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Letters of credit: what impact for the contract manager?

This publication on letters of credit was prepared by Marc Louet. Marc is a freelance consultant in Contract & Claim Management.

It was originally published on www.contractence.fr, the French blog on contract management by Jean Charles Savornin. Jean-Charles is the author of several books on contract management, the latest of which is “Putting leadership into your projects (published in French)”.

Letters of credit

Both a payment guarantee and a way of paying, the letter of credit (L/C) or documentary credit is a banking tool that is well known to exporters and importers. We can summarize the rules by saying that an L/C is an undertaking by the buyer’s bank to pay the seller when the seller sends him the documents detailed in the L/C without requiring the buyer’s agreement.

These documents are intended to attest to the seller’s proper performance of its obligations and typically include invoice, packing list, transport document, insurance certificate, certificate of origin, etc. The documents must be consistent with each other and scrupulously comply with the conditions set out in the L/C. These conditions are often difficult to meet.

What impact can the choice of an L/C as a payment method and guarantee have on contract management?

As a payment guarantee, the L/C is usually one of the conditions for the entry into force of the contract or the start of the contractual time periods. Any delay in its issuance could therefore have a mechanical effect on the project planning and generate a first claim situation.

Considering that it is not the buyer but his bank that opens the L/C, it will be in the buyer’s best interest to secure the subject in advance. A good practice is to attach to the contract a model of L/C on which the parties agree and which has been validated by the buyer’s bank (remember that the bank is not required to obey its customers and that L/C is a commitment independent from the contract…).

Discrepancies in documents

One of the key principles of L/Cs is that banks are only required to pay if the documents are strictly in accordance with the terms of the L/C. If they are not, the banks may request instructions from the buyer or even refuse to pay and return the documents to the seller. If the documents are incorrect, the risk is that there is a delay in payment, the duration of which depends on the buyer and its bank (I have known of some that lasted up to 1 year!) but for which responsibility can be shared between the seller, a third party (the carrier or insurer who has not provided all the details requested) and the buyer who has not obtained from the bank that it accepts and pays promptly, based on the incorrect documents. Between the needs of the on-site teams and the warning signals sent by your controller, I let you imagine the discussions that will proliferate on the clause “suspension in the event of late payment”…

The management of the contract, its changes and their impact

Before addressing this question, the first point to be stressed is that the L/C is independent from the contract. If the contract evolves, the L/C will have to be modified accordingly. And this implies having the bank’s agreement to do so.

This having been mentioned, let us imagine that an amendment with an increase in the contract price must urgently be implemented (e.g. repair/replacement of a damaged part). You may have difficulty obtaining the necessary L/C amendment if your customer does not have sufficient credit lines with its bank or if the bank is itself subject to credit restrictions (typical case of countries with low currency reserves). Again, expect discrepancies between the project’s operational needs and financial risk control.

Letter of credit at the end of the contract

Finally, let’s analyze what can happen at the very end of the contract (not considering the warranty period). Let’s imagine that you too have already known a customer who shows unwillingness to sign the acceptance reports even though he has put the equipment into production. But that, this time, thanks to a well negotiated contract, you will be able to invoice your last term with a report signed only by you on the basis of the deemed acceptance clause … If this clause is not transcribed in the terms of the LC, you will quickly see that it is as if it does not exist …

And what will happen with your last-minute claim in which you have put your extra costs, which have been validated “on the fly” by the customer? You may well realize that they will never be paid. Instead of financial compensation you should have offset these additional costs otherwise, for example by trading them for a reduction in your commitments.

As you understood from the above examples, the contract management can be strongly impacted by the need to have a letter of credit. Without questioning its usefulness in situations where the risks of non-payment are high, or where exchange regulations are stringent, a letter of credit can generate difficulties that the contract manager should not be underestimating.

PS: To simplify reading, I avoided in this article some aspects of letters of credit. Such as the difference between letters of credit and documentary credit or the complexity added by the L/C confirmation on the management of irregularities. I would be happy to answer any questions you may have and thank you in advance for your comments and feedback.

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Contract Management & Technology: feedback from IACCM Europe Conference

A lot of talk on the IACCM Europe Conference was about technology (this post is not publicity; I have no commercial interest in any of the companies mentioned):

Virtual assistants “Alexa-like” to work on contracts with a demo by APPTUS;
Smart / self-executing contracts;
Shredding contracts to data with AI (artificial intelligence) with a demo by Exari;
Negotiation between AI machines taking some “bad” human characteristics out of the equation and seeking for an optimized result for both parties.

