Contract Documents and Procedures which appropriately secure the interests of the Procurement Entity (PE), the Financing Agency and the Contractor

Last Updated 6 years ago by Kenya Engineer

Construction industry is an important economic growth driver (Radelet, 2007 p. 15). This position is supported by a contribution made to House of Representatives US) in 1926 urging the government to provide low interest lending for construction works; “Construction employs more labor, brings in to use more materials. It creates more spending power; and with that start, it will permeate through into the trades and the general price level.” (U.S. House of Representatives (1926), pp. 578-79.cited in Wheelock, 1992).

More recently the position was still found to hold true as Cridland (2009) observes that the UK construction industry makes a tremendous contribution to the national economy. Investment in high quality transport infrastructure is vital to ensure that the UK remains competitive.

The construction industry is an important segment of the Malaysian economy that contributes approximately 6% of the Gross Domestic Product. It generates wealth, improves quality of life and creates work opportunities for many.  (Azman M.N.A et al., 2014)

When America was under threat of a recession in 2011, as unemployment remained stubbornly high, the President proposed to spend $140 billion in construction works with a view to creating jobs.(The New York Times, Sunday, October 28, 2012)  the success of this initiative is corroborated the 2013 US Budget which included a six-year $476 billion reauthorization of the surface transportation program and the creation of a National Infrastructure Bank.

The United States has a history of investing in infrastructure and reaping the long-term economic benefits; this is evident with the space programme and associated infrastructure (David Aschauer,1999).

In Europe, construction is the largest industrial employer with more than 15 million (30%) workers, (FIEC, 2009, p.3), and the construction sector accounted for 10.4 % of the GDP in 2008 and more than 50% of fixed capital formation (Martinuzzi A., etal, 2011). Construction remains primarily a local industry, with a majority of small and medium- sized  enterprises  and  competition  with companies  outside  Europe  is negligible (FIEC, 2009). Construction sector is considered to be of strategic importance to the EU as it delivers the buildings and infrastructure needed by the rest of the economy and society. It represents more than 10% of EU GDP and more than 50% of fixed capital formation. It is the largest single economic activity and it is the biggest industrial employer in Europe. (Ecorys Scs Group, 2010).

In India, a national survey on employment (2009-10) showed that between 2004-05 and 2009- 10 sustained employment was created in construction sector. (Government of India Planning Commission, 2011)

Construction Industry is acknowledged as a major economic driver in India, and the vast majority of new jobs created between 2004 and 2010 were in construction and has maintained an average growth rate of 9.8% over the previous 10 years and having a peak of 11.8% (Government of India Planning Commission, 2011)

Achieving sustainable local SMEs is the expectation of all developing nations since it will lead to the following benefits.

1. a) Generate sustainable employment and contribute in poverty alleviation.
2. b) Create local capital in human resource, equipment, and technology.
3. c) Improve the retention level of foreign currency from donor funding within the developing nation

The World Bank has been a key player in development, support and implementation of policies for poverty alleviation and promotes the efficient use of the poor’s most abundant asset: labor. Construction processes throughout Europe are generally still based on manual labour (Girmscheid & Scheublin, 2010) and therefore, promotion of the construction industry is a direct response to the growth of the most developing countries including those in East and Central Africa. (The World Bank,1990). The Bank has also assisted and sponsored development and implementation of several institutional framework to make the procurement processes and project management in the construction industry a success.

However rapidly changing environment has made it increasingly difficult for the SMEs in the construction industry in Kenya to grow and become sustainable as was expected. One will note the numbers have increased but in terms of population growth and volume and value of work carried annually, the percentage taken by the local SMEs has not been encouraging.

Challenges facing SMEs in Construction Industry in Kenya.

Research carried out in the region indicate that the major challenges to SMEs in the construction Industry are payment paralysis, Access to finance and lack of work opportunities.

