Research Proposal on Unnecessary Burden of Security Deposits in the Form of FDR on Construction Contractors

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1 By Anand Shrivas (CUBE CONSTRUCTION ENGINEERING LTD RESEARCH FELLOW) DATE 5 th August

2 Research Proposal on Unnecessary Burden of Security Deposits in the Form of FDR on Construction Contractors Background and the Problem Usually the general conditions of contract for state government contracts are normally derived after some modifications to GCC of CPWD. In case of Gujarat R & B Form B-2 being followed as standard conditions of contract with Contractor s. Under Form-B 2, the contractor is required to furnish as Security deposit for the performance of the contract and oberservance of the contract conditions. The security deposits are to ensure the Contractor completes the work awarded to him and in case of default to cover the damages suffered by the Employer. The Form B-2 under Clause 1 requires the contractor to furnish security deposits in the following manner: A) In respect of tender upto Rs. 30,00,000 equal to 5% of the estimated cost of the work put to tender. B) In respect of tender above Rs. 30,00,000 equal to 10 % of the estimated cost of the work put to tender. In respect of 5%, 2.5% in the form NSSNL bond or NSS or FDR of any scheduled bank to be paid within 10 days of receipt acceptance of letter of contractors offer and remaining 2.5 % is to be paid in the form of cash/ retention money to be deducted from running bills that becomes payable to the contractor from time to time. Where the tender above Rs. 30,00,000 the contractor shall pay 5% of the security deposits same as specified aforesaid for contracts below Rs. 30,00,000 and remaining 5% the contractor is to be given a performance bond (Bank Guarantee) to be produced 10 days from the date of receipt of acceptance letter of contractors offer. 1. Provision for providing 2.5 % in FDR/ NSSNL/NSS is burdensome provision by which only banks gets benefited neither 2

3 the employer nor the contractor derives any value from such system. Also no interest is provided on such FDR s thereby producing the loss of income to the contractors and involving costs to bring FDR. To renew or extend a FDR is also a much more complicated process. 2. There is lack awareness and knowledge to the relevant government departments of Resolution No: TNC (part-2)-c which has also allowed release of 2.5 % retention money to the government contractors against furnishing of bank guarantee by the contractor. Normally the construction contracts are for more than Rs. 30,00,000 in that case 10% of the estimated cost of the project is to be furnished to Tenderer as per the Tender. Generally the Contractor may not have problem with giving 10% security deposit but they might face problem in the manner in which the Security Deposits are demanded. In spite the security deposits may involve certain costs the contractor both in terms of blocking of cash funds, blocking the facilities with banks and also the cost of the funds including funds involve in working inventories and work in progress. The Contractor generally may recover his costs from the project revenue and may build the costs in the tender offer. The research will be carried out to know alternative methods of keeping security deposits in order to reduce costs without compromising on the security deposits available to the Employer, the Contractor may be able to make the lower offer and thus reducing the total cost of the project to the Employer. 3

4 Research Questions to be put to test. What costs are involved to the Contractor for bringing security deposits by the method prescribed under Form B-2? Are there any practical problems faced by the Contractor in giving security deposits in the manner prescribed under the Form B-2? Is there any alternative method in which Security Deposits can be deposited without compromising on the security available to the Contractor in order to reduce costs and practical problems? To find out feasibility of carrying out proposed solutions. Problems faced under the current system. As a general matter of practice in order to furnish security deposits under the current method of Form-B 2 the contractor invests his own funds which he later deploys in the project but these funds are not sufficient to meet all the requirements of the security deposits. The Contractor borrows for the requirement of funds from the Banks and other institutions to the extent available and has to pay for the interest for the same. Even Bank borrowings are not sufficient to meet the requirement of the project and the contractor has to borrow at higher rates from other sources and/or by materials with higher credit periods where the cost of extra credit period is normally built in the price and as per market conditions the extra cost of credit is considered as 24% p.a. 4

