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Contracts & Project Funding: A Call To Action

October 11, 2012

In recent weeks I have encountered a growing number of conversations about project financing and the links between funding and contracts.

There is more and more discussion in many industries about new and alternative contracting models. In particular, there is wider acceptance that traditional approaches to negotiation and contract risk allocation are counter-productive and that they undermine outcomes. This leads to the conclusion that greater collaboration and a more appropriate and balanced allocation of risk and reward is needed – and that this must be reflected in how we develop terms and conditions and post-award governance principles.

However, such models fly in the face of long-established principles in which risk consequences are (at least in theory) well-defined and apportioned. The new multi-party arrangements are designed with risk prevention in mind and depend on a readiness by the parties to share information and techniques in pursuit of shared goals and benefits. For the financing community – whether it be banks or some of the other sources of funding – this is unfamiliar territory and they do not know how to assess the relative riskiness of differing contract models. ‘Behavioral impact’ is not a concept with which they are familiar.

At a recent conference, a banker sought o describe ‘what makes a project bankable?’ He made an analogy to a glass of water. If it is clear water, we drink it, but as it shows signs of cloudiness, we become steadily more hesitant. For a project to appear ‘clear and clean’, the technology must appear sound, the contracting parties must appear stable and have good balance sheets, the business plan must be clear, cash flows reliable etc. In many of today’s projects, there are high degrees of ‘murkiness’, in large part due to underlying uncertainties or pressures of change – new technologies, new regulation, new competition, industry consolidation, riskiness of other projects for the balance sheet etc. In this environment an unfamiliar contracting model tends to cause concern.

The conclusion from these discussions is interesting:

  • Banks will welcome a growth of contract standardization and also be more prepared to invest when the key participants show evidence that they learn from the lessons of the past
  • Banks expect to see commercial intelligence being applied. Specifically, the parties should reflect the uncertainties of change by making appropriate contingencies in their project plan
  • Banks understand the concept that complex projects depend on consensus building and collaborative communication, but need evidence to support this contention.

Overall, funding for projects is available, but in today’s risk environment those applying for support must illustrate they have effective understanding and appropriate project controls. Contracts that involve shared responsibility and collaborative approaches to issue and problem resolution sound like a good idea, but time must be taken to educate the financing industry and also to show there has been road-testing of these models that demonstrates success.

For the contracts and commercial community, this raises the question of how well we are coordinating and communicating with the finance community – not just externally, but within our own organization. We need to ensure our senior Finance executives similarly understand this link between project models and terms and the challenges of project financing.

2 Comments
  1. Bob Spence permalink

    Thanks for this Tim – trenchant and relevant as always! You allude to project financers’ wariness of new contracting models – in your view, is the finance community ready to let go of fixed price/lump sum as the contracting strategy they prefer to finance? I can imagine that in less “sophisticated” parts of the world there would be reluctance to take a chance on more innovative forms of contracting flowing from increased collaboration between sponsors and contractors…how quickly do you think attitudes are changing?
    Cheers,
    Bob

  2. Bob
    I have no evidence of acceptance of new models; but I also have no evidence of resistance to them. From the limited insights that I have at this time, it appears no one has made any effort to engage the banking / financial community in explaining the reasons for change or the potential benefits. I suspect the same applies with the wider (in-house) financial community – a theory I plan to test when I present to a large group of CFOs in the next couple of weeks.

    Tim

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