1. 1. Delayed payments (Payment paralysis)
2. 2. Limited work opportunities (access to investment and trade opportunities)
3. 3. Access to Credit and Financing
4. 4. High lending rates; (results in uneven playing field in international Bids)
5. 5. Unreliable and costly economic infrastructure
6. 6. Outdated policy, legal and regulatory framework or absence of clear policy;
7. 7. Obstructive Business environments to SMEs’ growth
8. 8. Industrial Polarization (more attention to micro-enterprises and Multinationals)
9. 9. Poor Leadership in Management of Construction SMEs
10. 10. Seasonality (stoppage of work and related difficulties during the rains)
11. 11. Corruption

Payment Paralysis

Payment is considered as the lifeblood of the construction industry because constructions often involve very large capital outlay and take a considerable time to complete. It is beyond the means or capacity of most SMEs to complete the whole of the construction work before they get paid. This is especially so among the medium and small size Contractors (Jud, S.S., et al, 2010) The  impact of late payment can be disastrous  to SMEs as during the 2008 recession it is estimated that 4,000 businesses failed  as  a  direct  result  of  late  payments  in  the  UK  (Abrahams,  D.  ,  2013). Late payment or nonpayment leads to “payment paralysis” which is a situations where the Employers delays payments to SMEs in the construction industry for long periods, making the SMEs to suffer acute and prolonged cash flow interruptions and is unable to meet his financial commitments to pay staff, service bank loans or to order materials (MDA Consulting, 2010). The works therefore come to a standstill and plant and labour become idle at the contractor’s cost while waiting for payments.  In such situations, the contract normally provides for the SME to be paid ‘interest on late payment’. The SME is rendered helpless and paralysed; unable to take any action or withdraw from the contract.

Insertion of Contingent Clauses in the Bid Documents

This situation is made worse by inclusion of Contingent Payment Clauses in the contracts (Prism Economics and analysis, 2013). Contingent payment clauses are provisions in  construction contracts that  allow for payment to  be  delayed notwithstanding that the construction work was performed satisfactorily. In some cases, a contractor who is not paid is allowed to suspend work. In other cases, work must be continued at least for a period of time, even though payment is in arrears. Some contingent payment clauses provide for interest on delayed payments.

For instance, the pay-when-paid clause often used in contracts agreement between main contractors and sub-contractors also known as “back to back” method of payment is relevant especially in the case of nominated sub-contractors (Hasmori, M.F., et al, 2012)

Gerald Mabveka (2014) observes that it is common to find Procurement Entities (PEs) include payment terms that are unfair to the SMEs. The SMEs are forced to accept these terms because during the years, with the diminished volume of construction work, SMEs are under pressure and at times engage in risky ‘suicide’ bids with little or non- existent profit margins just to sustain the flow of work and stay in relevant in business (Lip, 2003 cited in Amoako, K.B., 2011)

FIDIC was  inspired from the first edition of the Standard Form of Contracts published by “Institute of Civil Engineers” (ICE) in 1945  (Koksal, J.T.,2011). FIDIC “Conditions of Contract for Works of Civil Engineering Construction”; was in use upto the Fourth Edition 1987 (Red-Book87) when it was replaced by  FIDIC “Conditions of Contract for Construction for Building and Engineering Works Designed by the Employer”; First Edition  1999  (Red-Book99)  in  comparison  (Kolonne,  T.P.,  2011)  The  difference between the two books is that while the “Engineer” in the Red-Book87 was acting in the interest of the Employer, the “Engineer” in   Red-Book99 is more discretionary and should act in a fair manner to Employer and Contractor. Sarwono Hardjomuljadi, (2012) describes FIDIC Red-Book99 as “The answer to the need for a fair and balanced Conditions of Contract.

However, the Bid Document allow the Procurement Entities (PE) to modify, delete and/or add sub clauses to make the documents “project specific” and also to reflect the PE’s Project management processes. In majority of cases the donor agency also requires that they are involved at all stages of the procurement process and give a “no objection” at the conclusion of each of the major activities in the process.

