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)
Finance and Payment Conditions
Notwithstanding all that the construction industry has been through over the last several years, there continues to be hope for improved prospects in the Industry. However, such prospects are thwarted by the now established trend of state contracting agencies to increasingly find ways and means through manipulation of contract conditions, to provide cover for failures, both real and anticipated, in guaranteeing the financial arrangement to pay Contractors in accordance with reasonable contract payment terms. Many construction businesses, both consultants and contractors, have been to the edge of the financial cliff and many are currently surviving on bank loans and credit facilities which are attracting financing charges of at least 1.5% plus prime. Prime is in the region of 7.5% plus so that the minimum cost of capital at this time is of the order of 9%.
However, what has now become a norm is the serious imbalances of project financing and payments terms, written into the Particular Conditions of state contracts. The most egregious of these imbalances are contract conditions related to Delay Damages, Financial Charges for Delayed Payments and Limit on Retention. Clauses of FIDIC Contracts related to these issues are reworded, changed or omitted via Particular Conditions, and these have the impact of increasing adverse financial consequences to both Consultants and Contractors.
Such adverse financial consequences transfer undue financial risk to contractors making it difficult to manage their finances and potentially leading to insolvency where they cannot secure sufficient working capital through loans or other financing options to cover their expenses while waiting for payment, leading to increased costs due to overdraft interest, financing fee and lost opportunity costs.
Delay Damages and Financial Charges
State Contracts routinely and explicitly assign penalties for Delay Damages for late delivery on the part of the Contractor while just as explicitly omitting the Contractor’s right to receive financial charges for Delayed Payments. Where concessions are grudgingly made for payment of financing charges, the sum assigned is invariably 1% above prime, where the current cost of finance is at least 1.5% plus prime and FIDIC General Conditions proposes 3% plus prime. This is perhaps the most egregious example of disparity of financial risk imbalance since the Contractor is penalized for late delivery of the works but denied compensated for Delayed Payments.
State Contracts never ever consider the incentive of introducing a concomitant Clause to that of Delay Damages, such as a Bonus Clause for Early Completion, even when the nature of the project is such that early completion is of substantial economic benefit to the Employer. No consideration is given to the fact that a Bonus Clause for early completion aligns the interests of both parties, incentivizing efficient project execution while providing financial and operational benefits to both parties.
State Contraction Agencies should be acutely aware that early project completion can lower costs related to project management, supervision, and overheads, as well as mitigate risks associated with market and political changes, such as changing economic conditions and revolving political administrations. Early completion can also align better with the Agencies broader operational plans, facilitating smoother transitions and better project integration as well as enhancing their reputation with stakeholders, such as state ministries or departments on whose behalf they act, tenants or the general public.
Employer’s Financial Arrangement
Notwithstanding the usual explicit omission of FIDIC’s Contract Condition with regard to the “Employer’s Financial Arrangements”, the Employer is obliged to make payment under the Contract, irrespective of the Employer’s financing arrangements, and the Contractor ought not to be deprived of its rights under the General Conditions to receive financial charges for Delayed Payments.
It is clearly understood in common law, in all international jurisdictions, that it is illegal to enter into a contract for the provision of a service if the party who is contracting the services does not have the finance to pay for the service. You cannot, for example, ask a contractor to build your house or pave your driveway and when the job is finished tell the contractor that you do not have the money to pay him at this time but you will do so when you get some money, unless there was such a prior agreement. Because such action is universally accepted as being illegal, it is for that reason that FIDIC Contracts explicitly require that the Employer shall within 28 days of a request from the Contractor submit reasonable evidence that financial arrangements have been made and are being maintained which will enable the Employer to pay the Contract Price in accordance with the Contract.
Equally explicit in FIDIC Contracts is that failure to provide the reasonable evidence within 42 days after the Contractor has serve notice of the request, the Contractor is entitled to terminate the Contract. This provision in international Contracts reflects the seriousness of the matter. However, this provision is routinely omitted from state contracts. Any question about financial arrangement is treated with contempt and state contracting agencies routinely enter into contracts on the basis that the state does not have to provide evidence of financial arrangements for execution of its contracts. Fortunately, this matter has gained the attention of the Office of Procurement Regulation (OPR) in that it has published Guidelines for the ethical conduct of Public Bodies and Public Officers, which require that the Procurement Officer of such bodies shall confirm the allocation of funds before the initiation of any procurement and disposal of public property proceedings.