Many of these things will undoubtedly make our future. But, when the problems are still quite basic – as can be seen in my previous posts on negotiation and risk management – solutions should also be very pragmatic for immediate use by most companies.

One solution that I can immediately see implemented in many organizations, from small law firms to the sales & legal departments of multinationals, is “ClauseBase”. This recent start-up (www.clausebase.com) provides a handy tool to build up a contract from a set of clauses that form the bricks. The tool automatically corrects grammar, references etc. to avoid the annoying work of making a consistent contract out of separate clauses. Let’s admit it, that is usually time consuming and a source of errors. ClauseBase is also integrated with DeepL for translation and currently covers English, French and Dutch. What I find particularly interesting is that companies can make a template with optional clauses to adapt to the reality of a specific project and still guarantee consistency. In my opinion, this can also be suitable for medium size companies that do not have a permanent legal department. They are better off preparing standard documents with a library of clauses available to their sales department for adaptation to each specific project. Specific adapted user roles can be chosen. The monthly fees vary accordingly (from 29 to 99 Euro/month, if I remember well). It is also possible to send a link via email to have a third party or a sales rep, without a license, fill out a pre-formatted contract with data while selecting certain options. I’ve even been told that it can even be used on a website to create options for customers when doing online business with you. That’s smart!

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Risk Management: feedback from IACCM Europe Conference

Here are the takeaways on the subject of risk management from the IACCM Europe Conference 2019. It is based on the following sessions:

“Risk allocation & acceptance as a source of value creation and leakage in contracts” by Walter Akers.
A panel discussion about “risk allocation – when is it ‘good’ driving performance versus ‘bad’ undermining performance” with Natalia Ombach, Walter Akers and Tim Cummins
“Contract management and dispute resolution strategies” by Nicolas Gould.

Contracts and Risk

Contracts are all about risk allocation and risk transfer. Risk is to be seen as the fruit of uncertainty, positive or negative. A party should be rewarded for its ability to manage uncertainty. Very often, risk transfer is an illusion, on the paper, until that risk actually manifests itself. Tim mentioned that much of the conversation on contracts was a complete waste of time, that it should be more focused on quality assurance. When looking at what can go wrong, we fail to see recurrent patterns. in the reality, most of the problems are about scope.

Economic view on Risk

Contracts should be economic instruments to realize or protect value. In an economic view, it makes sense to shift your uncertainties, against compensation, to the party that can solve a problem for a better value than you can. Natalia warned that some risks can however not be managed and should then be monitored and mitigated in other ways.

Walter reminded us of the general principle that “risk is best allocated to the party best placed to handle it”. This means that it shouldn’t be allocated to the weakest party in the negotiation or the one that is most desperate to get the contract… yet, that is what happens so often.

Project price, cost and risk

Signing contracts just on the basis of the price, Walter said, is like asking the butcher to do you a complicated surgery. Yes, he has the knives and knows how to cut … but …

Every clause in the contract has something to do with risk, directly or indirectly.

The project price is the cost of the project plus the risk. It makes therefore economic sense to allocate risk to the party best able to handle it.

Suggested approach on Risk Management

Walter’s suggested approach is as follows:

Identify the risks;
Allocate the risk to the party best placed to handle it;
Never suffer from the illusion that risks can be transferred in totality. For example in an EPC Contract: shifting all the risk/uncertainty to the Contractor; it will come back, as a boomerang, to the Employer if the EPC Contractor goes bankrupt.

The whole contract management system should be designed around risk sharing.

Focus on EPC Contract Risks

Shift in Owner’s behavior

Nicolas Gould made a focus on EPC Contract’s Risks. Originally, Owners wanted control. But now, whenever a new risk is identified, it is passed on to the supply chain. And, as long as a Contractor doesn’t go into bankruptcy, he must fulfill the contract. According to the “fitness for purpose” principles, if things go wrong, even if the Contractor has been designed and built the project carefully, he will remain responsible.

Claims and their roots

Nicolas mentioned 3 causes for claims:

project uncertainties (such as complexity beyond the expectations of the parties),
process problems, and
people issues.

The roots go back to unclear risk allocation. Claims under EPC are normally for:

Employer’s instructed variations
Constructive variations
Delay in Employer approvals
Access to the site
Feed availability (for a power plant: supply of water, gas etc)
Lacking utilities
Unavailability on the off-taker side (power to the grid)
Force Majeure
Acts of prevention

5 steps towards a successful project

For Nicolas, the following 5 steps are needed for success:

Properly setting-up the project: follow the specs + seek clarification + schedule the project + apply the contract + appoint the DAB + establish the role of the Engineer or the Employer’s representative;
Running the project: this is about having a proper programme + progress meetings about the real subjects + applying the payment procedures + process & substantiation;
Managing change: build-up of the contract price + standards for measuring change + being aware of time bars and notices;
Avoiding disputes: honestly implement value changes with variation orders + understand the programme + identify facts and supporting evidence;
Dispute management: only as a last resort.