The PEs to enter contingent clauses in process of preparing the Contract Documents usually include for the following Documents

• Information to Bidders (ITB)
• Terms of Reference
• Conditions of Contract
• Specifications

The Terms of reference are project specific while the other 3 Sections are generic but each has a “section 2” termed as “Bid Data” in case of ITB, Special Conditions of Contract  or  “Conditions  of  Special  application”  which  the  PEs  use  to  make  the document comprehensive and all inclusive inn respect to activities and management procedures for the particular works.

Adjustments to suit project specific conditions affecting Eligibility and beyond

Here below are some of  the sections where the PEs exercises their discretion in deciding some elements which have far reaching consequences to SMEs as they prepare their bid, and even as the carry out the work upon execution of the contract.

1. The Bidder MUST submit his Litigation history together with the Bid.

European Union has, in recent Bids, Clarified that “Previous experience which caused breach of contract and termination by a Contracting Authority shall not be used as reference”.

2. ITC 12 a). Price Adjustment For assignments with a duration exceeding 18 months, a price adjustment provision for foreign and/or local inflation for remuneration rates applies if so stated in the Data Sheet. YES / N/A

3. ITB 1 The Proposal Validity period shall be —— days. The PE may request the bidders to extend the validity period. (No compensation or price adjustments are allowed for this period particularly in contracts without the price escalation clause)

4. SCC 1 Payment shall be made by the Procuring Entity within —-days of receipt of the request for payment and within —-days in the case of the final payment.

5. SCC 4 Interest shall be paid on late payments at the rate of: — percent above the base lending rate published by the Central Bank

6. SCC 1 Prices charged by the Supplier shall/ not vary from the prices quoted in the Contract.

 

The  current  framework  makes  it  possible  for  the  Procuring  Entity  (PE)  to  enter conditions  which  may  obviate  appropriate  Compensation  for  SMEs  awarded  the contract. In some instances “NIL” would have been entered for”interest to be paid on late payments”

In Kenya, other that the contract agreement, there are no laws regulating either the period of delays in payments or the compensation that the SMEs may claim. The situation is made more compromising because the contracts documents are made by consultants hired by the contracting authorities and therefore tend to reduce risks that may affect the Client rather than focusing on fairness  to both the Employer and the SMEs.

Measures to reduce incidence negative contingent clauses

 Payments,

The duration from the point of submission of an Interim Payment Certificate and actual payment is usually a minimum 60days because it allows the Engineer, 28 days to verify, and certify the measurements and calculations.

Lip, E.( 2006, Cited in (Emenke, F.O., 2010) found that critics blame  the construction industry for its outdated and inefficient payment practices resulting late payment and the uncertainty on effective payment date relative to certification of Interim Valuation Certificates.

The author agrees with this view and particularly in respect to the 28 days the Engineer is allowed to measure and certify an interim Certificate. In the process of supervising the works and enforcing the quality control processes, each element of the works has been measured and approved at the time of construction.

In roads, every layer is measured in length, width and depth with every excavations measured for levels before and after excavation with approval forms signed by all parties. For concrete works we have the formwork measured and inspected in accordance to drawing and the steel fixing checked, and volume and class of concrete measured and sampled at time of placing. It is therefore correct to state that at any date the Engineer can satisfy within a few days the volume of works or material deliveries made on site within the month and since the certificates are monthly 28 days is a long time. The Employer is also allowed a similar amount of time. Further the SME are required to give notice if payment is not received within another 28 days before taking any action.

For comparison, it is noted that in the UK payment term of strictly 60 days are enforced and in Malaysia  an Employer must make payment within a period of 2 – 3 months after the invoice

Framework to reduce incident and severity of Payment Paralysis

In Malaysia, based on the conditions of contract, an Employer is considered to have neglected or failed to pay the Contractor if the latter does not receive his payment for a period of 2 – 3 months after the period of honoring his certificate Judi S.S. et al (2010). Based on the research conducted by the construction industry Development Board (CIDB) of Malaysia (2006), (Emenke ,F.O., 2010) both contractors and consultants agreed that they suffered late payments frequently.

