By Eng. Vaughn I. Lezama, B.Sc., FAPETT, M.ASCE, R.Eng.
Registrar, Board of Engineering of Trinidad and Tobago (BOETT)
CEO and Principal Engineer, Consulting Engineers Associates 2005 Ltd (CEAL)
Introduction
I have previously written about the increasing imbalance and onerous finance and payment terms appearing in State construction contracts in Trinidad and Tobago. Those concerns have included extended payment periods, the removal or reduction of financial charges for delayed payments, excessive retention provisions, and other amendments to standard forms of contract which progressively transfer financial risk from the Employer to Contractors and Consultants.
An Invitation to Bid (ITB) and Request for Proposals (RFP) issued by a State Agency appear, however, to take this practice to a new and troubling level.
The payment provisions advise bidders, in effect, that amounts properly due under the contract will only be paid after the State Agency receives the corresponding funds from its line Ministry. The RFP states that the project is a Public Sector Investment Project (PSIP) and that amounts due on invoices will be paid within seven working days after receipt of funds from the Ministry.
At first glance, “seven working days” may appear to constitute a reasonably prompt payment provision. It does not.
The critical issue is not the seven days. The critical issue is: seven days after what?
If there is no defined period within which the Ministry is required to provide the funds to the State Agency, there is consequently no defined period within which the Contractor or Consultant can be assured of receiving payment. The payment period is therefore potentially indeterminate.
A Fundamental Transfer of Financial Risk
This represents a significant transfer of financial risk.
A Contractor or Consultant pricing a tender or proposal must be able to assess the anticipated cash flow associated with performing the contract. Employees must be paid. Subconsultants and subcontractors must be paid. Materials, equipment, accommodation, transportation, insurance, professional services, statutory obligations and other operating expenses must all be financed as the project proceeds.
The Contractor or Consultant must therefore know, with reasonable certainty, when payment for properly executed work or services is expected.
If the contract instead provides, in effect:
We will pay you after somebody else provides us with the money, but we cannot tell you when that will occur,
then the bidder has no reasonable contractual basis upon which to quantify the financing exposure associated with the work. The problem becomes considerably more serious where the same contract also provides that no interest or financing charge will accrue during the period in which the Employer is awaiting the release of funds.
The Contractor or Consultant is then being asked to accept both the time risk and the financing cost arising from circumstances entirely outside its control. This is not an equitable allocation of contractual risk.
The Seven-Day Payment Period Is Illusory
Consider the practical effect. A Consultant submits a properly supported invoice. The invoice is reviewed and certified. The Consultant has performed the services and incurred the corresponding costs.
The State Agency may be perfectly willing to pay. However, the Agency has not yet received the necessary allocation or disbursement from its Ministry. Does payment occur after 30 days? Fifty-Sixty days? Seventy days? Six months? The contract provides no answer.
Once the Ministry eventually releases the funds, the Agency undertakes to pay within seven working days. But the seven-day period does nothing to quantify the financial risk preceding it.
For tender-pricing purposes, therefore, the relevant payment period is not seven days. It is an unknown period + seven working days. That is the commercial risk that the bidder is being asked to accept.
Contractors and Consultants Are Not Project Financiers
There is a fundamental distinction between providing construction or professional consulting services and providing finance. Contractors inevitably finance portions of their operations between expenditure and receipt of interim payments. Consultants similarly incur salaries, specialist fees and operating expenses before invoices are paid. Normal payment periods recognise this commercial reality. But there must be a limit.
A Contractor or Consultant should not unknowingly become the financier of the Employer’s project because the Employer’s own funding arrangements have not produced the cash required to satisfy contractual payment obligations.
Where a public project depends upon PSIP funding or periodic Ministry disbursements, that is an Employer-side funding arrangement. The Contractor or Consultant has neither control over the Ministry’s budgetary processes nor any contractual relationship with the Ministry through which it can accelerate the release of funds. To transfer that risk entirely to the service provider, while simultaneously denying compensation for the resulting financing cost, creates a particularly severe contractual imbalance.