Conclusions

The many examples provided during the event and the arguments extracted above show that, across businesses and over the past decades, people – Employers, Contractors and Engineers – continue to make the same mistakes: lacking proper risk management & allocation + not identifying, acknowledging and speaking about the real problems when there is still time to mitigate. Usually, the parties are technically knowledgeable, are not so good at communicating and really bad at using the contract.

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Negotiation: feedback from IACCM Europe Conference

Here are the takeaways on the subject of negotiation from the IACCM Europe Conference 2019. I attended the following sessions:

Tiffany Kemp and Keld Jensen shared some “negotiation experiences from the trenches”.
Tiffany also had a session about “The perils of fighting on two fronts at once: why stakeholder management is critical to negotiation success”.
Keld brought us a short form of his “SMARTnership negotiation workshop”

Trust in negotiation

Keld stressed the importance of trust in negotiation. The higher the level of trust, the better the results and the lower the transactional costs.

In complex negotiations, there is no luxury of time to build up trust. Therefore, we need to verbalize trust:

Confirming the need for trust;
Say what people will do when trust is falling;
Establishing a “code of conduct” in negotiation: the parties should be honest and transparent, shouldn’t lie nor bluff etc.

Such a “code of conduct” actually increases honesty. If we are reminded to be good, we actually do that. Most people don’t want to lie or bluff. This code of conduct is like a contract for negotiating the contract and usually established a week before.

Someone from the public was wondering what would be the consequences of breaching this code of conduct: “negotiation is as an audition for the performance of the real contract”. If people already fail on what they agreed in their “code of conduct”, they will probably not reach an agreement anyway.

Stakeholder management

In her session on stakeholder management, Tiffany mentioned that collaborative behavior is far less practiced than collaborative theory is preached.

A common idea for negotiators is that “negotiation with counterparts is OK but the internal stakeholders make their life terrible”. She encourages people to make a RACI matrix or responsibility assignment matrix for the stakeholders in a negotiation on each of the key deal points. The RACI letters stand for Responsible, Accountable, Consulted and Informed.

SMARTnership negotiation workshop

We do contracts to create financial benefit. We have to make sure that the counterpart is successful and happy but not at our expense. At the start of a negotiation, we have to be able to say to the counterpart: “we are here to try to improve your profit, reduce your risks and manage liability”. And vice versa for the counterpart.

Facts from Keld:

According to studies, 42% of the value present is not captured in negotiations.
Trust has plummeted with 55% in the last 20 years.

Can you price trust? Yes. Keld showed it with an example of the price reduction required to make us shift from a long-standing appreciated supplier to an alternative supplier of whom we dislike the sales representative: 5%, 7%, 10%, …? Depends. But there is definitely a value linked to trust.

Unfortunately, many people still see negotiation as a zero-sum game, as haggling, as a competition. The party that is getting less is unhappy and up for revenge. Even partnerships are typically based on limited disclosure and minimal trust.

Keld’s concept of SMARTnership is to find the true potential creating added value through 346 variables across industries. The goal is to find asymmetric differences. But this exercise requires trust and transparance. Typically, people negotiate on too few variables: price … and few more.

Conclusions

At an inquiry at the World Economic Forum, negotiation came out as the fifth most important skill regardless of the job one is in.

One of the reasons why even experienced negotiators never become good at it is … because they don’t like to negotiate.

Better to start liking it! Some training or coaching will sure help.

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IACCM Europe Conference 2019, some takeaways

As promised, I will share some takeaways from the IACCM Europe Conference held in Madrid form 13-15 May 2019 on my blog. Of course, I could tell you how great it was, a real networking event etc. But that brings nothing to the readers than regret of not being there. No worries, I will try to give you some feedback useful for those not present. In case anything is not clear, please reach out to me.

In separate posts, I will focus on 3 subjects close to my hart (click on the respective words to access them): negotiation, risk management and contract management & technology.

It was a special event as IACCM, the International Association for Contract & Commercial Management, was celebrating its 20^th birthday.

20 years ago, there was no visibility for CCM’s (Contract & Commercial Managers). Everyone considered she/he was doing a different job. IACCM has been able to show similarities and bring consistency within its ever-growing member group (> 55k). This through research, establishing a Body of Knowledge and networking.

