The key steps to successful project establishment
|Construction Law International homepage » January 2019|
The key steps to successful project establishment
This article was prepared by the Project Establishment Subcommittee1 to summarise the key operational, legal and financial issues to consider and steps to take when launching a major infrastructure or construction project. The intention is that this article serves as a ‘thought starter’ or the basis for a project specific check-list, adaptable to all markets. It should not be considered in any way as a comprehensive guide.
The steps discussed in this article are:
• identifying, allocating and managing imperatives and risks;
• understanding the context;
• defining the project structure;
• parties to a project;
• understanding the bidding process;
• identifying the resources required; and
• identifying the financial structure.
Identifying, allocating and managing imperatives and risks
Every project will carry with it certain key imperatives and risks. Identifying these will assist in designing project documents (both the agreement and the technical documentation), management and review processes, and risk management strategies that support the project and enhance the prospects of project success.
There are three major project imperatives that must be met for a successful project:
• Quality: This concerns the quality of both the design and construction. A well-designed project that caters to the needs of the client and is built to the specified standards will determine a project’s long-term success.
• Cost: This concerns controlling costs while achieving the requisite level of quality. This is fundamental to the success of the project in terms of financial performance and return on investment.
• Time: This covers the timely delivery and completion of a project. Prolonged durations directly affect costs (prolonged project team and equipment deployment) and financing (ability to generate revenue in time to repay loans). Very tight durations can adversely affect quality, leading to potentially lower returns (sale or rent prices and operations or maintenance costs).
Every endeavour has associated risks. Much effort is invested in identifying, allocating and managing risk. However, this effort is not always reflected in an improved risk profile for a project. In order to derive greater value from the identification, allocation and management of risk the following approach can be implemented.
Identify key risks
A frugal but intelligent approach should be taken. It is often the case that many dozens of risks are identified and complex risk matrices prepared. This approach can result in losing sight of the key risks and a sense that the ‘risk management task’ has been completed. This, in turn, can result in an abdication of the real risk management task – the task of being alert to and ready to anticipate or respond to risks during the life of the project. The risks that might affect a project will inevitably vary from project to project; however, there are recurring themes:
• Resource availability: The availability of adequate personnel (both in terms of quantity and expertise), as well as physical resources, is important and not always analysed sufficiently.
• Senior decision-maker availability: As a subset of resource availability, the availability of senior decision-makers, at critical times, is often overlooked.
• Political will or corporate policy: All organisations, whether public or private, will have certain ‘red lines’ that they will not cross (or to do so involves significant time and effort), for example, a defined period for the payment of bills by the client.
Difficulties may arise if these red-line issues are not identified and accommodated in the project structure and project documents (agreement and technical documentation).
Remember the forgotten risk
The risk that a risk management strategy will fail is often overlooked. For example, the party who bears a risk in the first instance may become insolvent. This ‘forgotten risk’ should be taken into account with the other key risks.
Undertake a traditional risk analysis
The traditional risk analysis involves reflection on the probability and consequences of an anticipated risk occurring. This often involves a three or five-scale ranking for each of these characteristics. Another characteristic should also be considered: the ‘amenability of the risk to control’. Consideration of this characteristic can remind the team that some events could have a negative impact on the project and little can be done to prevent that occurring. Mitigation of consequence, rather than avoidance of occurrence, might be the most appropriate response in these circumstances.
Identify the natural owner of each risk
The natural owner of the risk might be regarded as the participant who will bear the burden of the risk if no steps are taken in relation to the reallocation of the risk. There may be multiple owners of a risk. For example, in relation to the risk of defective work, the contractor may be regarded as the natural owner of the risk. However, if the contractor does not repair the defective work, the consequences are left to be dealt with by the client. The client might then be regarded as the owner of that risk (ie, the risk of non-compliance by the contractor). Identifying the natural owner of the risk is important in terms of considering the allocation, management and mitigation of the risk.
Identify how each risk is to be dealt with
The traditional techniques available for dealing with risks include:
• neutralising the risk;
• bearing the risk;
• transferring the risk; or
• mitigating the risk.
The implementation of the various mitigation and management strategies is more important than the development of the risk management plan.
This list omits one common technique: ignoring the risk. Ignoring the risk is effectively bearing the risk, but usually doing so in ignorance of that fact. It often arises as a result of the ebb and flow of negotiation. A risk that may have been treated in an explicit way (using one of the four techniques) becomes the subject of negotiation with the possible outcome that the initial technique is abandoned, but it is not replaced with any other technique. This dynamic can be one of the significant causes of project risk being inadequately managed.
Document the strategy
If the risk management plan is not documented, it is less likely that the plan will be implemented as conceived.