On account of these problems, some developed countries like United Kingdom, Singapore,  New  Zealand  and  some  states  in  Australia  have  passed  construction specific legal payment security regimes that deliberately enact provisions to address issues on immediate payment in the construction industry, and to eliminate, as much as possible, poor payment practices and smoothen the contractor’s cash flow. (Hasmori, M.F, 2012)

The Need for Prompt Payment Legislation in the Construction Industry (2013) records that in a 1994 report on the construction  industry, commissioned by the U.K. government, drew attention to the damage to the industry caused by payment delay.

The report recommended that “any attempt by an Employer to include a clause in a bespoke  form  with  the  effect  of  introducing  ‘pay-when-paid’  conditions  should  be explicitly declared unfair and invalid.

Subsequently the government prohibited ‘pay- when-paid’ clauses in section 113   of the Housing Grants, Construction and Regeneration Act, 1996 (commonly known as the ‘Construction Act’). Section 113 provides that ‘pay-when-paid’ clauses are void, except in conditions of insolvency. The Latham Report to the Housing Grants, led to the Construction and Regeneration Act (Construction Act) in 1996 which had several aims including improving cash flows in the construction Industry. This came to effect in October, 2011 in England and Wales and November 2011 in Scotland.

Penalty to defaulting Employers

Florini B. and Singh K. (2014) record that in Quebec in a case; 9149-5408 Quebec Inc v Groupe Ortam Inc the Quebec court of appeal ruled that a an annual interest of 15% be paid to compensate the complainant for late payment, statutory additional indemnity of 2% for costs of legal proceedings and collection fees at a time when the legal annual interest rate was 5%. This indicates that the interest rate offered to the claimant was 3 times the ruling commercial interest rate.

The Government of the UK strengthened this position when further steps were taken to address delayed payment or nonpayment by enacting a legislation entitling SMEs to charge interest of 8% above base rate on late payment since 1998 and, following two additional EU directives, there is a legal default maximum payment term of 60 days, unless otherwise agreed (Vince, C., 2013) payments must be made within a maximum of 60 days (Winther,M,2011) In the UK the payment period is being reduced even further and  government is  encouraging central government departments to  aim  at paying 80% of undisputed invoices in 5 days. (Cable, V., 2013)

Table 1. Interests on Late Payment payable to SMEs in Kenya

Year	2011	2012	2013	2014	2015
Base Rate (BR) %	10	18	9	9	12
Interest above(BR) payable to SME (Compensation) %	2	2	2	2	2
Compensation as % of base Rate	20	11	22	22	17

 

Table 2. Interests on Late Payment payable to SMEs in the United Kingdom

Year	2011	2012	2013	2014	2015
Base Rate (BR) %	0.75	0.25	0.25	0.25	0.25
Interest above(BR) payable to SME (Compesation)	8.0	8.0	8.0	8.0	8.0
Compensation as % of base Rate	1067	3200	3200	3200	3200

 

It is also worth noting that the commercial Banks from which the SMEs borrow offer the facilities at interest rates about 50% higher than the Base lending rate and therefore the base rate has no relevance to the SME.

In the UK, the interest rates charged for late payments are so high that they are indeed an incentive for the Employer not to default.

The eligibility and evaluation criteria adopted by the Procurement

The eligibility and evaluation criteria adopted by the Procurement entities and the Bank are not favorable to local SMEs and are sometimes not considered reasonable. Some of the Conditions to which attention is drawn is the experience of personnel for Consultants and the turnover and experience for Contractors.