A new trend is the interest of the academic world. The University of Leeds Business School & Law School is a good example because they are setting-up a MSc / LLM in Commercial and Contract Management. Others are showing interest and ready to follow.

Satisfied, yes I am, with this year’s IACCM Europe conference. See you next year in London.

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Power to negotiate contracts: Are you “too big to fail” or do you “fail to be big”?

Let’s put ourselves in the position of a Contractor, whether big or small. We are at the tendering/pre-award stage in a public tender or a direct negotiation. When receiving the Contract draft from the Employer, from what I see, there are two types of behaviors when it comes to the power to negotiate contracts corresponding to two very distinct profiles:

“Too big to fail”,
“Fail to be big”.

For the moment, just words, but let’s dig a bit deeper into the subject:

“Too big to fail”

This is the attitude we find in big contractors (unless they are desperate and close to bankruptcy). They consider that each-and-every-contract should be taken individually to contribute to the results of the company. Also, the individual contracts should not endanger the health of the whole portfolio. While Customer see them as “big, powerful companies”, they work on a project-by-project basis.

To do this, they have an “army” of internal Subject Matter Experts (SMEs) on all issues from technical to commercial (including legal, tax, insurance, financial etc). Their problem is that these SMEs are very good at identifying the risks for their specific subject but not to look at the overall picture. They usually have “golden rules” or contract standards, training programs, risk review processes etc.

The result is that the Commercial & Contract Manager (CCM) is overloaded with good recommendations that she/he cannot implement, all at the same time, even with power to negotiate. This would upset the Customer, show a lack of focus and make the contract negotiation extremely time consuming. The challenge is to find strong CCMs that can interact with the SMEs. They need to challenge the SMEs on the need for all those comments, to find “lean” solutions that can be acceptable for the Customer.

Sometimes contracts are lost because of excessive deal-breakers and not only due to price or technical issues.

“Fail to be big”

On the other hand, we have small and medium size companies who don’t have any of these specialized resources and lack the power to negotiate their contracts.

They often deal with the big companies of the preceding chapter. Most probably with their procurement department. The legal department of these big companies, in spite of the “good contracting standards” for their own sales, has taken pleasure in producing completely biased procurement contracts. The small and medium companies are “invited not to change anything” to these contracts.

Accepting these standard terms means no rights for the Contractor (no suspension, no termination, no limits of liability) and excessive rights for the Employer (broad indemnification rights). When things go well, the parties will not even look at the contract. But when things go wrong, the contract aggravates the situation by a pure “attack” and “defense” situation.

If it would come to a dispute, arbitrators and judges, in application of the law, may not have a lot of sympathy for contracts that are not the result of mutual agreement but were forced by one strong party on the other weaker party (“take it or leave it”). Unfortunately, smaller companies often “fail”/go bankrupt before they reach that point. And then, the boomerang of unbalanced contracts comes right back at the big companies.

Usually, these small companies do not have any “red flag” mechanisms like a risk review meeting (before tender submittal) or a contract risk scoring process leading to well-informed decisions.

Conclusions

If your company is in either of the above situations, the challenge is to find the personnel that can handle this and identify those commercial & contractual comments that are worth fighting for, will create balanced contracts and that will make a serious difference in case things go wrong.

I strongly recommend that you think about your situation and keep moving/improving: setting up a contract risk scoring to rank the issues in order of priority, taking informed decisions by well trained staff, acknowledging and mitigating residual risks, pro-actively “defend” one’s position etc. An ostrich strategy has never been a good long-term solution.

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CIArb, The Key Players in International Arbitral Proceedings: Roles and Evolution

Introduction

On the 12^th of April 2019, I had the pleasure to participate to an event organized by CIArb in partnership with the LL.M Business Law, Arab World and Middle East of Université Paris 1 Panthéon-Sorbonne. The subject was the key players in international arbitral proceedings.

The speakers were as follows:

Dr Amel Makhlouf – French Qualified Lawyer, Lecturer at Sorbonne Law School
Olena Gulyanytska – head of the dispute appointment service of CIArb
Hanna Abdou – Avocat / Associate at Reed Smith LLP
Prof. François Ameli – Professor at Ecole de Droit de La Sorbonne

Iolanda Ghica, Head of Marketing at CIArb introduced the Chartered Institute of Arbitrators as the world’s leading qualifications and professional body for dispute avoidance and dispute management. CIArb has 16 000 members and 39 branches.

Then, she introduced the speakers, each of whom represented one of the key players in international arbitral proceedings: arbitrators, administrative secretaries, arbitral Institutions and counsel. Emphasis was on their changing roles.

Arbitrators

Prof. François Ameli provided the arbitrators’ perspective in international arbitral proceedings, with specific references to the Arab world and Middle East.

