4.  CONSTRUCTION AGREEMENT

Lenders are prepared to look primarily to the reserve steam of the BOT facility once it is operating. Construction agreement helps the lender to analyze the risk involved before the start-up of a project (Completion risk & risk mitigation measures). Lenders will look primarily to the project company for cost, schedule and completion guarantees during the construction period. Project company, in turn, will try to reallocate this risk as far as possible to the contractor through construction agreement or where appropriate, into the insurance market.

Investors in the project company are making investment with the intention of directly winning the construction contract/equipment supply contract. Will prefer to avoid competitive bidding and want to negotiate a risk-free contract and taking profit from construction contract. It is also essential that such conflicts are recognised and risks allocated at an early stage in the negotiations between project participants. Project Company may propose a contracting strategy but it is often the requirements of lenders and host government that dictate the procurement strategy and the minimum terms in the contract.

As per the lenders' requirements, the construction contract for the project should be on lump-sum turnkey basis, which ensure that the construction contract is committed to a defined scope of work; to a firm price for the construction works; and to a stipulated time in which to carry out those works. In order to ensure that contractor is not prevented from completing on time and within budget, lenders also seek to limit the project company from changing the scope of work. And, the circumstances in which contractors may claim relief for force majeure should also be limited, clearly defined and coordinated with project agreement. Lenders also wish to confirm that contractor has a proven track record of competency and experience in all areas relevant to the project and financial ability to carry out and complete the works. In addition to the lenders, the requirements of the host governments should also be taken into account in the construction agreement. The construction agreement needs to take into consideration the following issues:

• Taking into consideration the legal and environmental norms of host government.
• Promote involvement of local companies and services in the construction phase.
• Ensure that construction agreement should not violate the project agreement.

Besides the need to take into consideration the requirements of the host government and protect the interests of the lenders, the other key contractual issues are relating to quality and performance of the project facilities, pricing and payment aspects, and transferring the work to subcontractors. These contractual issues are discussed below.

• Quality : Quality assurance procedure should be described in the construction agreement. Standard of quality expected should be clearly defined and the design parameters set out in a functional specification. Standards should include relevant health, safety and environmental consideration. Provisions should also address the situation where workmanship and/or materials fail to meet the required standard or quality.
  
  
• Performance: Contractors are often requested for operational and performance guarantees. Performance parameters including quality and quantity of products and level of output or off-take should be attained in a BOT project. Failure of the facility to perform at the projected level means the loss of revenue to the project company.
  
  
• Pricing and payment: Construction agreement should clearly define the scope of works and the liability parameters. Costs of construction should also include the costs of risk management the contractor is responsible for. Terms-of-payment clauses are important to ensure that the contractor is not overpaid through stage payments. Payments should be linked to the value of work that has been carried out. Specified percentage of payment withheld in escrow account pending successful completion and testing of the facility. If contractor is behind schedule, contract mechanism should permit withholding money until it catches up. Procedure for certifying the progress and value of work done before payment.
  
  
• Subcontracting: Works may be subcontracted for a number of reasons, need for a particular expertise in certain aspects of the construction work and lower cost of local contractors. Right to subcontract should be subject to the approval of the host government and the project company. Procurement of major equipment should be monitored and approved by project company/host government. Provisions covering the liability of the contractor for the failure of its subcontractors are important.

REFERENCES FOR FURTHER READING ON THE TOPIC

Kerf, M., Gray, R. D., Irwin, T., Levesque, C., and Taylor, R. R. (1998). "Concessions for infrastructure - A guide to their design and award." World Bank Technical Paper No. 399 , World Bank, Washington D.C.

UNIDO. (1996). Guidelines for infrastructure development through Build-Operate-Transfer approach , UNIDO, Vienna.