TYPES OF PROJECT CONTRACTS

In a project one has to deal with numerous contracts. These contracts are awarded depending on
the diversity of activities pertaining to the project, spread of the area involved, availability of
agencies etc. For example, in a typical gauge conversion or laying of new track project of the
railways, there may be a separate contract for each of the major bridges, tunnels, earthwork and
minor bridges. There are contracts for supply and laying of ballast. There are numerous
transportation contracts. There are welding contracts as also several contracts for supply of track
material, signaling equipment, telecom and electrical works. The failure of one of the contracts
could result in delay of the whole project. Hence the number of contracts in a 100 km track-
laying or gauge conversion project of railways could be typically between 60 and 100. Every
contract is typical in its contents.

The popular types of civil engineering works, project contracts are the following:

1. Turnkey Contract: A turnkey contract is a total package for design, supply,

installation and commissioning. Generally payment of turnkey contract is a
lumpsum, divided among the main contract components for progressive
payments.
2. Product-in-hand Contract: This is a turnkey contract with an additional obligation
on the part of the contractor to run the facility and stabilize the production and
maintenance operations.
3. Lumpsum Works Contracts: This is for execution of a task spelt out in detail in
the tender documents. It is similar to the turnkey approach with the exclusion of
some responsibilities like engineering and performance guarantees which the
owner or technology supplier might retain.
4. Cost-plus Contract: In a cost-plus contract the contractor is reimbursed the cost,
plus a fixed sum or a percentage of the costs towards his overheads and profits.
The cost is defined and agreed upon in advance so that there is no dispute later.
The rate of the ‘plus’ provision would depend on what all is included in the cost
and how big is the job. The rate may vary between 7% to 20% of the cost.
To discourage the tendency on the part of the contractor to overspend,
there are two measures. They are:
a) Guaranteed maximum cost (GMC) and
b) Shared saving provision(SSP)

Under GMC, the parties agree in advance that if the costs exceed a certain
estimated maximum sum, the contractor does not get his percentage on such
excess. Under SSP if there is a saving from the estimated project cost for
execution, the owner and the contactor share such savings at a pre-agreed ratio.
5. Performance-based contracts: Construction + AMC(Annual Maintenance
Contract) for six years. Thus construction is linked to maintenance. During
construction the performance indicators and their weights are defined. Here
surveillance reports certifying performance is essential which guarantee

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 progressive payments. For e.g. for the construction of a road the performance
indicators could be the following:
a) Lane Painting: 15% payment
b) Installation of road signs: 15% payment
c) Street Lighting: 20% payment
d) Road Leveling: 50% payment
Here, if lane painting is not done, 15% payment is cut.

6. BOOT Contracts: (Build/ Own/ Operate/Transfer) projects are mostly public

infrastructure projects which enjoy a particular form of structural financing. The
Sponsor or Project Company constructs the project and owns and operates it for a
set period of time, earning revenues from the project in this period, at the end of
which ownership is transferred back to the public sector government agency. The
hallmarks of BOOT-type of project financing are:
a) The lenders to the project look primarily at the earnings of the project
from which the repayments are to be made. Hence the credit-rating of
the project rather than the credit-worthiness of the borrowing entity is
more important.
b) The security taken by the lenders are largely confined to the project
assets.
Parties to a BOOT project are the following:

a)Government Agency: This is the statutory authority or pivotal

party. The pivotal party grants
i) The sponsor, the ‘concession’, that is the right to build, operate
and own the facility.
ii) Long-term lease or sells the site to the sponsor.
iii) Often acquires most or all of the services provided by the
facility.
The cooperation of the government is critical as all approvals and authorizations
and consents are given by the governments.
b) Sponsor: The sponsor is the party, usually a consortium of interested
groups which responds to the government invitation with an offer to
build, operate and finance the particular project.
c) Construction Contractor (EPC Contractor): The construction company
may also be one of the sponsors. If not, the sponsor always aims that
the construction company enters into a fixed time, fixed price,
construction contract.
d) O & M contractor: This contractor will normally be expected to sign a
long-term contract with the sponsor for the operation and maintenance
of the facility. Again the operator may also inject equity into the
project.
e) Financers: In large projects there is likely to be a syndicate of banks
providing debt funds to the sponsor. The banks will require the first
security over the infrastructure created. The same or different bank will

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 often provide a stand-by loan facility for any cost overruns not covered
by the construction contract.
f) Equity investors
g) Other parties: Insurers, equipment suppliers, engineering and design
consultants, project monitoring consultants etc.
7. BOT Contracts: These are Build-Operate-Transfer Projects also known as DBFO
( Design-Build-Finance-Operate) Projects. In this type of project the Sponsor
never owns the assets that are used to provide the project services. However the
Sponsor constructs the project and has the right to earn revenues from the
operations of the project. This structure is used where the public nature of the
project may make it inappropriate for a private-sector sponsor to own the assets –
like in the case of a tunnel or a bridge etc.
8. BOO or Build-Own-Operate Projects: These are projects where the ownership
remains with the private-sector project sponsor throughout the life of the project –
for example a power station in the private sector or a mobile phone network. Here
the sponsor gets the benefit for any residual value of the project.

