Académique Documents
Professionnel Documents
Culture Documents
Solomon molla
July 2007
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EXAMINER
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ii
Acknowledgement
Our heartfelt appreciation goes to Ato Solomon Sertse, who gave us invaluable
advice and guidance toward the ultimate goal of this paper.
Our thanks also go to the people who supported us in resources to full fill our
paper.
We should also mention all those who invested their precious time filling out
our questionnaires and giving us, in person, all the useful information related to
our specific concern.
Finally, we would like to express our deepest gratitude to our friends and
families especially Meti, Esayas, Hilawi for their admirable support throughout
the whole journey of this project.
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ABSTRACT
Remedial rights are provisions entitled for non-performance of contractual obligation by the
contracting parties. In this thesis the remedial right is focused only on the bases of securities that
demanded before and after the contract. The remedial right is categorized in two to bodies. The first
one is the remedial right for the client on the issuing of securities like acceleration, tender security,
liquidated damage and contract securities. The second one is the remedial rights of the contractors
on the image of the right to guarantee for their payment, time extension and remedial right on
liquidated damage.
This thesis work presents the results of the investigation on the impacts of the remedial rights on the
construction contractors. Understanding the impacts will be useful when the local law adopted from
the foreigners to take a contextual considerations. This means the clauses we take require debate
and discussions among actors in the construction industry.
The thesis is based on three bases namely methodological, conceptual and contextual frameworks.
The two conceptual and contextual frame works discussed on the subject matter of remedial rights
and the necessity of risk management and risk allocation system in the contract. In addition, it is
also reviewed on rules, regulations, and determination of premiums, conditions, exclusions and
arbitration of our Ethiopian sureties. As part of the research, we interviewed and distributed
questionnaires to the stakeholders each representing different interests in the industry.
Among other things, after the collection of data, analysis has been made. The analysis shows that
there is an impact of remedial rights on construction of contractors. Those remedial rights are
creating an opportunity cost and cash flow problem on contractors, contractors are damaging
amount of money to the employer with out proof of loose on the employer, and employers are
giving termination right with out the consent of the contractor after the limited amount of LAD is
passed. On the other hand the rules and regulation of sureties especially the government ones are
rigid.
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Table of Contents
ACKNOWLEDGMENT
vi
vii
Abbreviations
ADB-
CBE-
EBCA-
ERA-
FIDIC-
IDA.ITB-
Invitation To Bid
LAO-
MoWUD-
PPA-
RFI-
viii
Remedial rights associated with delay or in time completion of projects such as; time
extension and liquidated damage
Remedial rights associated with non-performance contractual obligation such as, demanding
securities for delay payments, demanding securities for procurement successes, demanding
securities for the performance of the contractor.
1.2-Objective
The aim of this thesis is, therefore, to explore the impacts of remedial rights on construction
contractors in our country and come up with possible ways of alleviating these impacts. In this
thesis because of the scope of the research, the remedial right is focused only on the bases of
securities that demanded before and after the contract (see also on scope and limitation section). The
remedial right is categorized in two to bodies. The first one is the remedial right for the client on the
issuing of securities like acceleration, tender security, liquidated damage and contract securities. The
second one is the remedial rights of the contractors on the image of the right to guarantee for their
The
willingness
to
provide
information
from
the
respondents.
The research, under our context, is written for the first time.
Therefore, there are limitations in acquiring sufficient
references in libraries.
Methodological
Conceptual and
Contextual frame
The construction business furnishes capital improvements to countries, which is very much related
to the development of investments to provide future benefit to nations. Since the construction
industry primarily represents investment, construction activities drop more than other industries
during recessions. For example, construction services considerably slowed during the devaluation of
the Ethiopian Birr in 1992. Almost all construction companies suffer out of this depression and their
activities dropped severely until 1994 whereby their suffering partially relaxed when regulation for
price escalation compensation in the form of price index came into force. However, its effect has not
been totally solved until 2000 for some projects, which are still standing and not completed.
[Wubishet, 2005]
In addition to this, the fact that construction works being a team work output, the individuals
involved in carrying out the works and their separate outputs is given the highest importance.
Hence, workers in the construction industry shall be highly motivated and well skilled. However,
the individuals shall be geared to focus on the group coordination and its output. The construction
industry in Ethiopia often makes skills more immediately rewarding and that is why mostly workers
in this industry became more prosperous professionals than in other industries. Considering the
allocated budget every fiscal year and the number of workmen involved, construction industry is
second only to agriculture in Ethiopia.
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11
sector.
At present, after the new restructuring of the ministries, on October 2005, the ministry of
works and urban development was re-established by regulation No. 471/98
CALANDER
EUROPIAN
construction sector.
Under the Ethiopian system of government, it is the power and duty of the ministry of
public works and urban development to administer any construction contract undergoing
in the country financed by the federal government. The reason why the ministry of works
and urban development is administering construction as an independent entity is because
of few reasons and one of them is the peculiar nature of the construction contracts. The
variety of factors makes a construction contract different from most other types of
contracts. This is because of the length of the project, its complexity, its size, site
conditions, the use of many materials, and the employment of various kinds of operatives
and the fact that the price agreed and the amount of work done by changes as it proceeds.
This makes it virtually impossible to compare it to other contracts and it leads to the title
construction contract.
12
13
14
documents
Samples:
MOUD, FIDIC, PPA of standard conditions of contract and Other General and
15
Cause to effect- if this cause happens what effect will it have on the
objectives?
16
Calling your agency area expert. Who Are the Agency Area Experts?
o Your Manager, program staff or managers
Impact and probability of occurrence: since risks influence all aspect of a project, each
party should quantify and measure the impact a risk will have on the project cost,
schedule, quality or profit. To analyze the impact first;
What is your agencys appetite for risk?
o Risk appetite is the degree of uncertainty an agency is willing to accept to
reach its goals.
o Risk appetite is a key factor in evaluating strategic options.
o Risk Assessment helps management consider risk appetite when setting
goals that align with overall agency strategy, and managing risks related to
that strategy.
