Niti Aayog proposals may result in high project costs and increase litigation
While the NITI Aayog proposals are expected to ensure construction of projects is not stalled for want of funds, they may force contractors to significantly change their business models for government projects, possibly resulting in higher costs and increase litigationreal estate Updated: Sep 01, 2016 13:22 IST
The government’s nod to NITI Aayog proposals to ensure that construction of projects is not stalled for want of funds is a move in the “right direction” as it will unlock thousands of crores and infuse liquidity into the stressed construction sector. Contractors, however, are likely to be forced to significantly change their business models for government projects, possibly resulting in higher costs and increased litigation, say experts.
Under the proposal put forward by NITI Aayog and approved by Cabinet Committee on Economic Affairs (CCEA), government agencies will have to pay 75% of the arbitral award amount to an escrow account against margin-free bank guarantee, in cases where the award is challenged. What this means is that in case of a dispute between Delhi Development Authority (DDA) or the National Highways Authority of India (NHAI) and the concessionaire, where the case has gone to an arbitration tribunal and the former has challenged the arbitral award, the DDA or the NHAI will have to award 75% of the amount to the concessionaire against a bank guarantee.
Construction activity usually gets hit during arbitration involving a project. In case an arbitral award is challenged by a public body, under the new regime, 75% of the amount will be released to the contractor against a bank guarantee. This amount will be used to pay off liabilities towards the bank and financial institutions and any money left would have to be used for completing the projects.
The proposal will impact all stakeholders involved in construction such as banks, financial institutions and government bodies such as Port Trust, Airports Authority of India, NBCC, NHAI, Indian Railways, DDA etc which give contracts to private companies . It could impact all kinds of infrastructure development projects such as road, hydropower and even housing projects.
If this proposal goes through, it will ensure that bank loans don’t turn into non performing assets (NPA) and cash flows are not impacted. Enough money will be left to complete projects embroiled in litigation allowing public works to continue, benefiting the public, say experts.
The “revival package for the construction sector by the government will translate into a huge liquidity boost for the system and would save many construction companies from being declared NPAs,” says Chandrajit Banerjee, director-general, CII
Shankh Sengupta, partner at the leading law firm Trilegal, however, says this might not be a viable solution, firstly “because the contractors may need to spend money or utilise lines of credit to furnish margin free bank guarantees”.
Secondly, “This proposal almost amounts to the government dictating the manner in which a contractor should manage his own affairs. In the proposed scheme, the contractor is required to first pay the bankers and invest the remaining amount in the project, which may not be work for certain business models. This may force contractors to significantly change their business models for government projects, possibly resulting in higher costs,” he says.
Another complexity that could arise would be the negotiation and effective monitoring of such terms by the government, which could lead to further litigation. While this is a step in the right direction, its implementation would require careful structuring, he adds.
An estimated Rs 70,000 crore is currently tied up in arbitration. Over 85% of the claims raised against public bodies are still pending, of which 11% is pending with government agencies, 64% with arbitrators and 8.5% with courts. The average settlement time for claims currently exceeds seven years.
“There are various challenges before the construction sector and the government has been trying over the last year to improve its functioning. We had simplified the arbitration law... so that the process of dispute redressal can be made easier,” finance minister Arun Jaitley had told reporters on Wednesday after the Cabinet meeting.
The construction sector accounts for 8% of the GDP and provides employment to around 40 million people in the country.