Bankability Issues in Construction Contracts

Project Management Conference

Yellowknife, N.W.T.
November 23-24, 2015
©Helmut K. Johannsen, P.Eng., C.Arb.
Partner, Fasken Martineau DuMoulin LLP
 Introduction

• Brief overview of basic Project Delivery Models as background

to discussion
• Some basic bankability issues
• Discussion of issues that impact bankability and/or financial
security requirements in contracts

2
 Introduction (cont’d)

• Bankability is often dependent on:

• Project Delivery Model
• Contract Model
• Pricing Model
• Are these all the same?
• If not, what’s the difference?
• What are the Lender’s concerns
• How do they affect the Contractor

3
 Project Delivery/Contract Model

• Project Delivery System (PDS):

• PDS is a logistical decision by the Owner as to how project
risks will be managed and how different parties required for
the project will participate in the project.
• PDS is an organizational structure adopted by Owners for
the management of the design and construction of a project
(Masterman, 2002)
or
• PDS is the particular contractual arrangements for the
approach implemented or utilized by the Owner to
accomplish a project´s goals, including organization, risk
allocation, and the assigning of responsibilities, pricing and
payment obligations (Juliana, Ramirez and Larkin, 2005)

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 Project Delivery/Contract Model (cont’d)

• Contract Model
• Follows the PDS adopted by the Owner
• A generally understood form of contract that specifies the
risk allocation that is generally assumed to apply and govern
the relationship between the parties, such as CCDC
standard contract forms.
• May include one or more pricing models, which in turn may
change the risk allocation generally assumed to apply by the
contract model
• e.g. Using CCDC 2 stipulated sum contract, but including
numerous cost reimbursable and unit prices for a majority of the
scope of work

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 Project Delivery/Contract Model (cont’d)

• PDS may include one or more of the following contract

models:
• Management (which includes those contracts in which the
Manager takes the risk of the delivery of the project and
excludes all contracts in which the Manager is a consultant
or good-effort contractor)
• “Traditional” (Design Bid Build)
• Design-Build or EPC (which includes all contracts in which
the Contractor is responsible to the Owner for design)
• Integrated-Collaborative (which includes all contracts based
on joint decisions, alliance agreements, BIM, IPD, etc.).

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 Contract Models

• PDS may include one or more types of contract models

• Contracts for managing projects

• PM (Project Management)
• CM or ACM (Agency Construction Management –
Consulting)
• CMAR or CM/GC or CM At-Risk (Construction Manager At
Risk)

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 Contract Models (cont’d)

• Contracts for delivery of projects

• Traditional (mixed responsibility)
• D-B-B (Design-Bid-Build or “Traditional”)

• Single Point Responsibility

• D-B (Design-Build)
• D-C or D&C (Design & Construct)
• EPC (Engineer-Procure-Construct)
• EPCI (Engineer-Procure-Construct-Install)
• S&I (Supply & Install, or Design, Supply & Install)
• EP+C (Engineer-Procure & Construct)

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 Contract Models (cont’d)

• “Hybrid” type contracts

• EPCM (Engineer-Procure-Construct-Manage)
• EP+CM (Engineer-Procure & Construction Management)

• Concession Type Models

• BBO (Buy-Build-Operate)
• BOT (Build-Operate-Transfer)
• BOO (Build-Own-Operate)
• BOOT (Build-Own-Operate-Transfer)
• DBFO (Design-Build-Finance-Operate)
• FDBOM (Finance-Design-Build-Operate-Maintain)
• “P3”, “PPP” (Public-Private Partnership)
• BLT (Build-Lease-Transfer)

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 Contract Models (cont’d)

• Non-Traditional Project Delivery Models

• IPD (Integrated Project Delivery)
• IPD (Innovative Project Delivery)
• Alliance Contract

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 Acronym Alley (cont’d)