Implement the strategy
In many instances, this process is followed and, on paper, there is a rational and appropriate risk management strategy. However, many of the intended mitigation or management steps are not actually taken. The focus on risk and the investment of relevant resources sometimes ceases when the project documents are executed or soon thereafter as project delivery picks up momentum. The implementation of the various mitigation and management strategies is more important than the development of the risk management plan.
The mitigation and management strategies should, at least, focus on ensuring that:
• good communication channels are established between various project’s teams;
• each team understands its role and role of other teams;
• all the teams receive adequate training in contract management and have a sound understanding of implications of decisions taken due to the speed of the project and schedule pressure;
• the decision-making process takes into consideration all the actors concerned; and
• response actions and responsibilities during an emergency or a force majeure event are defined and known to all teams.
Understanding the context
In order to efficiently identify, allocate and manage risks it is necessary to develop a clear understanding of the context in which the project will be executed, which in turn will allow for the development of a schedule and budget reflecting the activities to take place and factors that might affect these activities. The analysis of the project’s context should take into consideration, as a minimum, the following aspects:
Considering the geographical location of the site, a list of possible physical obstacles to be verified and how the site will be accessed for the entire duration of the project must be defined.
Offshore versus onshore
If the project is located offshore, the water depth for works and installations and windows of adverse weather will be the primary factors affecting the feasibility of the project and the schedule. If the project is located onshore, a wide range of more complex factors may potentially affect the project schedule, whether it is a brownfield or greenfield site: mountains (eg, limited availability of flat surfaces, seismic zones and landslides); deserts (eg, heat, sandstorms and the availability of water); rivers (eg, flooding and logistics for crossings); tropical forest (eg, protected zones and accessibility); arctic zone (extreme cold); and proximity of population (urban zoning and infill) to the project area. Depending on the site location, thought must also be given to the likelihood of possible archaeological findings at or near the project site. In both cases, it is necessary to examine and, as applicable, undertake project impact studies (which may be required in any case by local legislation) with respect to the project impact on the surrounding flora, fauna and marine life.
Access to the project site
The accessibility of the project site must be examined and defined to prepare a realistic project execution plan (PEP) and schedule.
Access by water
For offshore projects, it is necessary to verify if there are any restrictions for access by vessels bearing a flag of particular countries. As mentioned above, adverse weather patterns that could affect offshore works must be taken into account when vessel(s) are reserved. Consideration should also be given to the location and capacity of the nearest ports, including the size of ships that can enter and whether dredging is required so that the vessel(s) necessary for the execution of the project can enter the port. For onshore projects, consideration must be given to the proximity of navigable waterways and existing piers or the possibility of constructing a pier specifically for the project in order to deliver construction material, equipment and prefabricated modules. It is also necessary to verify whether local regulations might prevent the use of waterways for the transport of material or equipment due to environmental or other reasons. In both offshore and onshore projects, care must be taken in the selection of flotel, barges, rigs, support vessels, and so on. The age of the vessel and its availability in line with the project schedule should be determined at the beginning of the project; crew rotations should be defined, taking into account the applicable labour laws; and depending on the route the vessels will be taking, necessary security measures should be considered.
Access by land
If the project is to be accessed by road, it is important to verify whether the existing roads are fit for the transport of heavy machinery, equipment and construction material. In particular, it must be verified whether there are applicable regulations that would affect the days and hours during which the transport of heavy equipment or large loads of material may be carried out and whether it is necessary to engage police escorts or obtain special permits from local authorities. It is also important to consider whether existing roads require modification or if new roads should be constructed. As to existing roads, even if at the onset of a project it is not yet known whether existing roads are sufficient to support the size and weight of the equipment or material to be transported (normally this is determined at the end of the basic engineering stage), it is prudent to examine the applicable regulations with respect to road modifications. Alternative routes for project site access should also be identified in the case of unforeseeable circumstances (eg, the size of an equipment package changes and it will not pass under certain bridges). Construction of new roads should be discussed in collaboration with local authorities where necessary. Applicable laws must be examined, as well as the areas where it may be necessary to negotiate the right of way. The negotiations of right of way could be lengthy and, in some countries, the approval process for new road construction could also take a substantial amount of time and most likely be subject to extensive auditing by local authorities or other governmental entities. Once again, weather should not be forgotten, as during certain periods in tropical countries road access might not be possible due to flooding and torrential rain, or, in colder climates, access might be restricted due to heavy snowfall.
The use of railways as part of an overall access and transport plan for the project could be considered, depending on the available existing infrastructure. However, caution must be exercised as this can pose some schedule restrictions and disruptions may occur (eg, if a scheduled delivery to the train terminal is late and the delivery to the project site must be rescheduled, which is restricted by overall traffic). Also, railways in the majority of countries are heavily unionised and overall operation can be affected by strikes. Depending on the location of the project site, consideration can be given to the construction of a railway to access the site. However, the financial feasibility and collaboration with local government would have to be taken into account.
