More action needed to ease contractors’ liquidity crisis

By Dhirendra Negi and Ananya Kumar, J. Sagar Associates
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For several years the Indian government has been promoting infrastructure projects, to maximize growth and development of the economy. At the same time, the balance sheets of many infrastructure and construction companies have shown significant losses and high outstanding debts. This is because the rise in the number of projects has resulted in an increasing number of disputes, primarily because of time and cost overruns, leading to claims for extension and prolongation costs. Non-payment of such claims on time has in turn affected the cash flows of infrastructure and construction companies.

Dhirendra NegiPartnerJ. Sagar Associates
Dhirendra Negi
Partner
J. Sagar Associates

The Niti Aayog (National Institution for Transforming India) in 2016 issued an office memorandum to the central and state governments and central public sector undertakings (PSUs) on measures to revive the construction sector. The memorandum recognized that the failure of government departments and PSUs to release payments due under arbitral awards was a significant cause of the problems faced by the construction sector. Instructions with respect to treatment of arbitral awards and payment of money to contractors were, therefore, included.

The memorandum recognized the root problem, but the remedial measures it suggested were inadequate. The poor liquidity and cash flow of construction companies does not arise solely because of delayed payment of arbitral awards. The problem arises earlier because of a failure to expeditiously and fairly resolve claims when they are raised during execution of a project, resulting in higher costs and lower returns for contractors.

Despite the onerous nature of government contracts in the infrastructure sector, it would be incorrect to assume that every claim raised by contractors is untenable. The project owner’s representatives, however, are unwilling to allow even genuine claims, deterred perhaps by fear of an inquiry, with the additional pressure of completing the project within (often inaccurate) time and cost boundaries laid down in the contracts.

Construction contracts usually provide for an “engineer-in-charge” (EIC), who is supposed to be an independent authority under the contract for taking decisions, or advising the project owner, on various issues including contractors’ claims. But the EIC often fails to fulfil this function. Decisions are not taken in a timely and impartial manner but instead are based on the owner’s convenience. On occasions where the EIC makes recommendations in favour of the contractor, these are ignored or overridden by the owner.

Ananya KumarPartnerJ. Sagar Associates
Ananya Kumar
Partner
J. Sagar Associates

Even more surprising is to see state entities and PSUs refusing to accept the correctness of any arbitral award that may subsequently be passed against them and instead carrying the matter all the way to the Supreme Court. Delhi High Court recently deprecated PSUs’ practice of challenging arbitral awards all the way to the Supreme Court merely because they had the financial wherewithal to do so.

The result of these factors is a situation where time and money are wasted in fighting legal battles that do not benefit any party.

It may be overly optimistic to say that there is a panacea to the problems that exist. A real solution would need discussion and overhaul of wholesale aspects of public contracting.

The contractual framework needs to be reviewed to achieve unambiguity and fair allocation of risk. India’s construction industry first requires standardization of at least the key terms of construction contracts. Currently, it appears that every PSU or government department follows its own set of contract documents, each having their own provisions. Standardization could bring uniformity in implementation of contracts and consistency of court decisions on issues arising under such contracts. This in turn would help the contracting parties to be certain about what they are agreeing to instead of arguing in courts for several years after the works are completed.

Project owners’ representatives must be empowered to take fair decisions while overseeing execution of contracts, and not just convenient ones. This could help discourage contractors from pursuing inflated or unwarranted claims, and avoid formal dispute resolution by arbitration and prolonged proceedings in courts.

Most importantly, responsibility needs to be taken by the state entity or PSU, as the owner of the project, for factors that cannot be within the realm of the contractors’ knowledge.

It is creditable that the executive has recognized the existence of a problem. The initial steps that have been taken are positive. However, a lot more needs to be done, particularly at the time of implementation of a project, which would likely result in long-term gains to the country and the economy.

Dhirendra Negi and Ananya Kumar are partners in the Delhi office of J. Sagar Associates. Views are personal.

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Ananya Kumar | Tel: +91 11 4311 0629
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