In the last three types of Projects explained above, the most important contract
entered with the pivotal government agency is that which provides the framework
under which the project obtains its revenues. The two main models for such a project
agreement are:

I. The Offtake Agreement under which the

project Company sells the output of the project to an Offtaker. The off-take
agreement is normally a key document in an infrastructure project. It is the
agreement between the government agency and the sponsor under
which the government agency agrees to purchase the output of the
infrastructure( be it water, health services or electricity) at agreed prices and
volume. The off-take agreement must contain: (i) Performance
warranties dealing with the quantity, quality and timing of the output. (ii)
Also the consequences of failure to meet the provisions of the
performance warranties are built into the performance warranties.
II. A concession agreement, under which the Project Company provides a service
directly to a public authority or to the general public.

Types of Offtake Agreements: Offtake agreements can take various forms as

below.
a) Take-or-Pay contract: This provides that the offtaker must purchase the
output of the project, of course as per the quantity and quality and other
requirements of the offtaker, or else the offtaker makes a payment to
the Project Company in lieu of this purchase.
b) Take-and Pay agreement: In this case the offtaker pays only when the
output is purchased. But this has limited certainty as there is no long-
term guarantee of compulsory purchase.
c) Long-Term Sales Contract: In this case the offtaker agrees to buy a pre-
fixed quantity of the product on a price that is either the market price or

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 a pre-fixed or a pre-indexed price. This type of contracts may be
entered when the product is a easily saleable one like oil, gas etc..
d) Hedging Contract: This is found mostly in commodity markets such as:
i) A long term forward sale of the commodity at a fixed price.
ii) An agreement on a certain floor level price in case the prices
fall below this level. If the price is above the floor price then
the product could be sold in the open market.
iii) An agreement of both a floor level and a ceiling price. If the
price is below the ceiling or above the floor price, then the
product could be sold in the open market. In this way the
project is assured of a minimum level of income and at the
same time does not benefit additionally when the prices breach
the ceiling.
iv) Contract for Differences (CfD): Under the CfD agreement the
Project Company sells its product only in the market and not to
the offtaker. If however the product price goes below a certain
level, the offtaker pays the difference to the Project Company
and vice-versa.
v) Throughput Contract: This is used, for example in Pipeline
Contracts where the user agrees to carry not less than a certain
volume through the pipeline and pay a minimum price for this.

Some Tariff Details of Offtake Contracts: In offtake contracts like a Power

Purchase Agreement between a power generating company and a say
government power-purchasing entity, the tariff may consist of two main
elements:

 The Availability Charge that represents the fixed costs

incurred by the Project Company just by building the plant and making
it available for purchase of power. This element of the tariff is intended
to cover:
a. The fixed operating costs like land rental, staff costs, insurance
premiums, payments to fuel supplier for fuel already contracted
for supply, taxes etc..
b. Debt Service which cover interest payments and principal
repayments
c. Equity Return as per the agreed terms with the power producer.
d. Depreciation is generally NOT covered in this as this is not a
cash flow item.
 The Energy Charge which cover the variable costs of the project
of which the most important is fuel. The Energy Charge takes into
account the Quantity of fuel used, the indexed price of fuel used
and any other O & M costs that are incurred with the usage of the plant.
 Other Charges which could include payments for more than the
agreed number of start-ups in a year or the higher costs or running a
plant at partial load etc.

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 The Tariff structure however leaves any costs of inefficiency on the part of
the Project Company. These could typically be:
1) Project Overrun Costs: If the projects costs more than the agreed sum
and hence perhaps more financing and more interest payments than
were earlier envisaged.
2) Non-Availability: If plant is not available for operation for the
committed time then revenues are lost and perhaps penalties are to be
paid.
3) Higher Operating Costs: If the plant does not operate at the expected
levels of efficiency.

Effect of defaults on Tariffs: Government will always want to reduce tariffs

payable or impose LD if performance standards are not met. Financers, on the
other hand, would prefer only levy of LD and not tamper with the tariffs as that
would affect the sponsor’s ability to meet the loan repayment commitments.

Escalation of Tariff: this provides for tariff escalation clause during the
projected long-term life of the agreement.

Concession Agreements: A Concession Agreement is a contract between a public-

sector entity and the Project Company or Sponsor under which the project is
constructed to provide service to the public-sector entity or directly to the public.

The public sector entity with whom the concession agreement is signed could be a
national or a regional government, a municipality, a state entity set up by the state
to grant the concession.