Available public infrastructure
Available infrastructure plays a significant part in the definition of the project schedule and overall execution strategy. Developed countries might have the necessary infrastructure, but will be heavily regulated with respect to environmental and population effects as a result of transport and construction activities. The lack of infrastructure in developing countries can add significant costs to the project budget, but at the same time can be used as leverage in order to obtain project approval or specific waivers from local government in exchange for investment in infrastructure as part of the project. However, if a project includes public infrastructure works as part of its scope, this can be subject to stringent regulations and the approval process, as well as auditing by public authorities, may impact significantly the overall project schedule.
In addition to the physical setting of a project, another key consideration at the outset of a project is the political atmosphere of the country, region or city where the project will be carried out. The local laws might require that the foreign company executing the project can only do so in partnership with the government in the form of public–private partnerships, which can be heavily regulated and may be required to pass through numerous approval gates. The project might be considered as a strategic project by the government and local laws might stipulate that delays in the projects that are of strategic nature could be considered as damaging to the economy and carry prosecution under criminal law provisions. Due to elections taking place, a project approved under one government might be suspended or cancelled under a newly elected government. If a project is located in a socialist country, the risk of nationalisation or appropriation may need to be analysed in the light of the overall political situation in the country and the long-term plans of the government. A full analysis of the political atmosphere should, as a minimum, comprise the following:
Level of control exercised by the government or governmental entities
All project activities to be performed need to be analysed with respect to whether and in what form they are subject to control by a particular governmental entity and advice on applicable local laws should be obtained at the onset of the project, including applicable laws with respect to taxation; employment; health, safety and environment (HSE); and any permits required to proceed with the project. Some countries are very stringent with respect to reporting and auditing by various governmental entities, and the invitation to tender by a public authority might stipulate that the bidder must accept the contract as is without any qualifications.
Prior to the commencement of the project, the country should be examined in light of corruption reports issued by the United Nations, World Bank, the Organisation for Economic Co-operation and Development and so on, as well as whether the host country is a signatory to the Anti-Bribery Convention. The applicable anti-corruption and anti-bribery laws of the home country of the parties executing the project should also be considered. Mechanisms for preventing corruption should be implemented for the entire life of the project, taking into account local particularities (eg, gift giving before starting meetings is the norm in Asian cultures, but could be considered corruption in other cultures) and the internal regulations of the companies involved in the project.
Depending on local requirements, payments may be required in a specific currency. In such cases, it might be possible to incorporate a mechanism into the contract to offset the effects of exchange rate fluctuation such as hedging or, if permitted by local legislation, implement an invoicing system with amounts stated in required currency and project currency.
Sanctions in place
If the project is located in a country that is subject to some form of sanctions, these sanctions could impede the sourcing of construction material and equipment, entry of personnel of specific nationalities, acquiring required insurance and so on.
Stability of the legal framework
The stability of the legal system should be considered, especially with respect to laws relating to employment and taxation, as well as local corporate obligations in the case in which international parties involved in the project are required to be commercially registered locally. From the perspective of the project owner, it is also necessary to examine the possibility of being held responsible for any default on payments to subcontractors by the main contractor.
Specific requirements for local content
Local content requirements (eg, requirements with respect to the number of local personnel to be employed, the tonnage of locally produced bulk material to be used and the tonnage of bulk material to be fabricated locally) can be either imposed by law or imposed by the government or project owner for a specific project. Depending on the size of the project and the applicable local content requirements, waivers may be required.
Employment of foreigners
If the project requires personnel with a specific set of skills, consider restrictions regarding employment of foreign nationals that may limit the pool of specialists available for the project. The labour laws of certain countries permit only a certain percentage of the total workforce to be foreigners or establish a visa quota for the total number of foreigners that can work in a country. In order to mitigate this risk and the adverse effect on the execution of the project, the following options should be considered: the possibility of obtaining a waiver for the project, employing personnel through in-country employment agencies, development and training of local personnel, and so on. This risk would need to be examined and addressed in light of the project duration and the overall project needs, as well as economic considerations, including the cost of employing foreign personnel versus training local personnel.
The influence of the persons and businesses directly or indirectly affected by the project should not be forgotten. The way in which the project is presented to the ‘neighbours’, including public announcements and consultations with local businesses and landowners, should be carefully considered, as adjacent landowners, businessowners and registered voters might oppose the project. The access to the site by heavy machinery and the effect of an increase in traffic should be analysed and mitigating measures proposed and implemented. It might be necessary to negotiate right of way and the project budget needs to include a provision for corresponding compensation, which may be calculated with reference to applicable taking or condemnation laws. In some countries, the execution of a project requires specific consultation with or approval by the local indigenous population. It may be necessary to pay compensation to indigenous communities or to employ (and in some cases provide training to) a certain number of local workers. In some cases, a company that previously carried out a project in the same area may have created a particular expectation in this respect and the local community might block the project until this expectation is met by the new project owner or contractor. It is also important to be aware and monitor the risk of interference (eg, protests) by the local population and what circumstances will provoke such interference (eg, the project creating a disturbance to the day-to-day activities, an expectation of monetary compensation, environmental pollution, etc). In order to mitigate these risks, it is necessary to have in place monitoring practices and ensure the contractor follows up to confirm adherence to project requirements.
