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Copyright © International Chamber of Commerce (ICC). All rights reserved. ( Source of the document: ICC Digital Library )
by ICC PUBLISHING S.A.
This model contract intends to cover a particular category of turnkey contracts, i.e. contracts for the supply of a complete plant or production line to be erected within facilities which already exist or which are constructed by the purchaser (or by a third party, for the purchaser’s account). In other words, the model refers to a contract which is called “turnkey” because it comprises in principle whatever is necessary for a certain purpose (a complete production unit), but such “turnkey approach” is limited to the plant or production line, i.e. to the equipment necessary for manufacturing certain products, and does not extend to the items which “surround” the plant, such as buildings, supply of energy, etc., which remain outside the scope of the contract.
From this point of view, this turnkey contract must be clearly distinguished from more comprehensive turnkey contracts which cover all other items, like civil works, etc. The ICC is at present also preparing a model of an all-comprehensive turnkey contract, which is more suitable for large civil works or contracts for the supply of a plant where the contractor undertakes to supply a complete factory (including civil works, etc.).
The difference between the two types of turnkey contracts is substantial. While in a “full turnkey”, the contractor undertakes to perform a work (i.e. to build a factory, a bridge, etc.), in the contract for the turnkey supply of a plant, the supplier’s main obligation is to supply the equipment and to assist the purchaser during erection and start up, together with an overall warranty that the plant as a whole (and not only each single part of the equipment) will meet certain performance parameters.
A first consequence of this different approach is that the turnkey contract for a plant is mainly a contract for the sale of equipment, governed by the rules on sale contracts, and particularly the United Nations Convention on the International Sale of Goods (CISG)1, although with peculiar characteristics which are closer to a construction (works) contract (like the involvement of the supplier in erection, start up, etc. and the overall warranty of performance of the plant). In other words, this contract is mainly a contract for the sale of equipment, with accessory obligations regarding erection, start up, training of personnel, etc. This is shown inter alia by the fact that the contract price mainly relates to the equipment and is normally paid (for the greatest part) against delivery of the equipment.
Another important difference is that, while in the full turnkey contract the contractor will commonly have complete control and responsibility over the site until taking over, in the turnkey contract for the supply of a plant or production line, the supplier will[Page11:]perform its obligations regarding assistance during erection, start up, etc. within facilities that are under the purchaser’s control: this is particularly the case when a line is to be installed within an existing factory. Moreover, it is normal that the purchaser takes delivery of the equipment before erection and that consequently during the stage of erection, start up, etc., the purchaser controls the equipment and bears the respective risk.
Drafting a model of a contract which is not easy to standardise gives rise to a number of problems. The more the individual contracts differ from case to case, the more difficult it is to find common solutions that can be used for all contracts of the same type.
The easiest way to overcome these problems is to recognise that it is impossible to draft a model and to invite the potential users to draft ad hoc contracts with the assistance of an experienced lawyer. The Task Force on Turnkey Transactions has decided not to adopt this approach and has tried to work out a flexible model that takes into account, to the greatest possible extent, the need for differentiation.
In order to leave the greatest possible space to alternative solutions, many issues have been put in the annexes. In particular, the Task Force has worked out a Contract Schedule where a number of variable issues are mentioned and where the parties are given the opportunity to choose between different solutions and to fill in the points which are specific to their contract.
All this implies, however, that the model cannot be used as such. It requires a number of adaptations in order to take into account the actual needs of the parties and should consequently be drafted with the assistance of a lawyer specialised in this type of contract.
Parties often make the entry into force of the contract conditional upon certain events, some of which are wholly or in part outside their control (e.g. government authorisations) and others not (e.g. advance payment or bank guarantee).
The Task Force is of the opinion that the contract should come into force from the date of signature and that the events indicated above should only be conditions for the effectiveness of the contract.
Accordingly Article 3.1 provides that the contract is in force as of the date of signature, and the parties are obliged to take the necessary steps for its effectiveness (such as, for example, providing a bank guarantee or an advance payment), while the main obligations under the contract only arise at the commencement date, i.e. if and when the events listed in Contract Schedule B occur.
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As regards the events which are necessary for the contract’s effectiveness, the Task Force preferred not to use the word “condition” since within some jurisdictions certain events (for example, the provision of an advance payment by a party) are not “conditions” in the legal meaning of such word. In order to avoid possible disputes that this might cause, a more neutral term (“event”) has been used.
It is, of course, up to the parties to decide which events must occur before the contract becomes effective: Contract Schedule C contains a list of possible options in order to facilitate the drafting to suit the parties.
While, under the full turnkey contract, it is common that shipment of the equipment or other materials to the site remains an internal matter of the contractor, who undertakes to deliver the complete works at taking over, within the turnkey supply of a plant the normal solution is that the supplier first delivers the equipment to the purchaser and thereafter performs further activities (supervision of erection, start up, etc.) with respect to such equipment.