He mentioned the change in the arbitrator’s role in the recent past in the Arab world. Their role is moving from more mediation towards professional arbitration due to the sophistication of the cases and the need for impartiality. The development of certain boutique law firms can be one factor contributing. Because these are specializing in arbitration, pushing arbitrators to be more and more professional.

In the Middle East, there is a long-standing Persian tradition of arbitration. Now, as the development of regional arbitration centers like Dubai and Cairo shows, the Arab world is also shifting towards arbitration. Due to the current sanctions imposed on Iran, activity at the center in Teheran is now a bit suppressed.

The United Arab Emirates introduced new laws with the UAE Federal Arbitration Act (Law No. 6 of 2018)]. He mentioned certain improvements like the question of severability, incorporation of arbitration rules by reference and the allowance of new technologies. For those interested, please read the following publication on Lexology: Highlights of the UAE Federal Arbitration Act (Law No. 6 of 2018) (https://www.lexology.com/library/detail.aspx?g=b88a986a-6cc6-4f01-9c75-a14b06e08a20)

Prof. Ameli did also not shy away of mentioning some shortcomings and risks to arbitration in the Middle East. There is for example a recent case (from a lower court, still under appeal) where arbitrators were sentenced to prison and high indemnities for having shifted the arbitration to a neutral country with ad-hoc proceedings.

To conclude his presentation, Prof. Ameli also encouraged arbitrators to refect, before rendering their award, on how feasible the enforcement of the award will be in the relevant countries.

Administrative secretaries

Then, Dr Amel Makhlouf took over to explain the controversial and evolving role of administrative secretaries to arbitral tribunals. She made the case for their role, acknowledging the professionalization and complexity of arbitration, based on the following points:

Logistics: why would the arbitrators necessarily have to take care of this aspect on their own?
Procedural aspects and case management meeting
Optimization of resources: she made a parallel with the collaboration between judges and clerks.
“Paper tsunami”: it may be impossible for one person to handle the number of documents involved.
The need for efficiency, including the limitation of the duration of the arbitration.
Availability: the secretary can, for example, be contacted by the arbitral institution even while the arbitrator is travelling.

She also talked about some objections regarding administrative secretaries:

Perceived lack of legitimacy: However, the admin secretary gets her/his role from the relationship with the chairman or sole arbitrator. Also, impartiality requirements/no conflict of interest apply.
The fact of involving another 3^rd party and perceived risk on confidentiality.
“Acting as fourth arbitrator”: under no circumstances should the admin secretary take part in the decision-making process.

What is the process for getting an administrative secretary onboard?

Usually the initiative comes from the chairman.
Agreement is then sought from the co-arbitrators.
The subject is raised during the case management meeting. It is mentioned in the meeting report (including certain procedural aspects like confidentiality) for which non-objection of the disputing parties is sought. It was noted that the parties rarely refuse the administrative secretary in order not to go against the wish of the chairman of the tribunal.

The treatment of the costs of admin secretary’s performance depends on the applicable arbitration rules.

There have been challenges to arbitral awards based on the role of the admin secretary. However, state courts have been reluctant to set aside the award on this basis.

Arbitral Institutions

As the third speaker, Ms Olena Gulyanytska explained the role and evolution of the CIArb’s Dispute Appointment Service (DAS). It was created in 2012 and quickly gained traction, both domestically and internationally. DAS has access to an immense pool of qualified and experienced professionals, drawing from CIArb’s 16 000 members.

CIArb can appoint arbitrators but does not administer the arbitration itself. The tribunal can proceed on ad hoc basis without additional charges and interference from CIArb. It will only serve as back-up in case of challenges, e.g. concerning impartiality. The presidential panel of arbitrators insures the quality as the listed need to be chartered arbitrators, with reassessment every three years.

CIArb’s arbitration rules are based on Uncitral rules with some additions:

Waiver of the parties right of appeal;
Provisions for urgent injunctive relief (obtaining an emergency arbitrator within 2 days);
Case management conference.

Ms Olena Gulyanytska also explained the Business Arbitration Scheme (BAS). It has as objective to provide simple, cost-effective and timely resolution of disputes of low to medium monetary value (5000 – 100 000 GBP) by a sole arbitrator. A final, legally binding decision on the dispute will be provided within 90 days from the appointment of the arbitrator. Some other characteristics are as follows:

A fixed fee of 1250 GBP (if no hearing) + VAT is payable by each party to cover DAS’ costs and the arbitrator’s fees.
A sole arbitrator will be appointed by CIArb within 10 days.
The parties’ case and witness statements shall not exceed 5000 words.
The successful party may not recover more than its fixed fee plus 1000 GBP towards their costs of arbitration.