Work with your agencys management to decide:
o What is your agencys risk tolerance?
o How much or what are your willing to risk to accomplish the mission or
activity?
o How much can your agency afford to lose in any one occurrence or in the
aggregate?
17
Reduce the severity or cost of loss: lowers the severity or cost of lost.
Segregate to prevent one event from causing loss to the whole: arrange
the agencies activity and asset to prevent one event from causing loss to
the whole. In here there are two methods those are; one separate activity
and assets among several locations. The second one is, provide a duplicate
or stand by for use in case assets or activities suffer a loss.
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They thought Insurance and bonds as the safety net that catches when
everything else goes wrong.
They ask for appropriate insurance and bonds to cover the risk.
19
What are the potential loss exposures or risks? What can go wrong?
Who can be harmed?
What is the likelihood that each of these potential loss exposures will
happen?
Rate the severity of each potential loss exposure. How bad can it be?
What could it cost?
2.
Determine the necessary actions for the contractual transfer of risk, such as the
use of appropriate contract templates, contract language, insurance, bonds and
risk control measures.
3.
Review each contract to insure that clauses are up-to-date and the
language is appropriate.
4.
2.1.3-Remedial rights
Remedial rights are provisions entitled for non-performances of the contractual obligation
by the contracting parties. Such rights can be entertained considering the efforts sustained
by the contracting parties in lieu of their duty to mitigate the non performances. Unless
otherwise contracting parties can prove their effort for their duty to mitigate the
occurrences of non-performances, remedial rights are not directly entitled [Wubishet,
2006]. However, if those provisions come in entitle, they will bring a claim with them. A
20
Remedial rights associated with delay or in time completion of projects such as;
time extension, and liquidated damage.
Since the objective of this thesis is in assessing the impacts of the remedial rights that is
demanded from the contractor in the procurement and contracting time. Its focusing is
limited to;
1-Remedies for the employer
o Acceleration
o Liquidated damage
o Tender security
o Contract security
2-Remedies for the contractor
o Time extension
o Obtain third party guarantees; or
o Ensure that the contractor has resort to meaningful legal remedies to
collect
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22
2.1.3.1.3-Tender security
AAU, Technology South Faculty, Department of Construction Technology and
Management
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2.1.3.1.4-Contract security
2.1.3.1.4.1-Introduction
When entering into a large value contract it is usual for the employer to seek some form
or forms of security, which will reduce the risk of loss in the event that something goes
wrong with the project. Now days, it is usual that a contractor or a contracted supplier of
some high value item or goods requests a guarantee of payment from the employer, this is
not, however, common in conventional construction contracts as undertaken, for example
by ERA according to the manager of the legal services division. There are many ways in
which something can go wrong. Some of the most common ways are the following
The contractors quality of work or rate of progress is so poor that the contract is
terminated by the employer
The works are damaged or delayed by natural or accidental disasters e.g. floods,
fire, earthquakes etc.
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26
The principal - the primary party who will be performing a contractual obligation
which is the contractor
The oblige - the party who is the recipient of the security, which is the owner
The obligor - who ensures that the principal's obligations will be performed which
is the bond underwriter
Through this agreement, the bond underwriter agrees to uphold - for the benefit of the
obligee - the contractual promises (obligations) made by the principal if the principal fails
to uphold its promises to the oblige. The contract is formed to induce oblige to contract
with the principal, i.e., to demonstrate the credibility of the principal and guarantee
performance and completion per the terms of the agreement.
2.1.3.1.4.3-Types of securities
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28
As Mr. Lear said that it should be born in mind that notwithstanding any contractual
provision to the contrary, the employer will ultimately pay for the bond premium as it will
be reflected somewhere in the contractors price. Whilst it is generally considered that
unconditional/ on-demand bonds are onerous and inequitable, in many international
contracts, particularly in the Middle East and Africa, they are insisted upon by the
employer, as is the case with IDA and ERA.
It shall be noted that a contractor might not escape the financial consequences of default
by providing a bond, since a bond underwriters has common law rights of recovery
against the contractor. Under the Ethiopian civil code, such rights of recovery may also
be possible, depending upon the wording of the bond. Under common law system, the
bond underwriter requiring a written form of counter-indemnity or other security from the
contractor usually reinforces such rights of recovery. [Michael Lear, April 2007]
2.1.3.1.4.5-Bonds and Guarantees
29
Another form does however exist i.e. a surety bond via which the surety guarantees
completion of the contract. These are usually set at far higher percentage of the contract
price than conventional bonds and guarantees. It shall be noted that an employer holding
a surety bond cannot all upon the surety for payment of money he calls for completion
of the contract. [Michael Lear, April 2007]
However, what is the difference between bid guarantee or bid bond, performance
guarantee or performance bond?
Bid security can be in the form of a bid either guarantee or bid bond. While the bid
guarantee is usually issues by an authorized commercial bank, an insurance company
normally issues the bid bond. Bid bonds are generally given and are popular in
Ethiopia. Bid security (guarantee or bond), is provided by the bidder at the time of
submission of his bid, to the Client, as financial security for acceptance of a contract.
Appropriate wording for the guarantees are contained in the SBDs. However, if the
security furnished is substantially responsive to the bid documents, but differs in
wording without affecting its substance, it may be accepted. In addition, they have
difference in their validity time.
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1. Performance bonds/guarantees
2. Payment bonds/guarantees
3. Advance payment bonds/guarantees
4. Retention bonds/guarantees
5. Miscellaneous bonds/guarantees and Warranties
The above common forms of security are discussed further here:
The performance security
A performance security is a promise by a third party to cover any costs (in the case of a
guarantee or bond) incurred by the employer as a result of non-or poor performance by
the contractor or to complete the works (in case of surety bond) for the same reason.