• Contract models in turn may include one or more pricing

models, such as:
• FP (Fixed Price)
• GMP (Guaranteed Maximum Price)
• GMUP (Guaranteed Maximum Upset Price)
• UP (Unit Price)
• TP (Target Price)
• Cost+ (Cost Plus)
• Combination (stipulated &/or unit &/or reimbursable prices)
• OB (Open Book)
• Depending on project, Lenders will look at the Project Delivery
System, Contracting Model(s) and Pricing Model(s)

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 Risk Transfer
Shifting the risk
Increases Bankability
Contract/Pricing Model Risk
Owner Contractor
Management Contracts
Construction Management
Traditional Unit Price
Bill of Approximate Quantity
Traditional Lump Sum
Fixed Price / GMP
Design and Build
Complete “Package”
Design, Build, Operate &
Maintain

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 Typical Design–Bid–Build Relationship

LENDER

PREPARE
DESIGN OWNER

DESIGN
CONSULTANTS CONSTRUCTION TO
OWNER’S DESIGN

ADMINISTER
CONTRACT

CONTRACTOR

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 Design-Build/EPC Relationship (Theory)

LENDER

PERFORMANCE
SPECIFICATIONS OWNER

EMPLOYER’S
CONSULTANT DESIGN TO PERFORMANCE SPECIFICATIONS,
PROCURE AND CONSTRUCT

ADMINISTER
CONTRACT(?) EPC
CONTRACTOR

SPECIALTY
LABOUR VENDORS
SUBCONTRACTORS

Note: EPC Contractor assumed to be a single integrated firm

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 Design-Build/EPC Relationship (Reality)

PERFORMANCE
SPECIFICATIONS LENDER
OR
OWNER’S EMPLOYER
REQUIREMENTS

EMPLOYER’S DESIGN TO EMPLOYER’S REQUIREMENTS

CONSULTANT AND CONSTRUCT

ADMINISTER EPC
CONTRACT(?)
CONTRACTOR

DESIGN
SUBCONTRACTORS VENDORS
CONSULTANTS

Note: EPC Contractor on larger projects may be a joint venture,

consortium, special-purpose vehicle, etc.
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 Typical EPCM Relationship

LENDER
EMPLOYER

EPCM
CONTRACTOR

DESIGN / SERVICE CONSTRUCTION EPC CONTRACTORS VENDORS

PROVIDERS CONTRACTORS

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 Construction Management
(CM not “at risk”)

LENDER

OWNER

OWNER'S
CONSULTANT
CONSTRUCTION
MANAGER

Trade Contractor Supplier Trade Contractor D/B Contractor

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 Construction Management
(CM “at risk”)

LENDER
OWNER

OWNER'S
CONSULTANT CONSTRUCTION
MANAGER

CONSTRUCTION MANAGER
TRANSITIONS TO BECOME
CONTRACTOR

CONTRACTOR

Trade Contractor Supplier Trade Contractor D/B Contractor

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 Basic Bankability Issues

• Approach of lenders to risk?

• Project risk profile?
• Relevance of:
• Project Delivery System
• Contract Model
• Pricing Model

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 Lender’s “Wish List” for Financing

• Single point responsibility (i.e. EPC)

• Reputable, creditworthy contractor(s)
• Fixed completion date
• Fixed contract price (subject to [limited] change orders)
• Payment tied to completion of milestones
• Minimum performance (“threshold”) guarantees for which
contractor has unlimited liability (i.e. contractor must keep
working to achieve at least the threshold value of “x”)
• LDs for delay and non-performance above minimum
(threshold) performance guarantees

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 Lender’s “Wish List” for Financing (cont’d)

• Proven technology
• Adequate performance security
• Reasonable limitations on Contractor’s right to changes and
extensions of time; prior (discretionary) lender approval for
material changes
• Contractor obligation for all permits, licences and approvals (in
contractor’s name [and perhaps also in employer’s name])
• Reasonable defects liability period
• Restriction on subcontracting except to reputable
subcontractors

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 Pushback - Contractor’s “Wish List”

• Fair allocation of risk

• Contractual right to variation/change orders adjusting
schedule and contract price
• Non-interference by Owner
• Assurance of payment from Owner
• LDs that limit liability, rather than pay full loss suffered by
Owner for delay, non-performance, etc.
• Caps on LDs
• Overall cap on liability
• Prompt resolution of disputes during course of project, not
deferred until after completion
• Positive cash flow

• Question: How are these reconciled with Lender’s wish

list?