In practice, there are two main options used:
In the first case the purchaser will take delivery of the equipment as per the selected Incoterm and provide for transportation to the site. This may cause problems if there is a risk that certain parts of the equipment could get lost or deteriorate: although the risk of such loss or deterioration would be for the purchaser (if it can be proven that such events took place after delivery), the fact remains that the performance of the contract would be impossible until the missing or deteriorated parts were repaired and replaced. This is why in many cases a direct shipment to the site may be preferable.
It should be noted that the risk of loss or damage to the goods passes when delivery (according to the applicable Incoterm) occurs. So, for example, when using CIP (Cost Insurance Paid), the risk will pass when the goods are delivered to the first carrier; when using FOB or CIF, when they pass the ship’s rail at the port of shipment; when using DDU (Delivered Duty Unpaid), when the goods are placed at the purchaser’s disposal at the place of destination.
This aspect is important because if goods are lost or damaged before delivery, it will be the seller’s responsibility to replace them (and he will in principle be responsible for the delay caused by such replacement), while in the case of loss after delivery, the purchaser will bear the consequences of such loss.
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As regards the choice of the most appropriate Incoterm, Article 11.2 provides CIP (Cost Insurance Paid) as the “default solution”. If the parties prefer another solution, they may make their choice within Schedule E.
The turnkey supply of a plant is a complex operation which entails a number of stages. Although these may vary from contract to contract, we can try to give a general overview of the most common way these contracts are carried out.
The supply of a plant implies, of course, the need for a description of the plant. Normally the supplier will prepare a very general description when submitting the offer and, if the contract is concluded, he will proceed to a more detailed design (layout) thereafter. Such layout will take into account the information provided by the purchaser and will define the purchaser’s obligations regarding civil works, water and energy connections, etc.
Thereafter the supplier will produce the equipment (and/or purchase certain parts of it), which will be shipped to the purchaser (for further details see above, § 4).
When the equipment is at the site ready for erection, the purchaser will proceed to erect it under the supplier’s supervision. The Task Force has considered in the model the most common option, i.e. that the various activities, such as erection, start up, etc., are carried out by the purchaser and that the supplier’s task in this respect consists only in supervising such activity. This means that, in case erection and other activities (like start up) should be carried out directly by the supplier, the model should be modified accordingly.
After the erection stage, erection testing is to be carried out, under the supplier’s supervision. The Task Force has avoided the use of the term “commissioning” because it was felt that, due to the rather different meanings given to this word in practice, its use might create confusion. This is why erection testing, defined as “the running of every machine and/or group of machines of the plant with or without raw materials (as appropriate) in order to check their correct erection and functioning” has been preferred.
When erection testing has been completed, the plant will be gradually put into operation and the purchaser’s personnel will be trained in its use.
As soon as the plant has attained a sufficient production capacity, the Parties will proceed to the performance testing in order to verify its capacity to reach the guaranteed performance.
If the performance testing is successful, the plant shall be taken over by the purchaser.
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One aspect which cannot be standardised, because of the substantial differences from case to case, is that of the payment conditions.
The model only attempts to give, in Article 26, some general rules, applicable to the solutions the Parties may choose: so, for example, if the Parties choose a payment by documentary credit, Article 26.2 provides some default rules on the characteristics of the documentary credit. Along the same line, Article 26.4, contains provisions on interest due in case of delayed payment.
As regards specific payment conditions, the extreme variety of schemes used in practice led the Task Force to conclude that the preferable approach would be to leave this for completion by the Parties, depending on their specific requirements.
In many cases the purchaser makes an advance payment (against issue of a repayment guarantee by the supplier) and the remaining amount is paid against shipment of the equipment and issue of a performance guarantee, but the specific conditions will vary substantially from case to case. Consequently, Schedule G has been left blank.
In order to give the Parties some guidance when preparing the payment conditions, some typical examples have been put in Appendix I.
As a general principle of law, non-performance of the contract by a party gives the other party the possibility of suspending performance, requesting damages, and if non-performance implies a material breach, terminating the contract.
However, in the context of this particular contract, termination by the purchaser may – especially if it takes place when the equipment has been already manufactured, delivered and erected – cause disproportionate damages to the supplier. In fact the extreme consequence of termination, i.e. that the supplier should dismantle and take back the plant and give back the money, would in most cases imply for the supplier a loss much higher than the contract price. Considering that the equipment is frequently tailor-made and cannot be resold to others and that the dismantlement and transport costs can be very important, a termination at this stage could imply unreasonably high losses for the supplier.
On the other hand, the purchaser must be protected against the risk of being forced to keep a plant that does not fulfil its reasonable expectations. If the plant does not[Page15:]correspond to what the purchaser was entitled to expect, he must retain the right to terminate the contract and get back his money.
The model contract attempts to reach a workable compromise between the positions of the Parties by admitting the possibility of a contract termination under special circumstances and by limiting the effects of termination to obligations which are still to be performed (see Article 30.4).
Only in the extreme case, where the plant does not reach the minimum guaranteed performance, will the purchaser be entitled to terminate the contract with retroactive effect, i.e. to require the supplier to dismantle and take back the equipment and to return the price to the purchaser.
