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Who is Liable for the Construction Risks in Project Finance?

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In BOT project financing, it is generally the contractor, which takes full liability for the construction risks according to the commonly accepted rule that risks, should be borne by the party best able to take responsibility for them or manage them. The project company, which has limited financial resources, is not in a position to bear any significant part of the major construction risks and certain legal devices should be used to ensure that the construction risks are transferred from the project company to the contractor or other relevant parties.

First of all, it is important to ensure that the contractor accepts liability under the construction contract, without exception, for all of the relevant obligations, which fall to the concession holder under the concession agreement.

However, the coexistence of different applicable legal systems, one to the concession contract (generally the local law) and one to the construction contract (sometimes a legal system more familiar to the concession holder and the contractor) may make this exercise difficult.

In addition, and to improve transparency, “if and when ” or “pass-through ” clauses may be introduced to limit the contractor's rights (right of remedy or right to payment) to cases where the concession holder has been granted the same rights by the granting authority and such rights are actually honored (provided the concession holder is not itself liable for the events giving rise to such rights).Finally, transparency may be extended to arbitration awards through the operation of multi-party arbitration clauses, which allow the granting authority, the concession holder and contractor to resolve together in any dispute relating to construction with a minimum of time and expense.

Besides the obligations transferred under the concession agreement, contractors should be prepared to bear the financial consequences of contingencies, incorporating appropriate accounting provisions in their prices and cover for the numerous events included in the insurance policies in addition to the performance bond that a bank will issue on behalf of the contractor. The question is therefore who bears liability for any additional construction costs in excess of the construction risk limits accepted by the contractor. In order to cover this risk, the lenders sometimes provide special “stand by ” credit, available to finance additional construction costs.

Apart from such credit, lenders are very reticent to accept liability for any additional costs. They are concerned that they will be obliged to continue supporting a project, which goes off course financially in the construction stage for fear of losing their entire investment before even reaching the operations stage. To assuage these fears, undertakings from the sponsors, (stand-by capital) and also from the granting authority concerning satisfactory completion and construction cost overruns will sometimes be necessary in order to secure financing.

Aside from these legal and financial devices, a change of attitude is needed, particularly between the employer and the contractor. Effort need to be made to try and establish a true partnership, concentrating on satisfactory completion of the project within the projected budget and time frame and avoiding the traditional conflicts between these two parties. On the other hand, when we come to the structural links, which may in certain cases exist between contractors and concession holders should bolster confidence to a level that is not found in traditional employer/contractor relationships, even if relationships between companies in the same corporate group may at times be strained.

Moreover, even if there are no such structural links, informal relationships between sponsors and contractors, working together long-term on numerous projects, should also contribute to minimizing construction risks in project financing. In this respect the Japanese and a number of leading European companies are already showing the way forward.

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