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 Bankability/Role of Lenders

• Depending on type and value of contract, Lender protection

provisions will be required
• Lender requirements will differ depending on amount of equity
injected and type of financing used for project:
• Financing project out of corporate debt
• Project financing with recourse
• Project financing without recourse

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 Bankability/Role of Lenders (cont’d)

• Risk must be acceptable to Lenders or financing may not be

available
• Risk analyses/assessments by Lenders may differ
substantially from that of government party/private sector party
• Parties may apply probabilistic approach to risks (especially
for cumulative risks)
• Lenders may not use same probabilistic approach and/or
may look to “worst case scenarios”

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 Bankability/Role of Lenders (cont’d)

• RISK REGISTERS
• What are they?
• Are they used/useful?
• Only for Lender? Employer? Contractor?
• When should they be prepared?

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 Project Roadmap for Lenders

• In assessing risk, important that Lenders and Lender’s all

understand the Project Delivery System, Contract Models and
Pricing Models for the project
• Where project developed over several years often Owners
documents contain numerous conflicts in design, cost
estimates, schedule, etc.
• Consider developing a “Project Roadmap”
• Facilitates Lender review
• Facilitates obtaining internal Owner approvals
• Identifies conflicts within documents as well as missing
information that could influence not only bankability but also
lending rate

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 Project Roadmap for Lenders (cont’d)

Project
A Project Overview
• Project Components
• Overall Project Structure/ Organization Chart
• Overall Project Schedule
• Overall Cost Estimate
B Market for Sales/Revenue
C Overall Project Economics
• Capital Cost
• O&M Costs
o Annual Cost
o Sustaining Capital
o Capital Replacements
• Project Cash Flow
o Revenue
o Account structure
o Debt service
o Equity return
o Tax burden
o Contingency
o Depreciation
• Financial Model
• Overall Project Economic Performance Projections
• Taxation Summary

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 Project Roadmap for Lenders (cont’d)

D Ownership and Governance

• Sponsors (and background)
• Shareholder Agreements
• Project Ownership Summary
•
E Funding Strategy
• Capital Structure
• Equity
• Financing
• Credit Enhancement/Govt Guarantees
• Refinancing Risks
F Income Streams
• Competiveness of Market
• Sales Agreements
• Integration with other facilities
• Delayed Start-up Insurance
• Business Interruption Insurance
G Real Estate
• Ownership/Rights of Use
o Summary of First Nations agreements regarding
land use
• Statutory Rights-of-Way
• Other

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 Project Roadmap for Lenders (cont’d)

H Project Risk Management

• Risk Matrix
• Project Insurance Overview
• Project Bonding/Performance Security Overview
• Project Contingency/Reserve
• Schedule Risk Management
I Project Execution
• Technologies
• Contracting Strategy
o EPC v EPCM
o Design Review & E&O Insurance
o Contracts under EPCM
o Contracts outside EPCM
• Integration with existing assets
• EPCM Contract Overview
• Liquidity to withstand cost/schedule over-runs
• Guarantees and Warranties
• Force Majeure Risks
• Risks re Ancillary Infrastructure to support Project
• Labour
o Project Labour Agreement
o Availability
o Productivity
o Escalation

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 Project Roadmap for Lenders (cont’d)

J Overall Project Operation

• Operator Experience
• Operation Agreements
• Operation Risks
• O&M Costs

K Environmental and Regulatory

• Public Consultations
• First Nations Consultations and Agreements
• Environmental Assessments and Approvals
• Regulatory
o Legal Framework
o Permitting
o Regulatory Review
o Regulatory Approvals

L Project Status
M Summary and Conclusions

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 Project Roadmap for Lenders (cont’d)