These costs could relate to the employment of a second contractor to complete the works
or the demolition and reconstruction of unacceptable elements of the works etc. [Michael
Lear, April 2007]
This bond guarantees performance in accordance with the terms of the construction
contract. Obligations under the bond are identical with those of the construction contract
and hence any inadequacies in the contract will constitute similar inadequacies in the
bond. If the bond underwriter has to take over upon default of the contractor, it is obliged
to perform the work in accordance with the contract document to the amount of the penal
sum of the bond. Since the bond underwriter has no liability for costs exceeding this
amount, it is recommended that performance bonds/guarantees be written to cover 100%
of the contract price. In event of default, the bond underwriter may proceed according to
its own judgment about the best way to complete the contract. It may engage another
contractor to do so, may employ the forces of the default contractor, or may accomplish
the uncompleted portion of the work with its own forces. [Harold, 2nd edition]
In the case of IDA and ERA projects, the security is in the form of an unlimited bank
guarantee, which undertakes to cover all costs incurred. The value of the guarantee is
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32
33
In addition to the above performance securities, the employer usually retains a small
percentage of all interim payments made to the contractor as a further, more readily
available or liquid, security. The reason for this additional security is that the performance
security is provided by a third party and is considered to be available for more serious
failures by the contractor e.g. where the employer is required to undertake the completion
or rectification of the works. Where as retention fund is created to rectify defects or to
induce the contractor to return and rectify any defects arising after completion. Under
FIDIC clause__ created the retention fund.
Since construction contracts are usually carried out over quite lengthy periods of time, the
retention monies are often kept for periods of two years or more after completion. If the
employer becomes insolvent, what will happen to the contractor? The conditions of
contract that is used in our country they did not say anything about this. However in other
country, for instance, Britain, state in their local law; one way of ensuring this is to create
a trust of the retention monies. The retention money becomes a trust fund of which the
employer is the trustee. The employer cannot use the money in its own business and has a
duty to safeguard the fund in interest of the beneficiaries. However, there is no duty to
invest and account as trustee for the fund. A trustee of property normally has an express
duty to increase the value of the fund. Any liquidator appointed where the employer goes
bankrupt, or trustee in bankruptcy, must hand over the retention money in full. Where no
fund has been established, no mandatory injunction will be granted to create such a fund
if the employer is insolvent. The contractor becomes merely an unsecured creditor. [John
Adrrian, 2005]
In this country, not only in this country but also in those countries that have a trust fund
clause is not sufficient for such a claim to be made, as the money must be appropriated
and set aside. This requires it to be in a separate trust fund and usually in a separate bank
account.
34
35
36
In a contract, especially in construction contract, the parties are free to stipulate both
how much is to be paid and when payment is to be paid. They may also stipulate what
conditions have to meet before the obligation arises and how payment is to be made.
Payment need not always have to be in money (e.g., land can be exchanged in return for
services), and payment need not be in Birr. What matters is in fulfilling the obligation
required. For example, in conditions of contract the main obligation of the employer is to
pay the contractor for work and material supplied. In addition, the contractors right to
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38
A debt is money claimed under a partys contractual obligation, whilst damages are
compensation claimed for a breach of contract. The advantage in claiming for payment of
debt is that the claimant has only to establish the following: [John Adrian, 2005]
1. That the sum is due, and any conditions precedent has been met
2. Interest is payable at the commercial rate from the date the debt is payable to
judgment date. There is now a statutory right to interest on late payments and the
standard forms of contract regulate the position. In PPA conditions of contract
clause 43.1 sated that if the Employer makes a late payment, the Contractor shall
be paid interest on the late payment in the next payment. Interest shall be
calculated from the date by which the payment should have been made up to the
date when the late payment is made at the prevailing rate of interest for
commercial borrowing for each of the currencies in which payments are made.
2.1.3.2.3-Remedies for non-payment and delay on completion time
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40
41
42
43
United
Nations
Commission
on
International
Trade
law(UNCITRAL)
44
must
agree
to
the
employer's
terms
on
these
issues.
This is when the advance payment can become a factor. It is common in Asia and South
Africa for prime contracts to provide that the contractor will receive advance payment,
within a fixed period of time following execution of the contract, of 10 to 20 percent of
the contract sum. In a negotiation in which the employer has rejected the contractor's
request for new provisions of payment guarantees, the contractor can take the moral high
ground by asking for a substantial advance payment. The contractor's position is: "You
would not give me any payment guarantees. At least give me a 20 percent advance
payment."
This is quite a reasonable request, particularly when the contractor posts an Advance
Payment bond/guarantee.
The Advance Payment provides a hedge against owner insolvency. The 20 percent is
reduced proportionally as each progress payment is processed by crediting a portion of
the 20 percent against each progress payment. So until the end of the project, there still is
some paid but unearned money in the contractor's possession that the contractor can use
to cover non-payment in the event of owner insolvency.
2.1.4-Sureties companies
2.1.4.1-Historical background
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Surety bonds have been a valuable tool for centuries. The first known record of contract
surety ship was an etched clay tablet from the Mesopotamian region around 2750 BC.
According to the contract, a farmer drafted into the service of the king was unable to tend
his fields. The farmer contracted with another farmer to tend them under the condition
they split the proceeds equally. A local merchant served as the surety and guaranteed the
second farmers compliance. [Sio.org, website]
Surety ship was addressed in the first known written legal code, the Code of Hammurabi,
around 1792-1750 BC. A Babylonian contract of financial guarantee from 670 BC is the
oldest surviving written surety contract. The Roman Empire developed laws of surety
around 150 AD that exist in the principles of surety ship today. [Meek, T.J, 1958]
While surety ship has a long history, it was not until the 19th century that corporate bond
underwriters were used. Recognizing the need to protect taxpayers and public property
from contractor failure, in the United State Congress passed the Heard Act in 1894, which
required surety bonds on all federally funded projects. From this on wards the concept of
bonding and risk transfer comes to the mind of all investors in the construction industry.