As mentioned, the political atmosphere is relevant in a number of ways and it may be advisable to employ a government liaison or lobbyist to mitigate inherent risk.
[T]he political atmosphere is relevant in a number of ways and it may be advisable to employ a government liaison or lobbyist to mitigate inherent risk.
Specific legal considerations
In addition to physical location and political aspects affecting the successful execution of the project, the third facet that must be considered in full is the specific legal considerations that have an impact on the overall day-to-day operations of the project.
Local legislation or project bid documentation needs to be fully evaluated in order to ensure that the project execution strategy incorporates the creation of any legal entity necessary to execute the project and that the governing corporate policies allow for the creation of such an entity. It should also be verified that the documents that will be required from the parent company are in order. Depending on the country, it is necessary to analyse, in line with the overall corporate strategy, if there is an intention to only participate in one project or establish a long-term presence in the country; as such, consideration should be given to the establishment of a standalone company as opposed to the creation of a subsidiary or affiliate, or entering into a joint venture agreement with a local company. There might be a pre-existing legal requirement that the execution of the project must be done in a joint venture format with a local entity. The requirements for local company registration might not be explicitly mentioned, but may be implicit in other requirements, such as a requirement to issue bills in accordance with local tax norms, which requires registration with tax authorities, which in turn requires the registration of a local commercial entity. With respect to company registration, the existence of tax-free zones and the possibility of registering the entity that will be executing the project in such a zone should be considered. When registering a local entity, it should be verified whether there is a requirement that only a local resident can act as the legal representative of the company. When creating a subsidiary or affiliate, it should be examined whether the revenues earned by such an entity will be subject to an additional tax imposed upon remittance to the parent company’s country. The time needed for local company registration is a risk factor, as in some cases the public project bidding requirements have very tight deadlines for the presentation of the paperwork certifying the existence of the locally registered company.
This is a complex set of issues and must take into consideration the requirements with respect to municipal, departmental and national government-imposed taxes, as applicable. Depending on the project activity, particular royalties and activity-specific taxes may need to be paid. From a tax perspective, a joint venture could be an attractive mechanism as each party is responsible for its own taxes. Tax declarations are often based on a calendar applicable to the type of industry to which the party executing the project belongs or the type of activity the party lists in its commercial registration as being its principal activity. Withholding tax, value added tax, importation tax and so on also need to be taken into consideration with respect to the definition of the project budget. The project contract should contain a provision regarding who bears the costs in the case of significant changes in the taxes applicable to the project during the project duration.
Law of the contract
The law of the contract and the applicable laws must be clearly defined in the contract. The contract should contain a provision regarding who bears the increment in the contract price due to changes in the laws governing project execution.
Labour law obligation is another risk factor that can have an impact on the project budget, schedule and, more importantly, claims against the project owner. The aspects that have a direct impact on the budget are mandatory annual salary increases and bonuses, and mandatory health insurance and pension contributions. Depending on the type of employment contract in place, the project owner or contractor might need to act as an agent for the collection of employee withholding taxes and declare and pay these taxes to the tax office. The schedule of the project could be affected by legal requirements concerning leave and working hours. However, the aspect that carries higher risk for the project is the actual form of the employment contract, which needs to be drafted in such way that it avoids the risk of a person claiming that the person is a permanent employee of the company executing the project (most often, the project owner) even though the person was hired only for the duration of the project.
Permits, licences and certification
All the activities that will be performed during the life of the project need to be defined from the outset and the requirements for corresponding permits, licences and specific registrations need to be analysed. Depending on the country, there might exist the possibility of overlapping requirements for permits due to autonomy given to departments and municipalities and, consequently, different authorities will be issuing a permit for the same activity. As projects tend to be intensive in terms of pressure to complete on time, projects are quite often penalised by the relevant authorities with respect to the omission to renew required permits, licences, and so on.
Health, safety and environmental compliance
In addition to overall legal compliance, the non-fulfilment of obligations carries heavy penalties and fines imposed by the applicable laws or regulations and, in some cases, could include criminal responsibility. To mitigate these risks, it is necessary to consider conducting a gap analysis of the project technical specifications and procedures in terms of compatibility with applicable HSE laws, regulations and norms for the duration of the project. This analysis should be ongoing so that the applicability of new legislation to the activities of the project is identified.
