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Event update: Construction - Contract agreement for EPC projects made more stringent

Event:

The Ministry of Road Transport and Highways (MORTH) has published the amended Standard Agreement for National Highways and Centrally Sponsored Road works to be developed on EPC basis.

Details:

Norms tightened: The new agreement is effective for all new projects bid after 28 Nov 2018 and applies to all EPC works for national highways undertaken by NHAI, MORTH, State PWDs and other designated agencies. In general, the new agreement has tightened conditions in areas of execution and maintenance of projects, while making contractors more accountable for the quality of construction.

Right of Way: No change to obligation of the authority to provide minimum 90% Right of Way (ROW) prior to the appointed date, with an added condition that such ROW should be provided in contiguous stretches of at least 5km. This is a positive amendment from an execution point of view.

Mobilisation advance: While the quantum of mobilisation advance remains at 10% of the contract price, rate of interest has been increased to bank rate+300bp (9.75% currently) compared with the earlier bank rate. The increase has been aligned to that paid by NHAI on annuity payments under HAM. Also, the recovery of mobilisation advance is more front-ended now, besides an added provision of recovering the advance through encashment of mobilisation advance bank guarantee (BG) if progress is <20% in 50% of the construction period.  

Maintenance obligation & Defect Liability Period (DLP): Both maintenance obligation/DLP for contractors have been increased to 5/10 years vis-à-vis 4 years earlier. Maintenance payments by authority are largely the same (0.25%-1% of contract price per annum).

Performance security: The quantum of performance security BG has been maintained at 5% of the contract price but the extended tenure of DLP implies that BG limits remain blocked for 12-13 years.  

Retention money: The deduction towards retention money has been maintained at 5% of the contract price, but the provision for its release during construction against BG has been discontinued.

Blacklisting for delay in construction: The new agreement has a provision for blacklisting a contractor from future bidding in case the delay in construction is >90 days from the scheduled period (unless delay is caused by force majeure).               

Our view

Some of the changes in the new agreement for new national highway contracts on EPC mode add to the hardships of players facing delays in availability of financing for HAM projects. Apart from 300bp increase in rate of interest on mobilisation advance, the front ended recovery of the mobilisation advance would increase dependence on banks for working capital requirements. While increase in maintenance obligation/DLP period to 5/10 years makes contractors more accountable for quality of the highways constructed by them, it also implies that resources (men and machine) would remain blocked longer at one location. The increase in DLP period also means that the 5% performance security has to be maintained for 12-13 years compared with ~7 years currently. In the long run, this will increase the utilisation of non-fund based limits for contractors. The provision for withdrawal of retention money deduction against BG has been discontinued, which will again increase dependence on funded working capital limits from banks. This overall tightening in the contractual conditions for EPC contracts assume significance in the backdrop of the NHAI planning to award EPC contracts worth ~Rs700bn over next 1-2 months. Contractors will now have to price-in a greater amount of risk and cost in the new EPC contracts. Meanwhile, HAM projects of established companies are inching towards financial closure, albeit with some delays and more stringent terms on ROW requirement and upfront equity contribution by developers. We remain positive on road developers due to their robust order backlogs, strong growth visibility over next 24 months and attractive valuations.