There Is Also a Cost to the State
State Agencies may understandably seek contractual provisions that protect themselves against circumstances outside their immediate control. However, transferring a risk through the contract does not make the economic consequences of that risk disappear. Someone must carry it.
A knowledgeable bidder faced with an uncertain payment period has essentially three choices. It may price the financing risk into its tender; seek to qualify or negotiate the payment provision; or accept the provision without adequate protection and hope that payments will nevertheless be made promptly.
The first alternative increases the cost to the State. The third may produce an apparently lower tender price but can ultimately contribute to cash-flow distress, delayed performance, disputes, suspension, reduced resources, insolvency or abandonment.
None represents an optimum project outcome. Fair and balanced risk allocation is therefore not an act of generosity toward Contractors and Consultants. It is sound procurement and project-management practice.
Bidders Must Read Beyond the Tender Sum
This development also reinforces an important lesson for Contractors and Consultants participating in public procurement.
The lowest tender price is not necessarily the lowest commercial risk.
Before submitting a tender or proposal, bidders should carefully examine the conditions governing:
- the period for certification and payment;
- any condition precedent to the Employer’s obligation to pay;
- the Employer’s funding arrangements;
- entitlement to financing charges or interest for delayed payment;
- rights of suspension or reduction in the rate of work;
- retention and release provisions;
- payment for variations;
- advance or mobilisation payments; and
- dispute-resolution provisions relating to payment.
These provisions should form part of the bidder’s financial risk assessment before the tender price is finalized. A contract worth $20 million with predictable payment arrangements may be commercially preferable to a $25 million contract under which payment is uncertain and the Contractor is expected to finance substantial expenditure indefinitely without compensation.
The same principle applies to Consultants, particularly those whose principal project expenditure comprises professional salaries that must be paid every month regardless of whether the Client has received its allocation from another public authority.
Do Not Simply Accept an Unquantifiable Risk
Bidders sometimes believe that because a State Agency has included a condition in an ITB or RFP, the condition is necessarily non-negotiable. That assumption should be reconsidered.
A bidder faced with an indeterminate payment provision should not simply acknowledge the condition without qualification where its financial proposal has been prepared on a fundamentally different payment assumption.
Doing so may leave the successful bidder contractually committed to financing an unknown payment period that was never incorporated into its price. The appropriate response is not confrontation. Nor is it necessary to accuse the procuring entity of acting unfairly.
The better approach is a clear, professional and commercially reasoned qualification.
Establish the Basis of the Financial Proposal
The bidder should first acknowledge the payment provision contained in the ITB or RFP. It should then explain that because the period between certification of an invoice and the Employer’s receipt of funding from the Ministry is undefined, the bidder cannot reasonably quantify the resulting financing exposure.
Most importantly, the bidder should state the payment assumption upon which its tender or financial proposal has actually been prepared.
For example, a Contractor may price on the assumption that certified and undisputed payments will be made within a defined period such as 56 days, depending upon the applicable conditions of contract.
A Consultant may prepare its proposal on the basis of payment within 30 days of invoice.
The particular period will depend upon the procurement, the contract and the bidder’s commercial assessment. The important point is that the pricing assumption must be defined and transparent.
This protects both parties. The Employer understands the commercial basis of the tender price, and the bidder avoids creating the impression that an indefinite financing obligation has been incorporated into its price.
Offer a Negotiated Alternative
A qualification should not end with rejection of the Employer’s proposed condition. The bidder should acknowledge the realities of PSIP funding and indicate its willingness to negotiate an arrangement that accommodates the Employer’s administrative requirements while mitigating the bidder’s financial exposure.
Depending upon the circumstances, possible measures could include an agreed maximum payment period; financing charges after a specified period; mobilisation or advance payment; adjustment to the payment schedule; reduced retention; more frequent invoicing; direct arrangements associated with funding availability; or some other commercial concession that reduces the working-capital burden being transferred to the Contractor or Consultant.
The appropriate mechanism will vary from project to project. The principle, however, remains constant:
If the Employer requires the Contractor or Consultant to assume additional financial risk, that risk must either be capable of being priced or appropriately mitigated through the contract.