Delayed Payments
Failure by State Contracting Agencies to comply with the contractual payment obligations is more often the norm than the exception. As such, the absence of financial charges payment, or some concomitant reciprocity in the Contract, such as a Limit on the Contract Retention Sum, constitutes an abuse on the part of such Agencies who have an unfair negotiating leverage over bidders on state Contracts. The case of Consultants who provide technological knowledge-based services to the industry is even worst, since their services contracts provide no remedy, such as that available to Contractors, to suspend work or reduce the rate of work, due to delayed payment.
Contractors often face cash flow challenges where payment terms are unjustifiably lengthy or complicated. For example, where FIDIC indicates a payment period of 56 days after the Engineer receives the Contractor’s Payment Statement and supporting documents, such period is increased to up to 77 days in some state contracts. This can hinder the ability to pay for labor, materials, and other expenses promptly. Such inordinately long payment period and complicated payment terms create cash flow problems for contractors, who need to pay for labor, materials, and other expenses upfront, exacerbating cash flow issues. Long payment periods may also lead contractors to include a premium in their bids to cover the risk of delayed payment, raising the overall cost of the project. Extreme payment delays often lead to work slowdowns or stoppages, where the contractor, having served notice, may suspend work or reduce the rate of work.
Contractors may need to take out loans or other financing options to cover their expenses while waiting for payment, leading to increased costs due to interest and fee. In any event, difficult payment terms often strain relationships between the parties involved, leading to disputes and a lack of cooperation, which can negatively impact the project’s progress and quality. Complex payment terms often lead to increased administrative work, as contractors have to spend more time and resources managing invoices, payments, and compliance with contract terms. Smaller contractors are particularly challenged when engaged in projects with onerous finance and payment terms, leading to higher level of indebtedness than would otherwise be the case and an evidential high level of project abandonment. Overall, an inordinately long payment period in a construction contract can create a domino effect of financial and operational issues that can severely impact the success of the project.
Fair and Balance Risk-Reward Allocation
Fair and balance risk/reward allocation is widely accepted as the most appropriate basis to minimize the prospects of disputes, enhance the likelihood of achieving a successful project outcome, and keep Contract Prices moderate and optimum. However, the negative impact of unfavorable and imbalance financial conditions places an inordinate level of financial burden and risk on proponents in receipt of state contracts. The evidence of this is the many low profile and sometimes overlooked public projects around the country, undertaken by small and medium-size contractors, that have been left incomplete and in a state of dilapidation because of financial issues related to delayed payments.
Restarting these projects involve the processes of retendering, condition assessments, renewed mobilization and substantial demolition, repair and redesign works. The result is increased project cost and the opportunity costs to both the state and end-use stakeholders. This is a circumstance that has particularly plagued the public housing sector where, not infrequently, largescale housing development projects throughout the country have been left partially completed and abandoned largely over disputes of payment, only to be restarted at a later date with all the attendant additional costs.
Performance Bond and Retention Money
Two other financial issues which exacerbate the financial risk to Contractors are those of Performance Bond and Retention Money, the latter being applicable to Engineering Consultants as well. There is at least one known case in which a Contracting Agency stipulated that the Performance Bond to be provided by the awarded Contractor must be on the Tender Sum inclusive of the Value Added Tax. There is something conspicuously depraved about this, since it amounts to asking the Contractor to provide a Bond on a Tax to be paid to the state, even while procurement of the Bond itself attracts a Tax of its own. From all reports, this was an anomalous case which is not the norm. However, the fact that it was a requirement in a particular RFP issued by a state Contracting Agency underlines the desire of such agencies to leverage and maximize their advantageous negotiating position without consideration of the negative financial impact.
Variations to be paid with the Final Payment Certificate
There is the case of an edict by one State Agency, and perhaps others as well, that all variations on the Contract shall only be paid with the Final Payment Certificate, simply based on a decision of the Finance Department of that Agency. This notwithstanding the provision of the Contract that the value of any approved Variation is to be included in the Contractor’s Interim Payment Certificate and this provision is not otherwise omitted or revised in the Particular Conditions. The consequence of this is that the Contractor has to forego compensation, until the end of the Defects Notification Period, for works duly authorized and executed under the Contract and the value of which was duly determined by the Engineer
If such payment terms are included in the Particular Conditions, then at least bidders can consider a negotiated position whereby the cost of variation should in include a premium for the intended payment period associated with the cost of variations
Positive Cash Flow and Limit of Retention
A Contractor’s positive cash flow is of value to the success of any project. Placing a limit on Retention Money is one way to facilitate a positive cash flow, particularly as the Works approaches completion. By the time that the 10% Retention Sum reaches 5% of the Contract Sum, the Contractor would have delivered 50% of the value of the work. Given such level of completion of the works, together with the 10% Performance Bond, the Employer’s financial risk is substantially reduced at this stage of the project. Common international practice is to limit Retention Money to 5% of the Contract Sum in the interest of facilitating a positive cash flow for expeditious completion of the project.