The above framework gives visibility on costs (remaining low), provides speed and simplicity (parties can even proceed without legal representation). All this with confidentiality and obtaining an award with the same enforceability as a court judgement.

Counsel

Finally, Ms. Hanna Abdou talked about the conduct of counsel in international arbitration. She pointed out that the counsel’s role is very broad. She would therefore focus on some specific points.

Who can be that counsel?

A lawyer representing the party;
An expert (sometimes a technical expert) when acting as party’s representative;
Inhouse counsel of a company.

Their mission starts with the request for arbitration, at least for the defendant. For the claimant, the interaction usually starts some weeks or months before. This period is used to establish the relationship, understand the claim and prepare suitable documents. When the parties choose the arbitrators (instead of relying on an arbitral institution or a nominating body like CIArb), the counsel also has an important role to advice on potential arbitrators. Counsel will also be strongly involved in the case management and the setting the procedural time table. The counsel’s role doesn’t end with the hearing because support is probably needed for:

Providing a statement of costs & fees.
Analyzing the award and explaining it to the Client.
Potentially filing for annulment of the arbitral award or launching the steps to enforce the award.

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Speaking with Howard Carsman from Intel about innovation in dispute resolution

I was speaking with Howard Carsman who is the Global Construction Claims Manager at Intel Corporation on innovation in dispute resolution. We are both elected members of the IACCM Council on Dispute, Claim and Conflict Management. The topic of this post is the feedback I got from Howard on the innovative ways that Intel is using to avoid conflict on its construction projects.

Starting Point

After a career as practicing lawyer (law offices, sole practitioner, arbitrator & mediator), Howard started, four years ago, as the global head for Intel’s construction claims.

Based on multiple bad experiences a couple of years ago, where two construction projects ended up in multiple arbitrations, Intel has drastically changed its approach on managing and resolving disputes on their construction projects. Intel has a considerable construction activity around renovating existing and building new industrial facilities.

It is worth noting that those two projects mentioned before also had failed mediation processes. Over the years, the experience in the US, at least from Howard’s perspective, is that mediation has become more complicated and more lawyer controlled. The frequency of actually resolving a dispute through mediation has reduced.

What did Intel change in terms of innovation in dispute resolution?

Intel’s new approach was to set-up a dispute avoidance and resolution program consisting of the following two layers:

• They have started a revised governance model. For each major project or multi-project program, an Executive Committee of Owner and Contractors is now meeting once a month. They go through the open issues and examine what is happening. If issues remain open for more than sixty days, the Executive Committee has 3 options: (i) dive in and solve, (ii) give directions, or (iii) refer to a third party neutral.

• Beyond the Executive Committee, the second line of defense to stop construction disputes from escalating relies on a Third Party Neutral. This characteristics are as follows:

Its working principles are similar to a standing Dispute Board (cfr FIDIC 2017 DAAB) with a role for both dispute avoidance and dispute resolution.
There is a fast track process of 30 to 40 days for smaller claims and a longer approach for larger claims.
The Third Party Neutral can also act as “coach” or “adviser” based on monthly site visits. It will then give its (non-binding) observations and recommendations to both the Owner and the Contractor(s).
The fixed costs of the Third Party Neutral are supported by the Owner. The Contractor and Owner jointly select the neutral, and there is an option to have a single neutral or a panel of three. If there are three members, one of them can step in as mediator in the earlier phase of the dispute. The potentially remaining dispute adjudication can then be handled by the other members. This will avoid or reduce potential conflicts of interest between mediator roles and adjudication roles.

What are the results of the changed practices in dispute avoidance and resolution?

So, what is the current feedback of experience from Intel? Well, this innovative dispute avoidance and resolution approach has already been used on 2 campuses in the US for construction projects of up to 2 BUSD. The process is also in place for the past eight months in Ireland.

And the good news is … that on these projects no claims have gone to arbitration anymore. Nor have any potential disputes triggered either of the formal claims resolution processes. All have been resolved informally, some with the use of the neutral in their capacity as mediator.

Conclusions & next steps

This way of working is innovative (in line with current trend on FIDIC DAAB) and other Owners could also be interested to know about it. The pool of suitable Third Party Neutrals should also be further developed. Ideally, we are speaking here of persons with an operational project background, not lawyers.

As the IACCM council on Dispute, Claim and Conflict Mgmt. we will be organizing events around innovation in dispute resolution. Probably the first event will be at the IACCM Americas Conference 2019 which will be hosted in Phoenix, Arizona from 4 to 6 November.