Personnel for Consultants

It is noted that in Kenya due to the mode of construction adopted,   road projects of 30km and above and other civil works take over 2 years to complete, and therefore requiring an Engineer to have carried out 10 such a projects implies that the expert must have been on such a jobs for over 20 years. The experience in Kenya is that most civil engineers get their registration as qualified Engineers after an average of 8 years post graduate experience and as such would be qualified to carry out their first such a job at the age of 33 years while the criteria set out in the table below would only be achieved at age 55.

Table 3 Criteria set for eligibility of Technical Staff

Table 7. Eligibility and Evaluation Criteria  considered unreasonable
No.	Position	years of professional experience	Specific experience
1.	Team Leader / Contract Document Specialist	15 years	The Team Leader / Contract Specialist shall have undertaken a minimum of 10 similar projects as a Team Leader or Contract Specialist but not less than 4 projects in either capacity Estimated total time- input is 8 man-months.
2.	Pavement/ Materials Engineer	10 years	shall have undertaken a minimum of 7 similar projects as a Pavement / Materials Engineer. Estimated total time-input is 3 man-months.
3.	Highway Design Engineer	7 years	Experience in the geometric design of at least seven similar sized road project. Estimated total time- input is 3 man-months.

 

The Question that also begs to be answered is “If the expert successfully delivered the first and the second such similar assignment, why does she/he have to deliver upto to the tenth such similar task to qualify for this “similar” assignment?” Clearly a review of the  basis  of  such  criteria  is  required  to  show  the  grounds  of  such  need.  The qualifications recognized by the ERB, IEK, EBK and NCA should be the only legal basis of any eligibility criteria as no one else is legally empowered to conduct such.

The process of vetting and examination for professional registration that Engineers go through should be the only criteria to be used by PEs in Kenya. It is also necessary to have the criteria gazetted for a range of works to make it “official” rather than having the criteria set for every assignment. A summary of Personnel in the construction industry suitable for works of particular extent and complexity should be made available and should perhaps be  in  a  similar format as the  NCA has adopted for the  SMEs in construction as in the table below.

Table 4. Classifying professional personnel by experience in years and value of assignment.

Item	Class	Title	Experience (Yrs)	Experience (Projects)	Upper limit AMOUNT
1		Registered Consultant	15 ++	unclear	Unlimited contract Value
2		Registered Consultant	1, 5,10	unclear	Not Specified
3		Registered Engineer	1, 5,10 , 15	unclear	Not Specified
4		Graduate Engineer	1, 5,10 , 15	unclear	Work under Supervision
5		Engineering Technician	1, 5,10 , 15	unclear	Work under Supervision

 

Note: Classification MUST not be construed to be in breach of the EBK and/or IEK legal mandate

 SMEs bidding for Works Contract

Table 5. Eligibility and Evaluation Criteria  considered unreasonable by local SMEs
	Eligibility and Qualification criteria			Compliance     Requirements			Documentation
No.	Subject	Requirement	Single Entity	Joint Venture (existing or intended)			Submission Requirements
				All Parties Combined	Each Member	One Member
3. Financial  Situation  and Performance
3.1	Financial Capabilities	(i) The Bidder shall demonstrate that it has access to, or has available, Liquid assets, unencumbered real assets, lines of credit, and other financial means (independent  of  any  contractual advance payment) sufficient to meet the construction cash flow requirements estimated as Ksh.—– or equivalent in a freely convertible currency for the subject contract(s) net of the Bidders other commitments   (ii) The Bidders shall also demonstrate, to the satisfaction of the Employer, that it has adequate sources of finance to meet the cash flow requirements on works currently in progress and for future contract commitments.   (iii) The audited balance sheets or, if not required by the laws of the Bidder’s country, other financial statements acceptable to the Employer, for the last Five years shall be submitted and must demonstrate  the  current  soundness  of the Bidder’s financial position and indicate its prospective long term profitability.	Must meet requirement                   Must meet requirement             Must meet requirement	Must meet requirement                 Must meet requirement             N/A	must         meet 25%   (Twenty Five   Percent) of the Requirement               N/A             Must meet requirement	Must meet 60% (Sixty Percent) of the Requirement             N/A               N/A	Form FIN – 3.1, with attachments

 

Matching the NCA categories with the international SMEs

The eligibility of an SME for construction works should be as set out by the NCA. The NCA carries out the registration of an SME in a particular category only after satisfying themselves that the SME has the necessary capital and experience to conclude construction works falling within the category for which the SME is registered.