A 5% Limit on Retention could in fact represent a reciprocal concomitant benefit to the Contractor and the project, in lieu of non-payment of financial charges. For Example, on a $20M contract, a 10% Limit on Retention is $2.0M. Half of this sum ($1.0M) is withheld over the Defects Notification Period (DNP) which can extend to up to two (2) years. If the Limit of Retention is reduced to 5%, then the sum withheld during the DNP is reduced to $500,000.00. While the Employer may feel that withholding as much of the Contractor’s accumulated earnings as possible is a matter of sound financial management on its part, the difference between the two circumstances can have a major impact on the profitability and sustainability of the Contractor’s organization and by extension the sub-contractors and design professionals whose services he would have engaged on the project.
Conclusion
If the industry is to return to a strong footing as soon as possible after the setbacks of the COVID-19 Pandemic and the slow recovery thereafter, it is important that due consideration be given to issues of payments and cash flow which progressively and negatively impact the sector. It is time that the state through its Contracting Agencies step up to the understanding that development is a process and not an end result. Development of the construction sector cannot be achieved by the unenlightened view that seeking to reduce adverse financial consequences to the Employer and increasing adverse consequences to the Contractor, on state projects, is in the best interest of either the projects under the purview of such Contracting Agencies or in any way advances the building of capacity, competency and sustainability in the local construction industry.
The time has come for a better understanding and appreciation of the negative impact of unenlightened, imbalanced and regressive payment and financial terms on the outcome of many state construction contracts
Recommendations for Contractors
To address the issue of onerous finance and payment terms on state construction contracts, a contractor can take several proactive steps. By taking these steps, contractors can better protect themselves from the adverse effects of onerous finance and payment terms, ensuring smoother project execution and financial stability.
Contract Review and Negotiation:
It is taken for granted that given the overwhelming leverage of local state contracting agencies, there is no room for negotiation of contracts which such agencies offer. Local contractors with or without the support of their association should disabuse themselves of this mindset and take a firm position on issues that relate to financing and payment terms. Some proactive contract review and negotiation approaches should include the following: –
- Engage the services of industry professional with experience in contract administration to review the contract terms and identify clauses that could pose financial risks.
- Seek to negotiate more favourable terms before signing the contract. This can include payment frequency, limit of retention, financial charges and the magnitude of delay damages, do so by sighting FIDIC guidelines as established international best practice.
- Seek to establish clear conditions for the release of retained amounts for the whole of the works or each section (if any).
- Negotiate Advance Payment Loan or mobilization payment to achieve favourable amortization terms
Clear and Detailed Payment Applications:
Engage the services of experienced construction professionals, including engineers who will: –
- Ensure that payment applications are detailed, accurate, and submitted on time.
- Prepare comprehensive supporting documentation to avoid delays due to disputes over payment applications.
Cash Flow Management:
- Implement detailed budgeting and cash flow forecasting to anticipate and manage financial needs throughout the project.
- Where possible, maintain reserve funds to cover unexpected expenses or payment delays.
Prompt Communication and Dispute Resolution:
- Maintain regular communication with the client regarding payment status and any potential issues.
- Ensure that clear dispute resolution mechanisms are included in the contract to address payment disputes efficiently. Be wary of the inclusion or reference in some contracts of dispute resolution mechanisms such as the Mediation Act and the Arbitration Act of the Laws of Trinidad and Tobago. These Laws by themselves, in my view, have no discernible procedural rules for the resolution of disputes or for arbitration. If they are referenced in the contract, seek legal advice to ensure that procedural rules for triggering and guiding recourse to these laws are spelt out in the Particular Conditions.
Project Management Practices:
- Implement strong project management practices to ensure that the project stays on schedule and within budget, reducing financial strain.
- Manage change orders efficiently to ensure additional work is properly documented and compensated.
Educate and Train Staff:
- Ensure that project managers and finance teams are well-versed in contractual terms and payment processes.
- Train key personnel in negotiation skills to better handle contract discussions.
Trinidad and Tobago Contractors Association (TTCA) Support:
- Ensure that your organization is a member of the TTCA, through which you can advocate for resources and support for fair payment practices and industry-wide changes in payment practices in the local construction industry.