was imperative in light of the various problems which the mining industry was facing and in light of the Supreme Court of India's judgment dated September 24, 2014 in the matter of Manohar Lal Sharma v. The Principle Secretary and Ors. To address and resolve the issue the Government of India had already taken the ordinance route and had passed the Mines and Minerals (Development and Regulation) Amendment Ordinance, 2015 on January 12, 2015. Now with the MMDR Act, 2015 being passed, the mining industry should be regularized and the much required transparency in the allotment process of the mining concessions will be brought about.

The key changes brought about by way of the amendments in the MMDR Act, 2015 are as under:

(1) One of the key purposes of the MMDR Act, 2015 was removal of discretion from the process of allotment of the mining concessions. The MMDR Act, 2015 has addressed the issue and it stipulates that all mineral concessions are to be granted only by way of auctions. This shall not only remove discretion from the process of grant of mining concessions but will also make the entire process more transparent, which should attract more private players in the mining industry and will eventually augment the growth of the capital intensive mining and minerals sector.

(2) The tenure of the mining concessions to be granted under the MMDR Act, 2015 has been increased from 30 (thirty) years to 50 (fifty) years. However, the MMDR Act, 2015 prohibits any renewal of the mining concessions granted under the MMDR Act, 2015 after the said tenure of 50 (fifty) years. Under the MMDR Act, 1957, the mining concessions were granted for an initial tenure of 30 (thirty) years after the expiry of which the concessions were further renewable. Therefore, under the MMDR Act, 2015 after the expiry of the term of 50 (fifty) years, there shall be no renewal of any mining concession and the same shall be put up for auction.

(3) The pendency of applications for renewals of the mining concessions granted under the MMDR Act, 1957 had greatly affected the mining industries and its output. The MMDR Act, 2015 addressed this issue under Section 8A(5) and Section 8A(6) by extending the tenure of all: (1) mining (captive) concessions granted under the MMDR Act, 1957 up to March 31, 2030 or until the completion of the period of renewal already granted, whichever is later; and (2) mining (non-captive) concessions granted under the MMDR Act, 1957 up to March 31, 2020 or until the completion of the period of renewal already granted, whichever is later.

(4) The MMDR Act, 2015 requires the setting up of a District Mineral Foundation (DMF) in every district where mining activities are carried out. This provision has been included in the MMDR Act, 2015 for safeguarding the interests of the people affected in the areas on account of the mining activities. The MMDR Act, 2015 also requires the State Governments, while framing the rules for giving effect to the DMF, to conform to the provisions of Panchayats (Extensions to Scheduled Areas) Act, 1996, Scheduled Tribes and Other Traditional Forest Dwellers (Recognition of Forest Rights) Act, 2006 and the provisions of the Fifth and Sixth Schedules of the Constitution of India.

(5) In order to address the inadequacy of mining explorations, the MMDR Act, 2015 has proposed to establish a National Mineral Exploration Trust (NMET), a dedicated fund for undertaking mining exploration projects. The NMET is envisaged to be created out of contributions received from the mining lease holders.

(6) Under the MMDR Act, 1957, the State Governments were mandatorily required to obtain prior approval of the Central Government before grant of any mineral concessions with respect to the 10 (ten) minerals listed under Part C of the First Schedule of the MMDR Act, 1957 which included iron ore, manganese, bauxite, copper, gold, etc. However, the MMDR Act, 2015 has removed this requirement of prior approval from the Central Government. Therefore, under the MMDR Act, 2015 now the State Governments shall not be required to obtain a prior approval from the Central Government for granting the mining concessions.

(7) In order to curb the ever increasing problem of illegal mining, the MMDR Act, 2015 has made the provisions pertaining to offenses and punishments more stringent. All offences under the MMDR Act, 2015 shall be subject to a maximum punishment of 5 years' imprisonment or fine of Rs. 5 Lakhs per hectare. The State Governments are also empowered under the MMDR Act, 2015 to set up special courts for speedy trial of offences under the MMDR Act, 2015.