The main aspects, discussed in this section, of understanding and defining the context in which the project will be executed, together with the definition of the associated risks and mitigation actions, should be incorporated into the PEP and other relevant project technical and legal documentation in order for the risk management strategy to succeed.
Defining the project structure
The PEP is the backbone of every project and should: clearly describe the project; identify the key parties with corresponding roles and responsibilities; state the manner and strategies that will be employed to complete the project in an orderly, economical, timely and safe way; and include the risk management strategy as defined by the risk analysis and analysis of the context in which the project will be executed. The project’s contract, general and technical specifications should be checked for inconsistencies in order to mitigate the risk of claims during the execution stage, for example, document review and approval process, work hours, site access and audits.
Complex or large projects may evolve over time, requiring updates to the PEP to ensure its continued relevance to the project. The project schedule included in the PEP needs to reflect activities identified as possible contributors to delay and take into consideration the context of the project, for example, long lead items, obtaining permits from authorities, obtaining visas for personnel, mobilisation, customs clearances and negotiation of rights of way with local landowners. The project budget needs to include the actual project costs and should incorporate a provision for risks, such as cost increase due to possible changes in law and annual salary increases.
The packaging and procurement strategy included in the PEP needs to be in line with the delivery time of long lead items, local content requirements, if applicable, and based on the material and equipment available locally, in the region or to be imported.
All projects come to an end and a number of issues always arise at that moment no matter how well the project execution is planned and performed. It is therefore imperative that the PEP and contract clearly reflect the process of project close-out and handover, issuance of applicable certification, transfer of ownership (including takeover by the project owner), warranties, provision of the required operation and maintenance manuals, spare parts, transfer of excess bulk material, technical support and so on.
The location of a project team can vary considerably based on a project’s geographical location, type, scale, complexity and various other factors. In today’s globalised world, with ever-increasing ease of communication, it is not uncommon for a project to have its team spread across several countries. For example, a project in Dubai may have its client based both in Dubai and Toronto, the architects in London and structural engineers in Chicago, while the contractor would, by necessity, need to be situated at or near the project site. It is also quite common for specialist contractors, fabricators and suppliers to be spread across the world, often with their own complex international supply chains. In this respect, the PEP needs to address how relationships between various teams are managed to ensure that timely and accurate communication occurs.
Parties to a project
In a construction project, there are typically several parties involved and each has a role to play. These parties can be from either the public sector or private sector and are not necessarily limited to the parties signing the main construction contract, but could also include lenders, governmental entities, contractors, subcontractors and suppliers.
To ensure a common understanding between the parties involved in a project, the following issues should be considered:
One important determination to be made is whether the core business of the client is relevant to the project or has no direct link to the project. This is relevant for putting in place mitigating measures in order to prevent project disruption. In the case of a client with little experience in the subject matter of the project, the schedule should reflect the float for the additional time required to provide the necessary explanations and training to the client, for example, construction of a nuclear power plant for a government client. The overall execution plan of the contractor should accommodate the level and extent of supervision and control from the project owner.
Differences in goals between parties can lead to disruptions in project execution and subsequent claims. It is important to bear in mind that the client’s primary goal is the timely completion of the project in accordance with the applicable criteria, whereas the contractor’s primary goal is timely and full payment. The importance of understanding each other’s goals can be illustrated by an example of an oil and gas company under strict contractual obligations with respect to the production start day due to its contract or licence with a particular government. Thus, its goal is the completion of the project on time. However, for the contractor performing the project, the primary goal is to be paid on time so as to ensure that it can meet its obligations to suppliers and subcontractors. Therefore, in the case that the client delays payment to the contractor due to a contractual provision, this can negatively affect the project, as the contractor might not have sufficient liquidity to ensure the progress of the works.
The amount and type of risk that each party involved in a project is prepared to undertake must be considered. Risk appetite is a major consideration when determining whether a party is likely to pull out of a contract should there be a change in circumstances.
Company culture includes a variety of elements, such as work environment, company mission, value, ethics, expectations, goals and work-life balance. Understanding each party’s company culture is important to prevent possible miscommunication.
The principal traits of the main parties to a construction project are outlined in the following. These profiles are to be considered depending on the type of contract used for the project, which party is the owner and which is the contractor.
Whether the client is a private or public entity can make a significant difference in terms of the financing of the project, the client’s goals and the role the client takes in any given project. However, all clients are concerned with the timely completion of the project and it is important to understand what impact a delay can have on the client. For example, was a bridge construction an election promise? Is the first gas production and thus the timeline for gas processing plant construction governed by the gas production licence? The client’s prerogative is to incorporate in the project contract the mechanisms that will protect its interests and provide remedies in case of a delay. The goal of a client is to maximise profits for the shareholders or create benefit for the country and such a client would not be inclined to spend more than is necessary on the project. Depending on the project structure (eg, whether the contract is design-build and whether the project owner employs a project manager), the client may define the basis of the project, choose the contractor, provide observations on the compliance of the project with pre-defined criteria and monitor the progress of the project. A responsible client will monitor and review the performance of the main contractor and the progress of the project without usurping responsibility or transferring risk from the contractor. Depending on the location of the project, care should be exercised with respect to the selection of the contractor, as in some cases local government might impose a contractor and such an imposition would be difficult to accommodate in a client’s internal bid evaluation procedures.