• Lender protection in construction contract

• Default by the Owner does not give Contractor grounds for
termination until after Lender receives notice of default and any
cure period for a default by Lender has expired without the
default being remedied
• Upon default, Lender may enforce its security agreement and
acquire the Owner’s rights and benefits under the construction
agreement and may sell them to a third party
• Until Lender has taken over the Owner’s rights and benefits
under the contract (i.e. the Lender has exercised its “step-in”
rights), the Lender is not liable for the obligation of the Owner
• After ceasing possession or control of the Owner’s rights and
benefits, or after transferring them to a third party, Lender
ceases to be liable for the obligation of the Owner

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 Mega Projects

• Many mega projects are too large for a single EPC contract or
a single contractor
• Split EPC contracts: Lender, Owner, Contractors,
Subcontractors and Vendors may have concerns
• Addressing concerns
• Clear contracts
• Clear scope definition/battery limits
• Clarification of inter-dependencies for performance guarantees
• JV/Consortium as Contractor:
• All for one and one for all? Or everyone for themselves?
• Should Owner/Lender be concerned?
• EPCM contract: is it a bankable alternative?

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 Bankability vs “Best Value”

• Evolution of Procurement Models, bankability, and attitude of

Lenders to different models:
• EPC/BOT/P3
• EPCM
• Alliance Agreements
• Integrated Project Delivery
• Lenders not concerned with “Best Value” as with minimum risk
to Lender
• As risk of catastrophic failure shifts from Contractor to
Owner, will Lenders also shift away?
• Attitude of Lenders may stifle innovation unless Owner can
demonstrate reduced risk to Lender rather than increased
risk
• e.g. on mega project, breaking project into separate packages
may prove less risky than large single EPC contractor

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 Lenders’ Direct Agreement

• What are they?

• When are they used?
• Lender perspective:
• What protection does the Lender really get?
• In complex EPC or P3 scenario, will lender ever exercise its
rights and, if so, what are the consequences?
• Contractor perspective:
• What benefit, if any, does contractor get?
• What are the consequences to contractor if lender exercises
its step in rights?

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 Lenders’ Direct Agreement (cont’d)

• Some Issues in Practice:

• Must Contractor agree to changes to underlying contract
required by the Lender?
• Or are these really driven by Owner to obtain a more
advantageous contract?
• Should Contractor consent to security given to Lender
without seeing the security documents?

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 Lenders’ Direct Agreement (cont’d)

• Some Issues in Practice (cont’d):

• Potential delay and cost consequences
• Giving up of set-off rights?
• Notice and time given to lender prior to suspension for non-
payment – who pays during this period?
• Consequences of requirement to provide statement of accounts
due within x days and waiver of claims for anything not included

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 Owner/Lender Step-in Rights

• If EPC Contractor insolvent, are Owner and Lender able to

easily exercise step-in rights?
• Difference between awarding an EPC contract to an
integrated EPC contractor vs. an EPC contractor that
subcontracts design?
• For major equipment contracts for specialized equipment
(turbines, mine processing equipment, etc.), are contractual
remedies and security retained realistic or merely wishful
thinking?

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 Security for Contractor’s Performance

• Performance Security:
• Letter of Credit/Bank Guarantee
• Surety Bond
• Parent Company Guarantee
• On demand or conditional security?
• To secure physical performance or LDs?
• Advantages and disadvantages of each to Lender, Employer
and Contractor
• Lender preference is often in favour of liquidity – on demand
payment instruments
• But is a 10% L/C really better than a 50% surety
performance bond?

