Risky funding for construction

Ordinarily, project owners engage consultants to design, estimate costs within budgeted funds, prepare tender documents and supervise project implementation.

Contractors are then invited to submit bids for the project and the consultant evaluates the contractors’ technical and financial competence.

The consultant then recommends the best bidder to be awarded the contract.

Once awarded, the successful contractor has to provide a performance bond as a stated percentage of the total project cost to the project owner.

This guarantees that the contractor will perform the outlined works or forfeit the amount in case of failure.

Thus, a performance bond assures the project owner of project completion.

To mitigate risk, some projects demand performance bonds issued by banks payable on demand.

While this protects the client’s interests, the contractor is still expected to perform the contract to benefit the end users.

Where funds are required for the project, the contractor is allowed to get an advance payment of around 20 percent of the project sum. This sum is deducted from proceeding payment claims.

The contractor, in this case, provides the client with an advance bond from the bank as a guarantee for repayment.  

However, we need to closely examine the risk exposure of the contractor.

In signed contracts, the client agrees to pay the contractor any amounts that become payable after executing the works.

However, it has become a habit for clients, including the government, to delay payments for extended periods much to the detriment of the project.

Although such delays allow for interest claims, the add-ons also pile on the clients’ desks due to a lack of funds.

This greatly disrupts contractors’ cash flows as projected in their applications for bank bonds and other facilities.

Consequently, banks have labelled contractors as high-risk clients, especially those with government contracts.

Despite being the biggest client in the country, the government is the top culprit when it comes to delayed payments.

The government owes construction firms billions in this respect.

Sadly, the National Construction Industry Council of Malawi’s strides to build local contractors’ capacity to compete with multinationals are being wiped out by the new norm, delayed payments.

To add salt to injury, the depreciation of the local currency due to external shocks has hit contractors hard as government projects are usually based on fixed-cost contracts.

These high-risk contracts assume that economic factors that affect market price will remain constant during the project duration.

 As this is not usually the case on the ground, many contractors abandon the projects or request project price adjustments, which stirs strong resistance from the client. In the end, both the client and the contractors lose out.

Therefore, it is unrealistic to always blame politicians for technical and ethical problems.

All technocrats involved in the project cycle should be held to account for not offering realistic advice to the government.

With the prevailing exchange rate volatility, it is unrealistic to offer fixed-cost contracts or award a contractor work without making available funds for the project.

In this regard, the government should offer contractors project funding guarantees just as they provide performance bonds.

Alternatively, the government can establish Escrow Accounts for projects to be managed by the Reserve Bank. This is an account where funds are held in trust while parties to a contract complete a transaction.

In this arrangement, a third party receives and disburses money to the primary transacting parties by their signed contract.

The funding guarantees will remove funding risks faced by the client and allow the country to live within its means.

However, it will not mitigate the insatiable spending sprees by some errant contractors after getting advance payment. Everyone needs to play their part.

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The post Risky funding for construction appeared first on The Nation Online.