That’s where you can come in as reader of this post. If you have similar experiences like Intel above, we would really appreciate you share this with us to present it as a best practice. You will certainly benefit from the exchange by creating positive visibility for your company. Also, the exchange with other companies progressing in the same direction can bring some further learning to you. Please contact Howard Carsman or myself, Jan Bouckaert, to discuss about this.

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One year of AfiTaC’s contract management blog

One year of AfiTaC’s contract management blog in the Project Businesses (Infra & Construction, Renewable & Power, Special Equipment Projects etc)!

As we have already done after six months, it is time to put ourselves in question. Please contact us to share also your ideas; you can mail to info@afitac.com.

Let us look a bit at the facts & figures:

Content this Blog on Contracts

We have a clear content for our contract management blog with four subjects on Projects:

negotiation,
risk management,
contract management and
alternative dispute resolution.

The more precise and technical the subjects on our blog, the more readers we get. And that is very motivating to write “deep content”. Some examples of the most successful articles (in the long run including through organic searching):

Growth of Contract Management Blog

Growth is good!

We are now reaching 1000 google searches a month and this is ever increasing.
Users come from more than 170 countries; so, basically the whole world.
20 000 page views in the first year, which – I believe – is good for a specialist blog.

LinkedIn is not what it used to be. Voluntary or involuntary, LinkedIn has spoiled its specialist subject groups; they still exist but with only a fraction of the former interaction. I must admit I also rarely go the groups nowadays. LinkedIn’s vision is to bring everything into the feed.

However, this makes all of us dependent on the algorithm. While before, we went to look for the information at the right place (the dedicated groups), now the information has to find us (in the feed). And the algorithm “feeds you” based on your and other persons likes.

What does that mean? A large number of people I interact with are very reluctant to give any likes to an article. It feels to them as making a strong quality statement. If you don’t “teach the algorithm” what you want in your feed, you will get posts based on other people’s likes and that will be two subjects only:

Big multinationals companies showing off (because they have a huge staff to get their likes).
Slogans about Leadership issue (because this helps people evacuate their anger about their direct management).

Either you start interacting more with small-bloggers’-content that challenge the status-quo or you will probably soon get bored – if not already the case – by publicity-packaged-in-a-different-way and loose interest… AfiTaC will remain present on LinkedIn but we will definitely put less time and effort in it if the current trend is continuing.

Further development

To get fresh subjects for this Contract Management Blog, we are interacting, more and more, with relevant associations like:

IACCM – the International Association for Contract & Commercial Management: I have been elected on the councils for Risk Mgmt and for Dispute/Claim/Conflict Mgmt and will certainly report back to you.
FIDIC: I am participating regularly to events related to FIDIC contracts.
CIArb – the Chartered Institute of Arbitrators: an extremely valuable source of information about alternative dispute resolution.

A monthly newsletter has been launched. As you cannot count on LinkedIn anymore to be sure to get our posts in your feed, we strongly recommend you to subscribe to this free newsletter (by writing to newsletter@afitac.com or registering on the appropriate location at the right of your screen). It will not overload your mailbox because you will only get once a month a summary of relevant articles (currently organized by theme: EPC, Risk, Negotiation, ADR etc).

As we want to be generous, we will regularly put some Training Material on the website. This is the content that is also sold to big or SME companies. We want to give you a learning opportunity if you don’t have access through an Employer. Cases like when you are preparing for a career shift, unemployed or just generally interested.

Interaction with you

As you probably imagine, maintaining and developing such a specialist blog requires a lot of time, energy and motivation. Therefore, don’t hesitate to interact with us by writing to us (info@afitac.com), putting comments below our articles, giving is a “like” on LinkedIn posts if you feel like. It keeps us motivated.

Also, many people I speak to think about it but need a little encouragement to transform this into action: you are welcome to propose relevant content as a guest blogger. I will be happy to exchange with you on this subject. It will improve your visibility and, frankly speaking, there is no better way to develop yourself than to write something you believe/hope will be of interest to others.

Last but not least, thank you for your interest.

Let’s keep this contract management blog going!

About AfiTaC

Bank rating clauses, a blessing or a curse in Project contracts?

This article about bank rating clauses is the first in a series about the specificities of bank guarantees in the Project Businesses (Construction & Infrastructure, Oil & Gas, Power & Renewable, Utility projects etc). You may be interested in the other articles in this series and can find them easily by clicking here.

Context

In order to be sure that bank guarantees are issued by sufficiently solid banks, the contractual provisions often include wording on the rating of the issuing banks. This is especially true for project finance, where the Lenders are particularly concerned about the performance of the main contractor, usually working on an EPC basis.