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 Security for Contractor’s Performance
(cont’d)

• Can cumulative security requirements of Owner or required by

Lender impact Project viability?
• Performance + Guarantees + Warranty + Defect security
and/or holdbacks
• Is Contractor partially financing the project?
• Delayed release of security/retentions/holdbacks
• Does contract specify clear obligation and timing?
• “Burn in Payments”
• Lender requirement that retentions not be released until end of
warranty period

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 Decennial Liability

• What is it?
• Concept of responsabilité décennale originated in French
Civil Code and desire to protect building owners who could
not ordinarily be expected to possess the technical expertise
required to identify defects in design or construction at
project turnover, particularly latent defects
• Concept now adopted in some common law countries and/or
states within countries
• Strict liability for period of 10 years from turnover, protecting
owner against collapse of building and latent defects
• Decennial liability insurance available (and mandatory in
France and some other jurisdictions)

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 Decennial Liability

• Why of interest in NWT/Nunavut and elsewhere in Canada?

• If foreign or domestic contractors involved in project who
often contract in jurisdictions where decennial liability exists,
may be possible to expressly include decennial liability in
contract.
• Rationale: can’t be opposed to this liability out of principle
because they agree to it in other jurisdictions
• If decennial liability imposed, bankability enhanced
• If decennial liability imposed and insured, bankability
enhanced further

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 Security for Payments to Contractor

• How can Contractor satisfy itself it will be paid?

• Owner obligation to demonstrate ability to pay?
• Production of financing documents
• Securing payment obligations through bank
guarantees/letters of credit or advance payments?
• Ability to suspend until payment assured?
• Contractor’s right of set-off?
• If Lender exercises step-in rights, can Contractor demand
Lender pay unpaid invoices before Contractor resumes work?
• What is Lender ’s obligation for unpaid work?
• For work performed after loan default and before Lender
decides whether to complete, sell or abandon project?

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 “Back to Back” Obligations & Liabilities

• What are they?

• Lender’s concerns
• Can everything be “back to back”?
• If LDs for outages in powerplant, for example, exceed value
of subcontract or equipment supply contract, who will be
responsible for the gap?
• How can the gap be covered?
• Contingencies?
• Insurance?
• Retained risk by Owner/Contractor if catastrophic failure exceeds
Contractor/Subcontractor/Vendor ability to pay

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 “Back to Back” Obligations (cont’d)

• Any problem with simply incorporating obligations in main

agreements by reference into subordinate agreements?
• Indemnity obligations
• Liability for LDs
• Dispute Resolution Provisions
• Requirement for conforming incorporated clauses to
subordinate agreements

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 Insurance as Risk Transfer Mechanism

• Owner controlled insurance program or Contractor controlled

insurance program?
• Disclosure requirements?
• Who has the obligation?
• Consequences and liability to other insureds for failure to meet
disclosure obligations
• Financing documents:
• Lender’s insurance requirements? or interference?
• Loss payee issues?
• Obligations to report loss and damage, and cause of loss and
damage, to Lender? Admissions against interest?

45
 Insurance as Risk Transfer Mechanism
(cont’d)

• Project-specific insurance policies

• Fixed term (i.e. 60 months) or floating term (i.e. “until
substantial performance”)?
• Ability to renew/extend if project delayed?
• Liability of party who has obligation to insure if insurer refuses to
renew policy (e.g. because claims have already been made and
insurer has concern more claims may be made in future)?
• Multi-phase projects with differing start-up, commissioning
and testing schedules?

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 Insurance as Risk Transfer Mechanism
(cont’d)

• Project-specific professional errors & omissions insurance

• Insurer’s consent required to add parties?
• Who is to be “first named” insured and required to meet
obligations of first named insured in policy?
• What happens if not identified in contracts and consultants
refuse?
• Is it worthwhile for megaprojects where limits are often
inadequate?
• Are there alternatives that provide better value for money?
• Decennial liability/policies?

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 Can Bankability be Enhanced?

• Select Project Delivery System, Contract Model(s) and Pricing

Model(s) that reduce risk to Owner and, thus, to Lender
• Obtain “Indicative Rating” in advance from rating agency,
based on preliminary documentation
• Prepare “road map” to documentation
• Prepare overview documents to explain missing documents,
reconcile conflicting documents, and explain evolving
developments
• Prepare comprehensive risk register in advance

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 ©Helmut K. Johannsen, P.Eng., C.Arb.
[email protected]
49 +1-604-631-4819