Main contractor profile
The selection of the main contractor plays a significant part in the overall success of the project. Whether the main contractor is a local or international company may make a difference in terms of resources. A local contractor might not have the necessary resources available for the completion of a large-scale project or experience. On the other hand, an international contractor might have the requisite resources in terms of labour and technical expertise but not have the necessary knowledge of local specifics relevant to the project. In such cases, it is not uncommon that an international contractor will work in a joint venture with a domestic contractor. From the client’s perspective, such an arrangement needs to be carefully examined. How is the joint venture structured with respect to each party’s responsibilities? What is each party’s contribution to the joint venture? Which party is designated as the joint venture’s leader? In selecting a main contractor, the contractor’s experience with similar projects is of the utmost importance and is a key indicator of whether a project bid is realistic and whether the contractor has the necessary skills and resources to execute the project or any of its specific parts. Another important aspect is what measures the contractor has in place in order to guarantee the completion of the project. As a mitigating measure, the client should request at a minimum:
• a parent company guarantee: the financial health of the parent company needs to be proven to the client, as well as that the parent company would be able to complete the work in the case of the default of the contractor; and
• a performance bank guarantee (or a surety bond, as the case might be): this should be executable on demand with the value defined in proportion to the value of the project.
The necessity of incorporating into the contract the requirement for the contractor to furnish other bonds, such as bid bonds, payment bonds or maintenance bonds, should be considered on a case-by-case basis with respect to the risks of the project, the subject matter of the project and the policies of the client. For example, typically, an oil and gas operator would request the following: bank performance guarantee; advance payment recovery bank guarantee; parent company guarantee; signature of a deed of mutual indemnity; waiver of recourse; deed of liability; and insurance
Third parties’ profile
There may be several third parties, such as governmental entities, suppliers, experts and subcontractors, that are not directly party to the project contract, but are in some way connected to the project. With respect to the project execution, it is necessary to consider which project activity could be affected by a particular third party (eg, obtaining the necessary permits on time to avoid fines from the responsible governmental entity or subcontractors’ failure to adequately address enquiries), and what would be necessary from the project execution perspective to ensure that the said third party would not affect the project, for example, including provisions in the contract that the contractor must protect and indemnify the client from claims of the suppliers. It is also necessary to consider whether it is possible for a third party to make a claim against the client under local laws.
The lender could either be a bank, syndicate of banks, equity investor or multilateral agency. The primary concern of the lender is to make a profit from its investment. In providing financing for the project, the lender is concerned with:
• whether the borrower has the financial resources required for project execution and is able to meet all corresponding obligations;
• the borrower’s commitment to the project and whether it has the relevant expertise for the project;
• the borrower’s independence from the influence of local government where the project is executed;
• the clarity of the bidding process and selection of an independent contractor;
• a clearly defined completion date for the project;
• how liquidated damages or penalties are defined in the contract, especially with respect to delay;
• the definition of force majeure and how the responsibilities of the parties to the contract are split should a force majeure event occur;
• the political stability of the country where the project is executed and the associated political risks that might affect project completion (eg, expropriation and nationalisation, currency stability, government friendliness or hostility that affects the issuance of required permits and licences and the frequency of strikes);
• whether project guarantees and bonds are of a sufficient amount to cover the completion of the project in the case of default by the contractor; and
• whether the borrower might be undertaking other activities aside from the project for which finance has been provided and thus the funds might not be used entirely for the purpose for which they have been provided.
To mitigate these concerns, apart from the verification of the financial health of the borrower, the lender will want to play a major part in adjusting rights and obligations of the parties through a review of the project terms and conditions, imposing its own conditions and reviewing the enforceability of the project contract as a whole. The lender will also be concerned with how well the project is insured against losses.
The main risk for project execution is the political stability of the country and the associated political risks that might affect project completion.
The role of local government depends on the type and significance of project and varies from being a mere observer or regulator to being the client or concessionaire. Typically, the government’s primary role is to issue the required permits and licences for the duration of the project. Whether the project is supported or interfered with depends on the interest of the government in attracting foreign investment and whether legislation or other tools are in place to support such investment and to provide an environment favourable to foreign investment.
The main risk for project execution is the political stability of the country and the associated political risks that might affect project completion (eg, expropriation and nationalisation, currency stability, government friendliness or hostility that affects the issuance of required permits and licences, frequency of strikes in the country and the likelihood of a change of government).