A typical example of such bank rating clauses is as follows:

“Acceptable Bank” means a commercial bank which has an international rating (long term credit rating) with S&P of at least A or equivalent with Moody’s.
In case of any decrease in the rating of the bank issuing the Performance Security, the Contractor shall substitute the Performance Security with a security issued by an Acceptable Bank.

What are the advantages of such bank rating clauses?

The above example seems reasonable and straightforward. By this wording, the Employer is guaranteed not to get a bank guarantee that he is not comfortable with. The Lenders in a non-recourse Project Finance, have to make sure that the Contractor building the financed asset is as secure as possible. Getting sufficient and solid bank guarantees is really helpful.

Furthermore, there is objectivity attached to it as the ratings of the banks are easily accessible by both Contractors and Employers. This should avoid any discussion about the acceptability of a bank. Great, an easy one. A “no brainer” as we are used to say. Or not so?

What could be the curse of bank rating clauses?

Let’s have a deeper look at the issue. The purpose of a bank guarantee, such as a Performance Guarantee, is to secure the performance by the Contractor. In case the Contractor fails (i.e. is in material default), the Employer has the possibility to reduce its exposure to the Contractor by drawing on the bank guarantee. Most of the time, we are talking about an on-demand bank guarantee. More on this in another post.

Now, by that typical wording, the situation is somehow reversed. The Contractor starts guaranteeing the financial health of the issuing bank over the entire contract execution period. Is a Contractor supposed to do that? In the next chapter, we will see some do’s and don’ts on this subject.

What is the right thing to do when it comes to bank rating clauses?

Let’s sum up the legitimate interests of all parties to a contract in the Project Businesses:

Employers (and their Lenders in a Project Finance) have a legitimate right to make sure they are getting quality bank guarantees (at the time they are first provided). The easiest way to achieve this is to foresee contractual wording checking the situation before actually issuing the bank guarantee. Making reference to “first class international banks” is usual practice. Including some preselected, acceptable banks in the contract language is also OK. The time between negotiating and signing the contract and the issuance of the bank guarantees is very short anyway.
By their complexity, projects take a couple of years to be completed. And bank guarantees cover the entire project execution period (and often also the warranty period). Even the most reputed financial institutions, can get into trouble over such a period of 3, 5, 7 or more years. Does Lehman Brothers ring a bell? Contractors are not responsible for, and have no influence on, any changes in the issuing bank’s rating.
While the downrating of a single bank is an unfortunate event, it can easily be handled, in agreement between the Employer and Contractor, by giving some time to the Contractor to replace its bank guarantees. It will probably have no impact on the bank guarantee costs. Remember, bank guarantees are only for special cases of specific, material lack of performance by the Contractor. It would be an unfortunate coincidence that this would be in parallel with the downrating of that bank. But, if that happens, well, I suppose it is fair for the Employer to call the bank guarantee out of precaution to avoid further exposure.
When the entire financial market gets into trouble (downrating of several major banks in parallel), the situation becomes more complicated. Especially in such a situation, banks should hope to avoid a “run on the bank” situation. This would happen when bank guarantees have to be replaced under most of the Project contracts simultaneously due to a toxic market practice, i.e. the rating mechanism. Automatic replacement of bank guarantees, in case of a rating change, should therefore be avoided.

While Lenders (often commercial banks in Project Finance) should be cautious to push their Clients, the Employers in this case, into a toxic situation, we all know that Project contracts are negotiated individually, one by one. It is therefore the responsibility of a large number of dispersed Project negotiators to act reasonably. We hope the above explanation can help the project stakeholders – Employers, Lenders, Contractors and Law Firms – to find reasonable solutions. In the negotiations I’ve been involved in, the Lender’s (of a Project Finance) internal risk review committees were the hardest to convince. But, with creativity, patience and persistence, we managed to negotiate something acceptable for all parties.

Are we missing something? If yes, please let us know by commenting below.

Conclusions

While the first reaction to bank rating clauses is, “yes, it’s a good thing and even a must have”, it is important to look deeper into the subject. When looking at an isolated project, it seems a good thing to do. The situation is very different when it becomes a market practice.

When bank ratings degrade due to an economic downturn or a banking crisis, such rating clauses can worsen the situation. It may come to a “run to the bank” kind of situation where a large number of Contractors could be forced to replace their bank guarantees on very short notice in the midst of a volatile market. If they don’t succeed, their contracts may be terminated. And this for circumstances which are entirely beyond their control… As can be understood from the arguments in this article, we are not favorable to simple rating clauses.