How one evaluates and manages risk on construction projects and makes fiscally
responsible decisions to ensure timely project completion is important. To gamble on a
contractor whose level of commitment or qualification is uncertain or who could become
bankrupt halfway through the job, can be a costly decision. How can a public agency
using the low-bid system in awarding public works contracts be sure the lowest bidder is
dependable? How can private sector construction project owners manage the risk of
contractor failure?
Surety bonds provide financial security and construction assurance by assuring project
owners that contractors will perform the work and pay specified subcontractors, laborers,
and material suppliers. A surety bond is a risk transfer mechanism where the surety
company assures the project owner (oblige) that the contractor (principal) will perform a
contract in accordance with the contract documents.
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2.1.4.2-Principles of sureties
To bond a project, the owner specifies the bonding requirements in the contract
documents. Obtaining bonds and delivering them to the owner is the responsibility of the
contractor, who will consult with a surety bond producer. Subcontractors may also be
required to obtain surety bonds to help the prime contractor manage risk, particularly
when the subcontractor is a significant part of the job or a specialized contractor that is
difficult to replace.
Most surety companies are subsidiaries or divisions of insurance companies, and both
surety bonds and traditional insurance policies are risk transfer mechanisms regulated by
state insurance departments. However, traditional insurance is designed to compensate
the insured against unforeseen adverse events. The policy premium is actuarially
determined based on aggregate premiums earned versus expected losses. Surety
companies operate on a different business model. Surety is designed to prevent loss.
Because of the tremendous financial exposure to the surety, bond underwriting involves
an evaluation and analysis of the contractors finance. The ability to obtain adequate
bonding is governed by the contractors financial strength. The surety may also place
limitations on the type, size, location, and number of contracts to be undertaken by its
principal and will probably insist that the contractor obtain all his bonding from one
source in order to maintain that control. Thus, the relationship between the contractor and
its surety is ongoing. (www.wikipedia.org)
The surety limits the contracts to be undertaken for various reasons. Size and number are
limited so that the contractor does not become overextended financially. The type of
contract undertaken is limited to those areas in which the contractor is experienced in
order that a journey through uncharted territory not results in financial ruin for the
contractor and exposure to loss for the surety. Most sureties will limit the geographic area
in which a contractor may bid for work under the belief that too many projects far from
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Before issuing a bond, the surety company must be satisfied that the contractor runs a
well-managed, profitable enterprise, keeps promises, deals fairly, and performs
obligations in a timely manner. Surety bonds have played an important role in the
construction industrys success, allowing the industry to sustain its position as one of the
largest contributors to the nations economic stability and growth.
2.1.4.4-Contractor failure
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49
50
Contractors are more likely to complete bonded projects than non-bonded projects
since the surety company may require personal or corporate indemnity from the
contractor;
The surety bond producer and underwriter may be able to offer technical,
financial, or management assistance to a contractor; and
The surety company fulfills the contract in the event of contractor default.
Any contractorwhether in business for one year or 100, large or small, experienced or
novicecan experience serious problems. Through the years, surety bonds have held fast
as a comprehensive and reliable instrument for minimizing the risks in construction.
2.2-Contexual framework
2.2.1-Banks and Insurance in Ethiopia
Historical overview
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2.2.2-Issuers of securities
In the construction industry of Ethiopia bonds and guarantees are issued by insurances
and banks. Both bonds, issued by insurance companies, and guarantees, issued by banks
have their own advantage and disadvantage.
Banks usually regard securities/guarantees as an extension of contractors line of credit
and as they usually know a contractor better than an insurance company would, the
guarantees can normally be issued more speedily. When a guarantee is issued by bank
however, the magnitude of the guarantee may affect the availability of that banks line of
credit to the contractor, which could have adverse repercussion on the contractors ability
to adequately fund the contractor or indeed other contracts taking place during the same
period of risk. Banks are however, generally more prompt in paying out on guarantee as
they are usually less willing to argue or investigate the merits of any claim than an
insurance company. (Micheal Lear, 2007)
Bonds issued by insurance companies will usually only be issued after the insurance
company has made detailed enquiries in to a contractors financial background and ability
to perform the contract in question. Such detailed enquires can be reassuring to an
employer as if the insurance company issues the bond then the company is satisfied with
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Whereas in insurances, the only thing that matters is the security [collateral] the
contractor can furnish. Now lets see first the securities that are asked by the surety
companies as collateral before we discussed the conditions, exclusions and arbitration of
the sureties of Ethiopian companies.
2.2.3-Securities
The letter of guarantee/bond issued by a bank or insurance is a written promise issued by
the sureties to compensate the beneficiary in the event that the customer fails to honor
his/her/its obligation. For this service, they demand collateral which is acceptable by the
sureties. Among the securities, the following are usually asked by the Ethiopian sureties:
1. Collateral
2. Work guarantee
3. Work payment guarantee
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55
The contract would have to state clearly which sums the bank would be allowed to
withhold at what moments:
-
Penalty interest
Outstanding principal
Legal expenses
Care should be taken in using this method even in countries where the legal framework
supports it. The advantage of the method is that the contractors are backed in their efforts
to establish contracts with a formal financial institution at no additional costs. The risk is
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57
58
59
60
claim
hereunder is received by the surety from the employer on or before the expiry date,
this bond will automatically become null and void irrespective of its being returned to
the surety or not.
Upon the discovery by the employer or by the employers agent or representative, of any
act or omission that shall or might involve a loss hereunder, the employer shall give
immediate written notice hereof with the fullest information obtainable at the time to
the surety at its Head office.
In the event of any breach of the provisions of the contract, the surety shall be subrogated
to all the rights and properties of the contractor arising out of the contract. All
deferred payments and all money and properties, that are then, or that may thereafter;
become due to the contractor shall be credited upon any claim that the employer may
make upon the surety.