Principally, an insurer’s interest is to make a profit by collecting premiums and avoiding indemnifications. The project contract should clearly define which party is responsible for which type of insurance (eg, contractor’s all risk), the coverage amounts and, vis-à-vis the contractor, the rating of the entity providing insurance. These provisions will be checked by the lender and need to be aligned with possible requirements of local legislation.
With respect to insurance provided by the contractor, it is important to also incorporate in the contract mitigating measures that will address the following:
• the duration of the insurance policy is aligned with the project duration and support after the project completion;
• the policy covers the risks associated with the location and context in which the project will be executed; and
• voidability of the policy by act or omission on the part of the contractor.
Understanding the bidding process
Call for bids and tenders is a specific procedure for generating competing offers for a project. The bidding process starts with the client preparing the project description documentation regarding site conditions, technical requirements, time constraints, contractual terms and conditions and so on. The call for bids and tenders package must allow the bidder to understand the scope of the project and submit the bid. In the case of governmental procurement, bidding could be governed by detailed procurement codes and policies that would require strict adherence and raise the risk of non-responsiveness. Contractors must then provide project-specific bids in accordance with the client’s specifications and with the lowest responsible economical offer.
Generally, before initiating a tender, a client will survey pre-selected companies and, depending on the outcome of the pre-qualification survey, define a list of the companies to be invited to participate in a tender. In some cases, the company rules or applicable laws require that a certain number of companies are contacted for a particular type of project. In such cases, some companies could be invited to participate merely in order to satisfy these requirements. For the identification of pre-qualified bidders for a given tender, consideration should be given as to: whether the bidders are qualified from a technical perspective; the proximity of the bidders to the project location and the location from which materials will be sourced; and overall capability in terms of resources and financial liquidity.
Care should also be exercised in ensuring that the contract included in the invitation to bid or tender reflects the position of the lender (in the case of a project being financed) and the client’s project insurer. Disputes between parties during project execution will always happen. Therefore, the contract should also define a clear dispute resolution mechanism, which could be a combination of the following: an initial step-by-step procedure of dispute presentation and a resolution process between the parties, including the dispute review board setup (if the project owner’s policies permit the use of such a board), mediation, arbitration or litigation (now almost uncommon due to time and cost considerations). Moreover, the dispute resolution mechanisms should cover the language to be used in the dispute proceedings, the location and the governing institution for the dispute resolution. If the project owner is a governmental entity, it is likely that the dispute resolution process would be governed by specific legislation.
From the project owner’s perspective, the risk with the bidding process is ensuring that only compliant bids are accepted, treating all the bids consistently and fairly, and that the bid analysis matrix is well defined and consequently results in the selection of the contractor that will perform the project on time, within budget and compliant with all the legal, technical, quality and performance requirements.
From the contractor’s perspective, the following points should be considered (in addition to the principal requirement that the bid submitted is compliant with the bid requirements):
Authority required of the person submitting the bid
Depending on the legislation governing government projects, the person signing the bid submission documentation may be required to hold a specific power of attorney, even if the jurisdiction where the company is domiciled does not have such a requirement (such a requirement is more common in projects where the owner is a governmental entity).
Timeframe for clarification
The bid clarification period is normally quite short and it is not uncommon that the answer to a question submitted by one bidder will be shared with others to ensure that no one is put in an advantageous position.
Time required for sending the bid in physical form
Care should be exercised if the bid is required to be presented in physical form by a certain date and time, taking into consideration the difference in public holidays among various countries.
Qualifications and clarifications
The overall bid strategy should take into consideration the ultimate goal of the bidder and achieve a balance of commercial considerations and the risks that a bidder is willing to take. When submitting qualifications and clarifications and consequently proceeding with the contract negotiations, the bidder needs to have a clear definition with respect to what points are necessary to be negotiated with the client in terms of the bidder’s strategy for project execution or are actually coming from the specific corporate policies and which aspects are nice to have but not essential for the project execution and could be used as bargaining chips for the points that are necessary. If during the contract negotiation round an agreement cannot be reached by the parties, then an option could be to price the disputed qualifications and submit the revised commercial offer upon the project owner’s request.
Previously concluded contracts between the parties should be referred to for return of experience and the reasons why specific points were negotiated and agreed in a particular way. If the parties have a frame agreement signed, it would be difficult to deviate from pre-agreed terms and conditions, even though the circumstances of the project might be driving this to happen, usually in the case of the contractor.
Identifying the resources required
With respect to project structure and the definition of project execution, it is necessary to examine in great detail the resources available: from the client’s perspective, the supervision of the contractor, actual contractors and the financing for the project; and from the contractor’s perspective, the actual physical resources, suppliers and subcontractors in relation to the client’s specifications and requirements for the project.