5 When the contractor provides bank FDR as has been provided in the Form B-2, the contractor may get 8% p.a or 9% on FDR against his cost of borrowing being 14.75% p.a or more and thus has a net cost of providing FDR comes to 6 to 7%. When the contractor provides the Bank Guarantee, the contractor has to provide security to the bank for issue of bank guarantee and part of this may be in the form of FDR also. In addition the bank charges for bank guarantee is 2 to 4% p.a+service tax of the bank guarantee amount. Further, the contractor can take Bank Guarantee from the bank only upto the sanctioned limit for him by the bank only. In addition to the cost of FDR stated in earlier para, the total cost of the bank guarantee to the contractor may be more than 6% p.a. However, as a matter of practice the contractor may prefer giving bank guarantees than FDR as the in case of extension required of the bank guarantee it is possible to get it without producing the original bank guarantee. The contractors over heads and profits are 10% of the contract value. The contractor generally quotes for his offer considering normal completion period specified in the tender and considering his costs. When the contract period is extended the contractor has to bear the overheads for the extended period towards his manpower, machinery and some extent increase in material costs. In addition the contractor has to bear extra costs for securities for the extended period. The small savings FDR s etc. are not extended as originals are required for extension but they are still valid for the employer and contractor loses out the interest for the extension time till he gets back such documents and gets back his money. The security deposit from the bills is 5% of the bill amount initially, income tax is also deducted from the bills and thus the entire profits from 5

6 the project are blocked and available to the contractor partly after more than 50% part of completion of the project and partly after the end of the defect liability period only. Proposed Solutions vs. Feasibility vs. Research for Solutions 1. It may be suggested that the security which is taken by way of small savings, bank FDR and deductions from the bills are allowed to be given by the contractor in the form of the bank guarantee where the interest of Employer is fully secured /protected. In case of small savings, the funds are never with the employer and in case of FDR also the funds are not with employer, but the contractor bears the cost of such investments. The banks are benefited at the cost of the contractor in FDR cases. In case of Bank Guarantee the interest of the employer is fully secured and protected and this may help the contractor in his fund management and better and timely execution of his project. Therefore, it is proposed that instead of Bank FDR, the employer should insist on demanding Bank Guarantee for 7.5 % in place of present 5%. Bank Guarantees is reliable mode of securing position of the employer and also more convenient for renewals and extensions whereas FDR go through much more complicated process for renewals or extensions. FDR remains idle with the bank with no use whereas banks get benefits out of such scheme. 2. To make to create awareness among all relevant government departments of Resolution No: TNC (part-2)-c which has also allowed release of 2.5 % retention money to the government contractors against furnishing of bank guarantee by the contractor. 3. To carryout research on the aforesaid topic to know what are the current 6

7 practices for security deposits in other states in India? Benefits of Solutions Objectives 1. Bank Guarantees are easily extendable and renewable 2. Money in the form of FDR will not be idle 3. Saves cost of the contractor thereby reducing the cost of interest the contractor gives for bringing in FDR. 4. The Contractor will have more liquidity to play with and utilize it in the project. 5. Therefore less monitory burden on the ultimate beneficiaries of construction project. To carry out quantitative and qualitative research analysis of the problems and solutions proposed under the research. To present to the government outcome of the research in best possible manner in order to bring about respective changes in the Form B-2 and relevant regulations. Research Methodologies To involve three GNLU students in carrying out quantitative and qualitative research analysis through survey, interviews and sampling methods such cluster, random and purposive sampling. Quantitative Research: 20 contractors on random sampling basis. Qualitative Research: 5 Contractors on purposive sampling basis. Student Researcher Take Away Inputs from CCEL Students will immensely get benefited out of the research as they will acquaint themselves of practices followed in construction contracts, the process of awarding the construction contracts, the dispute settlement mechanism etc. Students will be adept with the research methodologies followed for carrying out such kinds of activities. To suggest 25 contractors for the purpose of the research. To give their inputs and experience with regard to FDR problems as when 7

8 required To provide funding for the carrying out such types of research To give any necessary assistance required THANK YOU.. 8