Exclusions:
The surety shall not be liable under this bond for any occurrence whether directly or
indirectly caused by or arising out of:
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Arbitration
All differences arising out of this bond guarantee shall be referred to the decision of an
arbitrator to be appointed in writing by the parties in difference or if they cannot agree
upon a single arbitrator to the decision of two arbitrators, one two be appointed in writing
by each of the parties within one calendar month after having been requested in writing
so to do by either of the parties or in case the arbitrators do not agree of an umpire
appointed in writing by the arbitrators before entering upon the reference. The umpire
shall sit with the arbitrators and preside at their meeting and the making of any award
shall be a condition precedent to any right or action.
IV Retention bond
Under these bonds the surety and the contractor are held firmly bound to the employer up
to the amount sated in the policy document. Both the surety and the contractor bind
themselves, their successors and assign jointly and severally firmly by these presents.
The contractor has entered into a certain contract in writing with the employer
mentioning all the necessary information indicated in the policy.
The employer after having given the provisional acceptance, has agreed to enter into a
contract with the contractor, to release the retained amount of money to the contractor
before the expiry date of the maintenance period which contract with all its covenants and
conditions is hereby made part of this bond to all intents and purposes as through it is
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63
64
65
Next, with our preliminary conversations and encounters with practicing professionals
and our advisor, we were able to select our area of concentration. We chose to
meticulously address a limited types of remedial rights (in accordance with our initial
classification) thereby simplifying our questionnaire.
In our fieldwork research, we used the survey approach. Field work research refers to the
methods of preliminary data collection used by the researcher. In this case surveys are
used to gather data from a relatively large number of respondents within a limited time
frame, which is the main reason we used this method. it is then concerned with a
generalized result when data is abstracted from a particular sample or population.
After deciding what type of data to be collected (quantitative) and have also decided on
the research approach (survey) then the next will be how to select the technique to collect
the data. The two features in collecting data are either by questionnaire or by interview.
For the study, we selected questionnaire.
A questionnaire (to be covered in more detail in the next section) was prepared based on
our findings of the comparative study of the topics stated above.
What we had initially been able to obtain was knowledge from the insurers, contractors
and clients as part of the literature review. We thus had to review our work in light of this
finding and incorporate the practice.
66
67
68
69
70
DISTRIBUTED
RETURNED
USEABLE
RETURNED
No.
(A)
(B)
REJECTED
RATE (B/A)
USEFUL
(C)
RATE
(C/B)
Contractors
20
15
75%
14
93.3%
71
clients
75%
100%
Bond issuers
12
11
91.6%
11
100%
40
32
80%
31
total
During the process of distributing and collecting of the questionnaires there were some
problems which makes reduced to our number of returning questionnaires. Among the
obstacles were; the countrys budget closing is at the month of June. This makes the
construction companies and the employers busy to respond our questionnaires. The
second biggest obstacle were it was hard in getting an appropriate information provider
with engineering and remedial right know how at the same time. In addition, the
willingness to provide information from respondents is also considerable and last but no
least the respondents needed a lot of time to answer the questions provided and we did
not have that much time.
Assessing the rules, regulations and determination of premium of bond issuers.
As discussed in the literature review of this study we mentioned about ways of allocating
risks using contract and among these ways, contract securities are one of them. These
contract securities are provided by contractors as request of clients. Contractors get these
securities from bond issuers who have their own pre-qualification. In the construction
industry of Ethiopia, bond issuers provide different arrangements of securities for their
customers which seams feasible for them. Of the arrangements entertained in each bond
issuers there are arrangements is presently closed this is because in order to prevent
possible losses that insurers may suffer as a result of issuing financial guarantee, bonds
and other unconditional bonds, the National Bank of Ethiopia has issued directive no
SIB/24/2004, prohibiting insurance companies from issuing financial guarantee bonds
and other unconditional bonds with effect from 1 March 2004. 87.5% of bond issuers do
not have plan to introduce other arrangements that are not exercised locally while the rest
of the respondents do not know weather there is a plan or not in their company.
4.2.1 Arrangements of securities by issuers
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73
Collateral value
From this, the issuers may use one or more of these criteria to qualify the contractors.
Based on the data we collected 11.1% of the issuers use only collateral value as a
criterion and on the other hand 77.7% of issuers demand more than one criteria or
combinations of criteria and uses many screening for selection and the rest 11.1% use
trust worthiness for evaluation.
4.2.3 Types of collateral values
In terms of issuers, collateral value can be owned assets, account receivables, work
guarantee, work payment guarantee, and others. Owned asset is, from the data collected,
the most useable type of collateral used. And from the questionnaire distributed to
analyse this, almost 100% of them use this. The rest of them use work guarantee as an
addition. Moreover, owned asset can also be assets of third party. As one can perceive
from the data most bond issuers use owned assets as collateral to secure for the bond or
guarantee they provided. As to some contractors opinion, account receivable is more
liquid and most used in developing country. Therefore, local banks are advised to
consider it. (Account receivables are incomes to be collected where services are
delivered. In construction case it could be payment certificate, justified claim.) Looking
into contractors perception, 66% use owned asset as collateral although 26.7% work
guarantee ,6.7% of them exercise work payment guarantee and 26.7% use guaranteeing
loan type of collateral.
74
75
Contract price
Out of the collected data 55.6 % respondents they use size, type, contract price, location
of the contract and duration of the project in determining the premium(cost) of the
bond/guarantee while 44.4% respondents they use only a contract price as determination
of the premium of the bond.
