What is the Advantage of Using Model Contracts in Project Finance?
There are the advocates of tailor-made agreements in Project Finance which, they argue, properly incorporate the specific points unique to each individual BOT project, to each sector of activity and to each country, and who view model agreements as unnecessarily constraining and inevitably poorly adapted to the multitude of conflicting interests involved in this type of project.
On the other hand, there are the supporters of standardization who want to be able to rely on pre-established, internationally accepted terms and conditions, only making the minimum amendments necessary for each individual project in order to save time and reduce development costs.
Although the construction contract will be influenced by the specificity of the finance structure and by the interests of the various parties, this will be so to a lesser degree than the concession agreement itself or other project agreements which form the basis of the relationship between the granting authority and the concession holder and which frequently require heavier negotiation.
The construction contract is essentially merely a sub-contract entered into by the project company, acting as the employer, with a contractor. It should be possible to fashion it from with an existing model, which incorporates the particularities of traditional project financing structures.
The project company, which is required, simultaneously, to negotiate the terms and conditions of the project agreements with the granting authority, the finance agreements with the lenders and the operation and maintenance agreements with future operators, would be well advised to stick to a pre-established framework for the general terms and conditions of the construction contract. It can then adjust the terms and conditions into line with the results of the negotiations with the granting authority so that its main construction obligations under the concession agreement, or as a result of the requirements or recommendations of the future operators or lenders, are passed through to the contractor.
Using standard form contracts will certainly contribute significantly to a reduction in development costs which represent a major obstacle to the furtherance of BOT projects, particularly of a small or medium size.
However, lenders have been known to mistrust the use of model contracts and have considered that such contracts are biased towards contractors, engineers or employers. Lastly, the use of internationally recognized standard form contracts does provide some degree of legal security in the relationships between the numerous parties involved in project financing.
Choosing a Model Construction Contract
The design and build contracts are currently in existence which best satisfies the needs of all those involved in a BOT project. These kinds of models limit construction risks and provide a working base to reduce the negotiation time for “EPC” contracts and even to limit development costs, which are always very important in BOT projects. It is understood that a new contract is in the process of being drawn up which is specifically aimed at addressing Lenders' concerns relating to construction contracts in this type of project more completely then the previous.
The previous model allows the contractor a certain freedom. It defines the purpose of the contract not in terms of the technical specifications but rather the employer's requirements. These requirements are set out in an annex to the contract. The annex will constitute the key document, containing the operational specifications of the works, expected performance levels and the standards and norms to be respected if the works are to be fit for their intended purpose and future operation.
Such contracts stipulate a single, fixed and final price for the works, this sensibly reduces the possibility of modifications and variations except were the employer/concession holder wishes to change its requirements at the risk of a claim for corresponding additional costs and time extensions. Normally, any claim for additional costs and time extensions is only admissible in unforeseen circumstances, such as the discovery of archaeological remains, previously unknown man-made obstacles which the contractor did not agree to take into account, or if it arises out of a change in the applicable law or in the rules of taxation. The granting authority will usually accept liability for some of these risks; others may be covered by insurance obtained either by contractor or by the project company.
The contractor will bear almost sole liability for design. It will not be entitled to claim any additional costs or time extensions based on errors in the plans or background data, which it is responsible for verifying itself.
The employer/concession holder, and indirectly the granting authority, is much less involved at the plan and feasibility study approval stage and in overseeing the works. Limiting their intervention to key stages in the construction process may avoid disruption and delays to the work in progress but still enables them to make sure that the studies and works accord with previously approved studies and satisfy contractual requirements.
The model is expected to follow the same line. However, experience proves that it does not matter what type of construction contract is signed and how perfect it is, there are still risks of cost and time overruns and that, try as they might, it is very difficult for the concession holder and the granting authority to refrain from interfering in design and construction. If such interference is considered excessive or abusive, this may upset the economic balance of the project and give rise to certain liabilities for the interfering parties to compensate the contractor.