A Suggested Qualification
A bidder confronted with such a provision may therefore consider inserting a qualification along the following lines in its Cost Proposal:
Qualification Regarding Terms of Payment
The Contractor/Consultant acknowledges the payment provisions stated in the ITB/RFP whereby amounts due on invoices will be paid by the Client within seven (7) working days following receipt of the relevant funds from the line Ministry.
The Contractor/Consultant respectfully notes, however, that as the period between submission and certification of an invoice and the Client’s receipt of the corresponding funds from the Ministry is not defined, the proposed arrangement introduces an indeterminate payment period and consequently a financial exposure that cannot reasonably be quantified at the time of tender.
Accordingly, the Financial Proposal has been prepared on the basis that certified and undisputed amounts due will be paid within the payment period expressly stated in the proposal. This assumption has been adopted for the purpose of establishing a reasonable and quantifiable basis for pricing and associated cash-flow requirements.
The Contractor/Consultant recognizes the PSIP funding arrangements applicable to the Project and remains willing to discuss and agree with the Client an alternative payment arrangement that accommodates those arrangements while providing an equitable allocation of the financing risk associated with any extended or indeterminate payment period.
The Contractor/Consultant therefore respectfully proposes that the final payment provisions be agreed during contract negotiations, with the objective of establishing terms that are commercially reasonable and acceptable to both parties.
This is not an unreasonable qualification. It simply identifies an unquantifiable risk and establishes the basis upon which the bidder’s price has been prepared.
Procurement Authorities Should Also Consider the Consequences
The issue deserves consideration beyond individual tenders. A procurement system that encourages competition while simultaneously imposing risks that cannot reasonably be quantified may inadvertently disadvantage the very firms that undertake responsible financial and contractual analysis.
A prudent bidder will either qualify the risk or price it. A bidder that ignores the risk may submit the lower price. If the latter bidder subsequently encounters severe cash-flow problems, however, the consequences ultimately return to the project and therefore to the State.
The public interest is not served by obtaining a low tender price that cannot sustainably finance delivery of the contract. Public procurement should seek value for money over the entire project lifecycle, not merely the lowest apparent financial proposal at the date of tender.
The Wider Industry Issue
The construction and consulting sectors in Trinidad and Tobago cannot sustainably operate on the basis that private firms provide indefinite, uncompensated financing for public projects.
Contractors have employees, subcontractors, suppliers, plant and financing facilities to maintain. Consulting firms have professional and technical staff whose salaries must be paid monthly. Banks do not suspend interest because a Ministry has not yet released a PSIP allocation.
An Employer may transfer a risk contractually, but it cannot eliminate its economic consequences. Eventually, those consequences manifest themselves in higher tender prices, reduced competition, financially weakened firms, delayed projects, claims, disputes, suspension, abandonment or the loss of competent firms from the public-sector market. That outcome serves neither the State nor the construction industry.
Conclusion
Onerous payment provisions in State contracts are not new. Contractors and Consultants have for years encountered extended payment periods, restrictions on financing charges, excessive retention and other contractual mechanisms that transfer financial exposure away from the Employer.
A provision making payment contingent upon an undefined future release of funds by a third party represents something materially different. It converts a defined contractual payment obligation into an uncertain future event while asking the Contractor or Consultant to carry the associated financing burden. That is a new level of financial risk.
Contractors and Consultants should therefore resist the temptation simply to sign, acknowledge and hope for the best.
Identify the risk. Quantify what can be quantified. State clearly the payment basis upon which the tender or proposal has been priced. Qualify what cannot reasonably be priced. And offer commercially sensible alternatives for negotiation.
There is nothing improper about a State Agency protecting the public purse. But protection of public funds should not depend upon transferring an unlimited and unquantifiable financing obligation to Contractors and Consultants.
Fair contracts do not eliminate risk.
They identify it, allocate it to the party best able to manage it, and price it transparently.
That principle is as important to the sustainability of Trinidad and Tobago’s construction and consulting industries as it is to the successful delivery of the State’s development programme.