OTHER REGULATORY UPDATES SCHEMES FOR CARGO TRANSPORTATION

The Ministry of Shipping has proposed to initiate a scheme, viz., Scheme for Incentivizing Modal Shift of Cargo (Cargo Transportation Scheme), for providing certain monetary incentives for transporting certain identified commodities, containerized cargo and automobiles through coastal shipping/ inland waterways routes. The Cargo Transportation Scheme will not only decongest the roadways/ highways and railroads, through which the cargos are generally transported, but will also minimize the environmental impacts of such road and rail transportation. The Cargo Transportation Scheme has been proposed to be implemented initially during the period from April 1, 2015 up to March 31, 2017.

The Cargo Transportation Scheme can be availed by any transporter, if the identified categories of cargo are transported through coastal shipping or inland waterway routes or both. However, for availing the benefits under the Cargo Transportation Scheme, the identified cargos must be transported in vessels with Indian flag, river sea vessels or barges and the coastal shipping or inland waterway routes through which the such cargo is transported must pass through at least one major port, designated non-major port or Inland Waterways Authority of India terminal/jetty at the point of loading or discharge. The Cargo Transportation Scheme is proposed to be implemented using the Port Community System and such transporters who are eligible for grant of the incentives under the Cargo Transportation Scheme must register under the Port Community System with the Indian Ports Association.

ONLINE APPROVAL/ LICENSING SYSTEM FOR TRANSPORTATION OF ATOMIC WASTES

The Atomic Energy Regulatory Board has, with effect from February 28, 2015, implemented the web-based approval/ licensing system – eLORA (e-Licensing of Radiation Applications) for granting approval/ license for transportation, export and disposal of atomic wastes. The online process will not only simplify and fast tract the licensing process but will also make the process more transparent.

NUCLEAR REGULATORY INFRASTRUCTURE OF INDIA

The Integrated Regulatory Review Service Mission of International Atomic Energy Agency (IAEA) reviewed the regulatory framework in place in India with respect to nuclear safety, during March 16, 2015 to March 27, 2015. The review was focused on Atomic Energy Regulatory Board's (AERB) regulatory frameworks with respect to nuclear power plants and projects and was carried out by comparison with IAEA safety standards, which are recognized as international benchmark for atomic safety.

The review mission acknowledged that AERB continues to strengthen its regulatory frameworks regularly for regulating nuclear safety, by reinforcing the safety measures of existing nuclear facilities, monitoring ageing and decommissioning old facilities, and also by overseeing the construction, commissioning and operation of new nuclear power plants. However, the mission also identified certain areas which require improvements, such as: policy for radioactive waste management, regulatory independence of AERB, enhancing routine inspections at nuclear power plants. IAEA shall be submitting its final report to the Government of India later this quarter.

BOOSTING MARITIME INFRASTRUCTURE IN INDO-SRI LANKA REGION

In order to counter China's inexorable reach over the Indian Ocean, and to strategically strengthen its presence in the Indian Ocean region, the Government of India has proposed to substantially invest and develop the maritime infrastructure in the island state of Sri Lanka.

It has been proposed to restart the ferry services between India and Sri Lanka. The Government of India has also proposed that Indian and Sri Lankan companies should work together for developing oil tank facilities in Trincomalee for refueling ships at the port and in order to make Trincomalee a regional petroleum hub.

It is pertinent to note that by way of investing in and developing Sri Lanka's maritime infrastructure and regional connectivity, India is strategically strengthening its own security aspects.

CONNECTING INDIAN SKIES

In order to boost the air transport infrastructure in India, the Airports Authority of India (AAI) has undertaken the construction of five small airports during 2014-2015, located at Hubli and Belgaum in Karnataka, Kishangarh in Rajasthan, Jharsuguda in Odisha and Tezu in Arunachal Pradesh.

A Task Force has also been constituted for identifying certain other locations where such small airports should be developed, based on broad criteria viz., minimum population of 10 lakhs, tourism potential, commercial viability, details of the flight movements in past, social obligations etc. The Government of India proposes to develop these small airports in the Tier-II and Tier-III cities with private participation.