4.2.6 Limitation of contracts
The bond issuers limit the contracts to be undertaken for various reasons. Size and
number are limited so that the contractor does not become overextended financially. The
type of contract undertaken is limited to those areas in which the contractor is
experienced in order that a journey through uncharted territory not results in financial
ruin for the contractor and exposure to loss for the surety. Most sureties will limit the
geographic area in which a contractor may bid for work under the belief that too many
projects far from the contractors home base interfere with the contractors ability to
properly control the job. Therefore, out of the distributed data 55.6% say that they place
limitation on the type, size, location and number of contract to be undertaken by the
contractor in order to minimize their own risk. And the rest of 44.4% they do not provide
limitations. Sometimes this creates an impact on the growth of the contractor because at
the same time he does not allowed by its sureties to participate in different projects. In the
76
77
78
79
80
They are faster, flexible, transparent, and effective and this helps to save time.
81
Sometimes, they request to submit bid security much higher than the project
demanded. It may also be not returned on time. Therefore, one respondent
believe that change of the amount bid security will help solve this problem.
82
83
The total amount of retained money is by far than the contractors profit.
Whereas 57% of contractors believes increase contractors borrowing costs or elevate the
cost of construction. This is because as they say; when the contract amount is
significantly high the retained amount will have an impact on the working capital of a
given company. This means they make them to expense other costs for a means of
financing for their cash flow. As to some contractors opinion cash retention is not the
84
85
Employers opinion
-
Contractors opinion
significant
construction
effect
on
the
defects
the
companies
working
capital.
-
From the above table shown, comments from contractors and employers about retention
money were different. We can observe that retention money withheld, for the employer, is
always advantageous and direct guarantee. I.e. it is not a piece of paper that is withheld,
but direct cash. This is the only advantage for employers. On the other hand, some
contractors said it is not necessary and bad for the cash flow and the others say it has no
effect on them. The contractors from the claim side said in, other words, they could have
done better things with it, as there is nothing done with the money withheld, and they
86
87
Contractors opinion
support this.
contractors
finalized
is
to
trust
the
organization
-
Because
of
competition
the
88
89
Employers recommendation
-
Contractors recommendation
-
90
91
5.1 Conclusion
The construction of Ethiopia can be said it is in its newborn stage that requires integrated
positive contribution from all parties in the industry and to bring the desired development
to its beneficiaries. Though, such developments are not expected over night; investigating
the existing problems in the construction industry and taking timely remedial measure is
paramount important. Based on this, the other hand message of this thesis is to see into all
possible efforts to be made for the development of the domestic construction industry so
that the industry will be in a better position to contribute for the poverty reduction efforts
of the country. From the many ways the one possible way of developing the capacity is
through proper studying the impact of remedial rights on the domestic construction
contractors.
This thesis has included discussion on the risk management and how they allocate risks
on the contracts. Assessing the impact of the remedial rights on the domestic construction
contractors was a major part of the research. Therefore after the analysis of the collected
data the following conclusions were made
The major form of contract securities used in Ethiopia with respective of mostly
entertained is
Performance security
Tender security
Retention security
Payment security
92
Securities in the form of guarantee are more expensive than in the form of
bond.
Bond issuers require more than one criterion as compensation for the perceived
risk associated with giving securities to contractors.
The study shows that there are security issuers uses a lot of criterion for their
customers for the service demanded. The main reason of the sureties is to
compensation of the perceived risk. From the criterias chooses the sureties is:
Collateral value
Most sureties use most of the time owned assets as collateral to secure for the
bond or guarantee they provided. This situation is creating a highly impact on
the domestic contractors.
The study shows that most sureties use an owned asset for collateral. This
condition has a highly impact on the domestic construction contractors.
Contractors in our country are suffering from cash shortage to finance
construction projects. The only thing to solve this problem is getting a short or
long term loans. To get those loans contractors is expected to furnish an owned
asset. But this owned asset if it were occupied by a surety for the service of
security, the contractors would not have any means of substituting this value
because from the study of previous student thesis it was discovered that banks
93
use
different
condition
in
determination
the
premium
of
bonds/guarantees.
The study shows that sureties determine the premium based on size of the
security, type of the security, duration of the project, contract price and location of
the contract.
Sureties are limiting contracts to be undertaken by contractors for the perceived
risk associated with them.
The result of this study shows that the bond issuers limiting the contracts to be
undertaken for various reasons. Size and number are limited so that the contractor
does not become overextended financially. The type of contract undertaken is
limited to those areas in which the contractor is experienced in order that a
journey through uncharted territory not results in financial ruin for the contractor
and exposure to loss for the surety. Most sureties will limit the geographic area in
which a contractor may bid for work under the belief that too many projects far
from the contractors home base interfere with the contractors ability to properly
control the job. This limitation creates an impact on the growth of the contractor
because at the same time he does not allowed by its sureties to participate in
94
Their rules relatively flexible and their risk sharing contribution are
slightly greater than the government ones.
95
They are faster, flexible, transparent, and effective and this helps to save
time.
The new PPAs amount of bid security is not well known on the contractors but
this security has an advantage to the domestic contractors.
The result of the study shows that most of the contractors do not know about the
new statement. But from the contractors who have knowledge about this, they
found it advantageous. The main reasons for this merit are:
Sometimes, they request to submit bid security much higher than the
project demanded. It may also be not returned on time. Therefore, one
respondent believe that change of the amount bid security will help solve
this problem.
96
97
98
3. Sureties better decrease the amount of collateral and should see other collaterals
outside of owned asset like using account receivables. since construction needs to
much cash and it is difficult to get sufficient collateral to secure the amount of
loan if it is already occupied by sureties. So it is advised to provide the securities
by accepting work payment guarantee, third party guarantee and work guarantee
etc.
4. Sureties had better not limit contracts that can be undertaken by the contractor at
same time in order to minimize the effect on the capacity of the domestic
contractor. Because taking different contracts generate an opportunity to distribute
the cash needs in the different projects and this helps to create a cash, material and
human flow forecast and distribution.
5.
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9.
Contractors should try familiar themselves familiar with new conditions that can
be advantageous to them (for example on new PPAs SCC and SBD). In addition,
they should aware on the remedial rights they have on the conditions of contract.