Depending on the client requirements (which might be dictated by the requirements imposed upon the client by local government), the client could provide a list of approved subcontractors or provide guidelines for the contractor to submit its own list of subcontractors for approval. In such a case, the contractor runs the risk that the subcontractors will know that they are ‘imposed’ by the client and can use this position to their advantage in terms of pricing or responsiveness to enquiries from the contractor. Moreover, a contractor could be placed at a disadvantage if some of the client’s approved subcontractors have alliances with another contractor submitting a bid for the project.
It is also important to ensure that the procurement policies between the parties involved in the project are aligned. For specific packages or equipment, the client may require that it reviews and approves the bids submitted by the suppliers or subcontractor to the main contractor, and this approval time can affect the time required for placing orders. Accordingly, a specific time period for the client’s written approval needs to be specified, giving rise to deemed approval if comments are not received in a timely manner. In addition, governmental procurement procedures and policies might be quite cumbersome, thus it can affect the schedule for the project. The procurement process, no matter how well defined and planned, is not risk free and needs to have measures put in place to address the following risks:
• favouritism with respect to treatment of some subcontractors;
• security of information especially when dealing with sensitive information, such as commercial offers;
• no response from subcontractors’ suppliers due to project location or their workload; and
• offers that are not in accordance with the client’s specifications.
The overall industrial development level of the country where the project is to be executed should be considered. What equipment is readily available? Are bulk materials proximate? Other examples include the client’s safety specification call for a specific type of scaffolding to be used or personal protective equipment. From the global perspective, depending on various activities worldwide, project planning needs to also take into consideration the availability and sourcing of bulk material and specific equipment, for example, the availability of a specific diameter of piping and a long wait on generator orders.
The importation and exportation procedures of the project location should be carefully considered. The temporary importation of the equipment required for project construction versus permanent importation and the consequent disposal after the completion of the project should be considered in terms of the importation and exit taxes to be paid, complexity of the process and time required for customs clearance. The same consideration applies in the context of turbines or other similar equipment provided to a plant or facilities on the basis of a lease contract. The actual execution of the terms of such a contract might be impeded by local importation laws not being advanced enough to include such a case.
In developing countries, the cost of transport can be quite high as local companies might be required to invest in new trucks or ships, passing this cost on to the project. Local companies might even consider charging exorbitant prices due to the notion that international companies have money and will pay.
To start a project, the client must have finances available to pay the contractor and the contractor must have finances available to mobilise personnel, equipment and place initial orders and, accordingly, the parties need to discuss the project milestones and associated mobilisation and other advanced payments at the outset.
With respect to the identification of resources, one final point to consider is the feasibility and cost of maintenance of equipment integrated into the project design, as well as the training of local personnel to operate it. The project might be the design and construction of a state-of-the-art gondola system in the city of Mexico, but if the motors powering this system are German-made and if it takes three months to receive spare parts, the stoppage of this system for such an amount of time would be considered as a failure of the project.
Identifying the financial structure
The financial structure for a project needs to be well defined in order to avoid delays during project execution due to late payments, poor cashflow management or insufficient financial resources, and to mitigate the effects of financial market instability.
The financial structure for a project should take into consideration the following factors:
• the funds for the project provided by a lender and the specific terms of the loan with respect to when the funds are available and when and how the loan must be repaid;
• the cost of mobilisation and the funds required by the contractor with respect thereof;
• progress measurement mechanisms and the definition and agreement on the milestones in line with the cashflow requirements;
• in the case that the project owner is a governmental entity, the effect of the approval of expenditure that in turn extends the payment period for the payment of bills presented by the contractor; and
• the time required to transfer funds and fund clearance if payments are required to be made in the country where the project is executed.
The success of setting up a project depends on the identification and analysis of the project activities, the associated risks and the mitigating measures that can be put in place. These mitigating measures and the risk analysis cannot be static. They need to evolve as the project progresses and be adjusted in line with obstacles or events encountered during project execution.
1 The Project Establishment Subcommittee is a subcommittee of the International Construction Projects Committee of the International Bar Association. Its officers at the time of preparation of this article were Tuomas Lehtinen, Co-Chair; Phillip Greenham, Co-Chair; Aarta Alkarimi, Co-Vice Chair; and Polina Chtchelok, Co-Vice Chair.
This article was collaboratively written by: Polina Chtchelok, a co-founding partner of ESPCs Corporate Advisors, Santa Cruz De La Sierra, who can be contacted at firstname.lastname@example.org; Aarta Alkarimi, a partner at Chrysalis, Dubai, who can be contacted at email@example.com; Phillip Greenham, a partner at JBM Advisory, Melbourne, who can be contacted at firstname.lastname@example.org; and Tuomas Lehtinen, a partner at Castrén & Snellman, Helsinki, who can be contacted at email@example.com, under the overall coordination and efforts of Polina Chtchelok.