AUGMENTING ENERGY EFFICIENCY IN THERMAL POWER PLANTS

In order to boost energy efficiency and reduce fuel consumption by thermal power plants the Government of India has identified 144 thermal power plants under the Perform, Achieve and Trade (PAT) Scheme of the Ministry of Power which is being implemented by the Bureau of Energy Efficiency.

In order to give the necessary impetus for boosting the energy efficiency and for improving the demand supply management, various steps are being taken by the Government of India, viz. (i) advanced planning with respect to power generation projects to be taken up during the 12th Five Year Plan in detail and perspective planning with respect to power generation projects to be taken up during the 13th Five Year Plan; (ii) projects which are in the execution stage are monitored at the highest level for resolving bottlenecks with respect to the project and for ensuring that the projects are timely commissioned.

In addition to the aforesaid, the following steps are also being adopted with respect

to the designing and operation of power plants:

(1) Renovation and modernization and life extension of existing thermal power stations are being done for improving the performance of the power plant.

(2) The Central Electricity Authority has notified the Technical Standards for Construction of Electric Plants and Electric Lines Regulations, 2010 which sets out the requisite energy efficiency criteria to be complied with.

(3) Old and inefficient thermal power plants are being closed down in a phased manner. Supercritical technology is being adopted for enhancing the efficiency of coal fired thermal power generation and for reducing the coal consumption required for the power generation.

PROPOSED SCHEME FOR PROVIDING INCENTIVES FOR MAKING THE MAJOR PORTS GREEN PORTS

The Ministry of Shipping has approved of a new incentive scheme (Scheme) on March 10, 2015 for the purpose of giving the necessary impetus to the major ports to become green ports. Green ports shall be such major ports which set up green projects within the port area, viz., waste water treatment, renewable energy generation, using of bio-diesel and provision of shore power.

The Scheme proposes that the Government of India shall provide each of the major port a financial grant of up to Rs.25 Crore for undertaking these green projects within the port premises for the purpose of making th port a green port.

INDIA TO BENEFIT FROM THE SILK ROUTE PROJECTS

The Silk Road Project which is being undertaken by China comprises of a Silk Road and a Maritime Silk Route. Although the main intent of the Silk Road is to connect China with Europe through Central Asia, the Silk Road also connects Bangladesh, China, India and Myanmar (BCIM) and the Pakistan-China Economic Corridor through the Pakistan occupied Kashmir. In addition, the Maritime Silk Route (MSR) proposes to connect China's ports with the ports in Vietnam, Malaysia, Indonesia, India, Sri Lanka, Greece and Kenya.

Therefore it is evident that the US$ 40 Billion Silk Road Project not only connects India with rest of Asia but the project will also boost trade and commerce between India and the other connected neighboring countries. However, although India is participating in the BCIM segment of the Silk Road, India shall not be participating in the Maritime Silk Route project on account of India's strategic concerns over China's dominion over the Indian Ocean.

GUIDELINES FOR PPP IN INFRASTRUCTURE PROJECTS AMENDED FOR PROVIDING ADDITIONAL FINANCIAL SUPPORT

The Cabinet Committee on Economic Affairs has, at its meeting held on March 31, 2015, approved the amendment in the definition of a 'Private Sector Company' in the guidelines for providing financial support to public private partnerships in the infrastructure sector under the Viability Gap Funding Scheme (VGF Scheme).

The definition of 'Public Sector Company' has been approved to be amended in order to remove any ambiguity in the interpretation of the term and for the purpose of aligning the definition with the definition of a 'Government Company' as defined under Section 2(45) of the Companies Act, 2013.

Further, approval has also been accorded for the definition of 'Private Sector Company' being amended. The amended definition of a 'Private Sector Company' under the PPP guidelines shall include a company which is not a 'Government Company', where Government Company is defined under Section 2(45) of the Companies Act, 2013. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

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