10. The operation of the retention mechanism is an opportunity cost to the contractors
or sub-contractors, equivalent to loose of interest on the amount of money with
held. The contractor to balance the income lost and to have a guarantee in case of
owner insolvency or non/let-payment of the retention money, he should insist to
the employer to open a dual account by the name of the two stakeholders.
100
101
References
1. ERA legal services divisions securities guideline for projects counterparts
2. G.Christian Hedeman June 1995 & Robert F.Cushman Architect and Engineer
Liability, claims against design professionals, second edition
3. Gerald I. Katz, 2000 Presentation on contract risk allocation
4. Goetze, A
5. Harold D.Hauf, Building contracts for design and construction second edition
6. Henry A. Cohen, 1961 Public construction contracts and the law
7. http://www.wikipedia.org//puplic/english/employment/finance,
8. http://sio.org (index.htm),10 things you should know about surety bonding
9. http://www.ilo.org/puplic/english/employment/finance, equipment finance for
small contractors in puplic work programs lindea deelen kwaku osei bonsu,
working paper
10. James C.Van Horne, 10th edition, Financial Management and policy
11. John Adrianse, 2005Construction contract law, the essentials
12. Kassaw Bediru, Mesfin Hailu and Yehyes Dereje, 2006 " The role of banks in
minimizing contractor's cash-flow problems". A thesis summated to AAU of
technology faculty-south
13. Meek, T.S (translator),The code of Hammurabi in the ancient near East, J.B.
Pritchard,
14. Princeton University press, Princeton.N 1958,PP. 163
15. Conditions of contracts, Multilateral development bank harmonized editions,
march 2006.
16. The Federal Democratic Republic of Ethiopia, Standard Bidding Document
(SBD), For Procurement of Works, For National Competitive Biddings (NCB).
102
103
APPENDICES
APPENDIX: A1
THE IMPACT OF CONTRACT SECURITIES AND REMEDIAL
RIGHTTS ON CONSTRUCTION COTRACTORS
Questionnaire for contractors
i.
3) How often are you required to furnish bid/contract securities? (could be any kind)
Always
About times
About times
Never
A. When required to produce securities in what form are you often demanded?
(Multiple choices possible)
Type of security
Governmental
Bid security
Advance
payment
security
Performance bond
Performance guarantee
Payment security
Retention security
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Banks
Private
No
Collateral
Work guarantee
Work payment guarantee
Guaranteeing loan
Other _____________________________________
_____________________________________________
7) How do you see the rules and regulations of the issuers of bonds?
Banks/insurance Excellent
Very
good
Good
Acceptable Poor
Very
poor
Private
Government
iv.
The securities
Bid security
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Performance bond/guarantee
10) On average, in terms of percentage of the project cost, what is the amount of
performance bond you are required?
Less than 5%
5-10 %
No
B. If you think that the amount required is unfair, do you believe that this increases
construction costs unnecessarily?
Yes
No
11) If you have to provide collateral to secure a performance bond, on average what
proportion of the bond should the collateral amount be?
10-30 % of the bond
Above 50%
No
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No
Retention fund
13) If your contract stipulate provision for clients to retain a percentage of money from
the interim payment, on average, is the amount deducted fair?
Yes
No
14) As a contractor, do you think that retention has a significant impact on your cash
flow?
YesNo
15) Do you prepare budget for the retention that will be deducted?
Yes
No
16) Do your clients normally release the retention money on the time specified on the
contract?
Yes
No
17) In your experience how is the retained money handled? (Multiple choices possible)
Simple deducted by client and dont know how he/she handles it
The deducted money is stored in a separate traceable account in the name of
the client
The retained money is held in a separate account in the common name of my
company and my client
Other, please specify ___________________________________________________
18. Have you ever received interest on the retained money?
Yes
No
18) What difference would it make if there will be removal or reduction of the burden of
retention? ____________________________________________________________
___________________________________________________________________
19) As a major contractor, do you deduct retention money from your sub-contractors?
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No
20) If you deduct retention from your sub-contractors, when do you release the retained
money?
All at the substantial completion of the part they are sub contracted
Half at the substantial completion and remaining half after defect liability period
of their part
Half at the substantial completion of their work and remaining half after defect
liability period of the project
Other, please specify
______________________________________________________________________
_____________________________________
E. Contractors guarantee
21) Have you ever demanded your client any guarantee against defaulting from its side
(such as non/late payment, insolvency, etc)?
Yes
No
A. If yes what guarantee do you demand to protect yourself against your clients
defaulting? (Multiple choices possible)
Overtake the property delivered
Obtain third party guarantee such as payment guarantee
Ensure viable legal remedies like arbitration or using advance payment as
a security against defaulting by the client, etc.
Other, please specify
_____________________________________________________________________
_______________________________________________________
B. If you dont normally demand your client a sort of guarantee, please tell us your
reasons for not doing so
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22) In the last ten years, how often have you been involved in a case that was
triggered by defaulting on the part of your client (such as non payment, late payment,
insolvency etc?)
B/n 0nce and five times,
None
If you have been involved in such cases, do you believe that demanding a guarantee
from your client would have helped?
Yes
No
F. Compensations
22) Have you ever demanded liquidated damage for lost opportunities because of
defaulting by the employer (please note that this is not meant the claims for the actual
costs incurred due clients defaulting)?
Yes
No
No
24) What do you recommend in order to improve the contribution of clients and issuers of
bonds in minimizing the impacts of the contract security?
Client________________________________________________________________
_____________________________________________________________________
____________________________________________________________________
Bond issuers__________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
109
1. How many projects have you awarded to local contractors in the last ten years?
Less than 10
10 -20
above 20
2. From which company do you want the contractor to bring the bond? (Multiple
choices is possible)
Bank
Insurance
Other, _____
________________
________________
No
If yes, please list types of securities you requested from the contractor (multiple choices
is possible)
Type of security
Mark (X)
Bid security
Advance payment security
Performance an
Payment security
Retention security
If you dont request securities, what will you do on the wake of defaulting by the
contractor?