Table 6 below indicates the NCA classification which should be followed. The table includes the top of the range categories and does not include categories NCA4-NCA7

Table 6 NCA classification of the SMEs

CATEGORY  NO.	CONTRACTOR WORK	Upper limit AMOUNT
NCA 1	Contractor – Building Specialist Contractors Roads and other Civil Works	Unlimited contract Value Unlimited contract Value Unlimited contract Value
NCA 2	Contractor – Building Specialist Contractors Roads and other Civil Works	500,000,000 250,000,000 750,000,000
NCA 3	Contractor – Building Specialist Contractors Roads and other Civil Works	300,000,000 150,000,000 500,000,000

 

The NCA have clearly set out the requirements for particular categories of SMEs and they ensure that the said SMEs have the pre-requisite experience and capacity as measured by their human, financial and technological capital together with the available plant and equipment before registering the SME in a particular category.

This classification should be interrogated and adjusted to finality with the involvement of all stake holders to eliminate the need of for PEs and their Financiers resulting to carrying out classifications which might be in breach of the mandate of the EBK and or the IEK. Should such a classification and requirements have no legal basis it could be concluded to be arbitrary and therefore irregular.

Criteria Implying unfair demands

The Financial requirements set out in the criteria in Table 5 above, appear to imply that the Employer MAY require the SME to meet the cost of financing the works. This should not be the case; the SME should be required to have a good financial record and must not be in debt which might cause him to divert finances meant for the works to meet previous debts. The SME should be in a position to obtain the required Performance Bond, 10% Mobilization Advance Guarantee, and the plant and equipment befitting his category and must show that he has enough and balanced plant and equipment to maintain production levels required to deliver the works within schedule.

Mobilization which includes for setting up camps stores, and transporting plant and equipment to site usually costs more than the 10% offered as advance mobilization payment and the SME has to carry out works and finance time related costs upto the cost of the first three interim valuation Certificates (90 days) before receipt of the first payment. In the UK, it is recognized that SMEs in most cases do not have capital reserves at their disposal and are highly dependent on cash flow and interruption of anticipated cash flow can result in insolvency, and even when a company remains financially viable, late payment can drain resources, stopping businesses from investing and growing (Conway, J.,2013).This is equally true in Kenya and should be addressed accordingly.

 Mismatch in definition of SMEs in Kenya and those in Europe

However, the classification of SMEs in Europe and the ones in Kenya could be significantly different .The most frequent definition is based on the upper limit is 250 employees, as endorsed by the European Union, however, some countries set the limit at 200 employees (OECD,2005), while the United States considers SMEs to include firms  with  fewer  than  500  employees (Hammer A,  2010)  and  the  Government of Uganda uses 5-50 people (UNIDO, 2005). Vedanthachari LN.(2007) defines SMEs as enterprises which employ fewer than 250 people and which have an annual turnover not exceeding 50 million euros (Ksh.5.5 Billion), and/ or an annual balance sheet total not exceeding 43 million euro (European Commission, 2005). There are very few Kenyan SMEs with this turnover but when a joint venture is formed it should perhaps be encouraged by requiring one of the Jv entities having 40% of required resources while the other two between then cone the 60%.

Advantage of international SMEs to those in Kenya

The lending rates in Kenya and those of the countries of origin of some of the international SME are significantly different and gives the international SMEs an advantage over the local SMEs far above the 5% preference offered to local SMEs as may be seen from table 7.