Of course, in all other cases, the party terminating the contract in case of default by the other party will retain the right to recover damages within the maximum limits fixed in the contract (and even over these limits, if the default by the other party amounts to fraud or wilful misconduct: see Article 32.3).
As regards force majeure, the model contract has incorporated the ICC Force Majeure Clause 2003.
In certain cases, the parties may wish to make an exception with respect to acts of authority by expressly excluding that acts of authority, laws, regulations, etc. of the country where the plant is to be erected (which will normally also be the purchaser’s country) should be considered as force majeure for the purchaser. This is in order to prevent the purchaser from invoking events which, although outside his control, may be considered as being part of his risk area. In such cases, the parties can add to Article 33 the following paragraph:
Exception. It is expressly agreed that the Purchaser accepts the risk of any impediments due to acts of authority, laws, governmental orders, etc. – as described in paragraph 33.3, (d) – of the authorities of the Country and is consequently not entitled to invoke this force majeure clause in case of occurrence of such impediments, unless the aforesaid impediments are caused by circumstances occurring outside the Country.
The model form has been based on the assumption that it will not be governed by a specific national law, but only by the provisions of the contract itself and the principles of law generally recognised in international trade as applicable to contracts for the[Page16:]turnkey supply of a plant (also called “lex mercatoria”). The purpose of this solution is that the rules of this model form can be applied in a uniform way to suppliers and purchasers of different countries, without giving one party the advantage of applying its national law.
Of course, this solution, while avoiding the particularities of national laws, gives a wider discretionary power to the arbitrators, since it is based (at least for matters not expressly governed by the contract clauses) on very general principles.
The Task Force is of the opinion that the possible disadvantage resulting from the application of rather flexible and general rules is counterbalanced by the greater certainty of a uniform set of contractual rules and by the reference to the CISG as well as to set of general rules on contracts, like the Unidroit Principles of International Commercial Contracts2 , which offer a reasonably foreseeable legal framework for most issues which may arise.
With regard to the Unidroit Principles, it should be borne in mind that according to Article 36 A they apply only to the extent they do not conflict with general principles, trade usages and CISG, since Article 36A puts the various sources incorporated by reference in the following hierarchical order: contract clauses, general principles, CISG, trade usages, Unidroit Principles3 .
This also implies that, even when the Unidroit Principles provide that certain of its rules are mandatory, such rules will not prevail over the contractual clauses, general principles or trade usages.
In any event, if the parties wish to have their contract governed by a specific national law, they may use the alternative set forth in Article 36 B. In such a case, they should check carefully whether any provisions of the model form violate mandatory provisions of the national law they have chosen4 . The choice of submitting the contract to a national law is preferable if parties submit the contract to the jurisdiction of ordinary courts instead of arbitration, since it is highly unlikely that national courts would accept to consider general principles, “lex mercatoria” and the like as the governing law of the contract.
The problem of the law applicable to the contract, i.e. the law governing the respective obligations of the contracting parties, should not be confused with the need to respect rules and regulations applicable at the site (e.g. with regard to security regulations on the site, maximum labour time, etc.).
It is obvious that, when carrying out certain services on the site, the supplier (and his personnel) need to comply with the mandatory rules of this type.
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Another aspect which may be relevant is the compliance with local rules fixing certain requirements for the equipment (e.g. safety provisions). Article 4.7 of the model states in this respect the supplier’s obligation to comply with the rules existing in the country where the site is located. If the supplier is unable to get informed about such rules, the contract may provide an obligation of the purchaser in this respect.
Since the model form is a set of uniform contractual rules, avoiding (as far as possible) the direct application of conflicting domestic legislation, it is appropriate that possible disputes be resolved by a uniform resolution system organised on an international level.
From this point of view the best solution appears to be international commercial arbitration (see particularly Article 37.2-A), which permits a truly international approach not favouring one of the Parties.
However, the Parties may also have recourse to national courts by choosing Article 37.2, alternative B. As said before, this solution should be avoided if reference is made to “lex mercatoria”, general principles, etc.
1 The text of the United Nations Convention on the International Sale of Goods (CISG) can be found in Appendix I.
2 The text of the Unidroit Principles can be found in Appendix II.
3 This solution takes into account that a limited number of provisions of the Unidroit Principles may not actually reflect the expectations of international trade. This may be the case with respect to certain rules which protect the disadvantaged party to an extent that goes beyond the standards that are usual in business to relations: see, for instance, Article 3.10 on gross disparity (particularly as concerns the end of the sentence in para 1(a), where reference is made to “the improvidence, ignorance, inexperience or lack of bargaining skill” of a party in order to justify contract avoidance) and the rules on hardship contained in Articles 6.2.1-6.2.3 (particularly with regard to the rule authorising courts to modify the contract terms). With respect to such rules, general principles of law and trade usages will prevail over the Unidroit Principles. Of course, parties may also expressly exclude the application of specific provisions of the Unidroit Principles that they consider inappropriate.
4 It should in any case be considered that, even if no choice of a national law has been made, internationally mandatory rules (i.e. rules which would be applicable independently from the applicable law: so called “lois de police”) of a national law having a close connection with the contract may be applicable in certain circumstances under Article 36.2.