________________________________________________________________________
__________________________________
110
4. Do you think retention suggests lack of trust in the firms chosen to do the work?
Yes
No
No
Advance payment as
security
If no, why do you think they do not request a guarantee? _________________________
________________________________________________________________________
________________________________________________________________________
8. For untimely completion, do you request a liquidated damage from the
contractor?
Yes
No
No
111
In addition, by your interest or by your default may be you made an extension of time.
Do you believe this extension of time entitles the contractor to ask allowance money like
the one you request for liquidated damage?
Yes
No
No
10.
If you deduct retention from your contractors, when do you release the
retained money?
All at the substantial completion of the part they are contracted
Half at the substantial completion and remaining half after defect liability period
of their part
Half at the substantial completion of their work and remaining half after defect
liability period of the project
Other, please specify
________________________________________________________________________
___________________________________
11.
What do you recommend in order to improve the contribution of clients and
issuers of bonds in minimizing the impacts of the contract security on contractors?
__________________________________________________________________
__________________________________________________________________
__________________________________________________________________
__________________________________________________________________
112
Other _____
Bank
Other, ____________
113
Payment security
Retention security
If other explain________________________________
5. What are your major criteria to select customers, especially contractors? (Please
rank them from 1-4: One being the most major)
Collateral value
Credit worthiness of the company
Cash flow ability of the firm
If other, please specify_________________________________________
___________________________________________________________________
6. If your firm has issued the given bond by demanding collateral, which type of
collateral is accepted from construction firms? (Multiple choices possible)
Owned assets
Account receivables
Work guarantee
Work payment guarantee
And if other please explain _____________________________________
____________________________________________________________
7. Do you provide contractors advisory services about potential risks of their
proposed plan?
Yes
No
114
No
No
If yes, would you please give us an explanation based on the loses they incurred to your
firm.
. _______________________________________________________________________
________________________________________________________________________
________________________________________________________________________
10. How do you determine the cost of bond/ guarantee? Based on:
Size
Type
Duration of the project
Contract
Other pleas specify ____________________________________
______________________________________________
______________________________________________
______________________________________________
______________________________________________
______________________________________________
11. How fair do you think is that premium you charge in issuing securities to
contractors (compared to the services you provide to other sectors)?
Very fair
Moderately fair
Similar to other sectors,
More expensive than other sectors
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APPENDIX: A4
Note for Bidders: The Contract Security should be on the letterhead of the issuing Financial
Institution and should be signed by a person with the proper authority to sign documents that are
binding on the Financial Institution.
Contract Security
(Bank Guarantee)
116
117
Performance Bond
By this Bond, [name and address of Contractor] as Principal (hereinafter called the
Contractor) and [name, legal title, and address of surety, bonding company, or
insurance company] as Surety (hereinafter called the Surety), are held and firmly
bound unto [name and address of Employer] as Obligee (hereinafter called the
Employer) in the amount of [amount of Bond] [amount of Bond in words], for the
payment of which sum well and truly to be made in the types and proportions of
currencies in which the Contract Price is payable, the Contractor and the Surety bind
themselves, their heirs, executors, administrators, successors, and assigns, jointly and
severally, firmly by these presents.
Whereas the Contractor has entered into a Contract with the Employer dated the [day]
day of [month], [year] for [name of Contract] in accordance with the documents, plans,
specifications, and amendments thereto, which to the extent herein provided for, are by
reference made part hereof and are hereinafter referred to as the Contract.
Now, therefore, the Condition of this Obligation is such that, if the Contractor shall
promptly and faithfully perform the said Contract (including any amendments thereto),
then this obligation shall be null and void; otherwise it shall remain in full force and
effect. Whenever the Contractor shall be, and declared by the Employer to be, in default
under the Contract, the Employer having performed the Employers obligations
thereunder, the Surety may promptly remedy the default, or shall promptly:
(1)
(2)
Obtain a Bid or bids from qualified bidders for submission to the Employer
for completing the Contract in accordance with its terms and conditions, and
upon determination by the Employer and the Surety of the lowest responsive
118
Pay the Employer the amount required by the Employer to complete the
Contract in accordance with its terms and conditions up to a total not
exceeding the amount of this Bond.
The Surety shall not be liable for a greater sum than the specified penalty of this Bond.
Any suit under this Bond must be instituted before the expiration of one year from the
date of issuance of the Certificate of Completion.
No right of action shall accrue on this Bond to or for the use of any person or corporation
other than the Employer named herein or the heirs, executors, administrators, successors,
and assigns of the Employer.
In testimony whereof, the Contractor has hereunto set its hand and affixed its seal, and
the Surety has caused these presents to be sealed with its corporate seal duly attested by
the signature of its legal representative, this [day] day of [month], [year].
Signed by
on behalf of [name of Contractor] in the capacity of
In the presence of
Date
Signed by
on behalf of [name of Contractor] in the capacity of
119
120
Gentlemen:
In accordance with the provisions of the Conditions of Contract, Clause 51 (Advance
Payment) of the above-mentioned Contract [name and address of Contractor]
(hereinafter called the Contractor) shall deposit with [name of Employer] a Bank
Guarantee to guarantee his proper and faithful performance under the said Clause of the
Contract in an amount of [amount of Guarantee] [amount in words].
We, the [Bank or Financial Institution], as instructed by the Contractor, agree
unconditionally and irrevocably to guarantee as primary obligator and not as Surety
merely, the payment to [name of Employer] on his first demand without whatsoever
right of objection on our part and without his first claim to the Contractor, in the amount
not exceeding [amount of Guarantee] [amount in words].
We further agree that no change or addition to or other modification of the terms of the
Contract or of Works to be performed thereunder or of any of the Contract documents
which may be made between [name of Employer] and the Contractor, shall in any way
release us from any liability under this Guarantee, and we hereby waive notice of any
such change, addition, or modification.
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122