Construction Contract and Project Finance
The construction contract in an international project financing serves to give the project company a fully completed and equipped facility. In addition, it provides for delivery by the contractor of a facility that satisfies specified performance criteria, for a fixed or predictable price, and completed on a specific date. There are four types of construction contract which are engineering, procurement, construction and EPC contracts. EPC contracts concern all the stages namely; engineering, procurement, construction.
There Are A Multitude of Causes For Cost Overruns
Devaluation in the currency, which is converted resulting in increased cost of imported building material, an embargo against the host country resulting in increased fuel, energy and transportation costs, unexpected legal problems in land acquisition requiring additional expense in litigation or negotiated settlement. A certain measure of control can be exercised over some of these risks. Therefore, project sponsors need to expand their flexibility in their contractual arrangements. Otherwise they can face with pecuniary loss. In order to avoid this loss, project sponsors can make a new contract, they can alter existing actual contract or they can add some guarantees and contractual terms. Generally, project sponsors prefer to hold contractor liable to fully and timely completion of the project construction for a fixed price.
Obligations of Project Company and The Contractor
There are some obligations which are allocated between Project Company and the contractor. In case of failure of these obligations, Project sponsors should be compensated by liquidated damages provision which is divided into two types; delay liquidated damages and buy-down liquidated damages. Firstly, it is obvious that this provision mitigates risks on project finance sponsors and built flexibility by contractual arrangements. When the contractor fails to meet certain milestones dates then Delay liquidated damages become payable. Generally, cover additional interest cost arising from the delay and may compensate equity investors for additional interest during construction period. Latter is buy-down also called as performance liquidated damages. In addition, buy-down liquidated damages are used to pay down project debt to equalize the expected turn down in net operating cash flow. Buy-down liquidated damages are set at a value that will permit the debt service coverage ratios to remain unchanged and stable.
Contingency Reserved Funds
Alternatively, the other significant risk mitigation tool the creation of contingency reserve funds is in order to ensure flexibility. This fund is a line item in the construction budget, supported with loan or equity commitments, to pay cost overruns during the construction period.
The project sponsor will in turn obtain performance bonds from his contractors and sub-contractors in order that the persons having the most control over timely completion of the different project components are made responsible for the consequences of their actions, inactions, oversight, or incompetence. The delay may be caused by external events beyond the control of parties. While contractors may be willing to bear responsibility for delays attributable to them, they may not be amenable to being strictly liable for delays like civil disturbances and acts of God which are beyond their control. Some of these risks are insurable at reasonable premiums, others are not. Amongst the project participants, the project sponsor is often left as the bearer of residual risks. Performance bond -and also it can be issued by a bank.
Insurance Can Be an Alternative
In addition, Insurance is the other alternative for project sponsor to have greater flexibility. During construction period, construction all risk insurance is an insurance cover in order to protect the project construction against property damage and the loss occurred.