Examples of concession agreements include contracts for construction and

operation of:
 A toll bridge or tunnel or a highway where the public
pays tolls
 A toll bridge or tunnel or a highway where the
Government Authority pays and not the public.
 A Transportation system for which the public pays
fares.
 Water and Sewage systems
 Ports and Airports
 Public Sector buildings, hospitals, schools, prisons etc

Concession agreements for the above types of services can be divided into two
classes:
1. Service Contracts: This is where the project has to provide a service and the
Contracting Authority will pay for these services. Payments are made for the
availability of the project for the services to be rendered, but a split between the
variable charge and the fixed charges is not as easily defined as in the case of an

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 offtake agreement. Hence, normally one payment is made for the provision of the
facility as a whole.

The main issue that arises in a service contract is how to define the availability of
a service. Availability is relatively easier to measure in case of equipment but
difficult to define in the case of a public building or a hospital. Calculation of
pro-rata share of loss of availability is even more difficult if part of a building is
still available for the service. However some project-specific definitions are
worked out for this purpose and certain quality requirements are also set.

2. Toll Contracts:
i) Real Tolls: Here the concession agreement gives rights to the concessionaire to
collect tolls or fares from the general public. Typically the terms of such a
concession agreement are:
 The Project Company (i.e. the Sponsor) is obliged to complete the project
to an agreed specification by an agreed date.
 The government body makes available the land and rights of way required
for the concession.
 Ownership of project facilities atleast the immovable portion) remains
with the public sector ( BTO/BOT Projects)
 The concession is granted for a fixed period of time during which the
government authority agrees not to give competing concessions to another
party.
 Operation and Management of the concession is in the hands of the
project company.
 A maximum tariff is fixed with indexation for inflation within which the
project company sets the actual tariff.
 Minimum service provisions are specified relating to the availability and
quality of service.
 Project Companies are liable for heavy penalties for breach of safety
standards.

In addition to the above clauses possible variations in the concession

agreement could include:

 Although the maximum term for the concession is fixed, if the debts are
repaid and the investors have earned their agreed rates of return, the
concession may be terminated. This takes care of cases where actual
returns from a project are way higher than the projected returns, rather
because of extraneous factors than because of the quality of service
provided by the project company and hence the investors should not earn
excessive profits.
 In case the usage level may not be adequate to finance the project a
minimum guarantee clause assures a rate of return good enough to attract
investors.

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 ii) Shadow Tolls: This is resorted to when payment by the contracting authority
directly to the project company becomes necessary due to the following:
 Direct levying of tolls is too complex, for example in the case of a road
network.
 Traffic flows would be distorted by drivers trying to use alternative routes
where tolls are not paid.
 Traffic flows too small.
 There is public opposition to payment of tolls.

In such cases the project company is paid according to usage ( say so much per
passenger or car kilometers). The payment formula is often on a diminishing
sliding scale.

Some other important agreements/ contracts in BOOT Projects:

 Construction Contract(EPC Contract): This contract addresses the usual scope

of construction work and its schedule. The other aspects that it addresses are
force majeure delays, underperformance( because of sponsor or construction
contractor or government), limitations of liability, termination, changes/
variations/ scope changes.
 O & M Agreement: This agreement addresses the following major issues:
a) The pre-operation phase O & M contractor will have to advise, prior to
the handing over of the facility on the necessary staffing levels and
functional and administrative maters required to be put in place upon
acceptance and handing over of the facility. The acceptance testing
procedures may take substantial time. During this time the manpower
that works would normally belong to the O & M contractor but the site
is still under the construction contractor.
b) Operation of the facility.
c) Sponsor’s obligations during the operation of the facility. The sponsor
may be required to provide utility fuel, water and other consumables
and also in certain cases the initial mandatory set
of spares.
d) Performance obligations: this deals with the detailed technical
requirements.
 Other Documents:
o Shareholders’ Agreements (between investors)
o Site Lease (between government and sponsors)
o Design Agreement(between sponsor and design consultant)
o Equipment supply agreements.
o Fuel/Water supply agreements

Some Issues of Importance in BOOT/BTO/BOO contracts:

(i) Interdependencies of Contracts

(ii) Mismatching of Risks

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 Each project document will contain an allocation of risks to the contracting parties. For
example, if the construction company’s obligations are simply to design and construct the
infrastructure, with the commissioning obligation lying with the operator, agreement will need to
be reached between the construction company and the operator company as to when each party’s
liabilities commence and finish. If the Operator is liable for liquidated damages, or delays in
commissioning, it will want to ensure that its commissioning period does not commence until
such time that the construction company has satisfied all of its obligations under the construction
contract.
It is therefore critical that all parties carry out a review of all documents and the risk
allocation inherent in them.

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