CCEA measures will improve liquidity of the construction sector: ICRA

CCEA measures will improve liquidity, trigger revival of the construction sector: ICRA

In ICRA’s view the recent initiatives put forth by the NITI Ayog, and approved by the Cabinet Committee on Economic Affairs (CCEA) for revival of the construction sector, are a key positive for the stressed construction sector. A major respite is likely to come in the form of the release of the much-needed liquidity in short term from long-pending claims, which would also help reduce the leverage of construction companies and enable them to focus on improving execution.

This way, while the dispute resolution process may continue, releasing 75% of arbitral award to contractors (against margin-free bank guarantees) will help improve their liquidity, and project execution. However, this would require a sizeable fund outflow from the Government Department/PSUs for payment of 75% of the arbitral awards, which have been made in favour of construction companies but have been contested at the next level.

Shubham Jain, Vice President, ICRA, said:“Stress in the construction sector is visible from the meagre 1.5% growth in construction GVA in Q1 FY2017. CCEA’s recent initiatives will provide immediate liquidity to the developers by releasing their capital blocked in claims. This in-turn can assist developers in reducing debt, and expediting execution. Over the longer term, measures announced will also help in faster dispute resolution and lower blockade of funds in disputes.”

Close to Rs. 70,000 crore claims are stuck in various stages of arbitration. For the National Highways Authority of India (NHAI) alone, as on March 31, 2015, 113 arbitration cases and 83 court cases involving Rs. 22,426 crore were pending. As per CII, pending claims constitute close to 1.5 times the debt of construction companies with average settlement time for claims being more than seven years. In the case of NHAI, out of a total of 347 arbitral awards, 89% (309 awards) were in favour of the contractor/concessionaire. However, many arbitration awards are contested in the courts and majority of the arbitration decisions are upheld by courts, but this leads to delays in realization of claims.

CCEA announced other measures like move towards the amended Arbitration Act, and item rate contracts will yield positive results in medium to long term. Earlier, in Dec-2015, the Arbitration and Conciliation (Amendment) Bill, 2015 was passed. As per the amended Act, timelines have been defined for the arbitration tribunal. To start with if the parties are not able to appoint arbitrators within 30 days, the matter is to be referred to courts to make such an appointment. The arbitration tribunal has to make its award within 12 months, which may be extended by another six months. Furthermore, any challenge to the arbitration award before a court must be disposed off within a period of one year. With the new guidelines, if the arbitration tribunal award is in favour of contractor and even if the authority chooses to appeal in court against the award, it will have to release 75% of the award amount. The new Arbitration Act would reduce the time taken to realize claims to a maximum of ~1.5 years for atleast 75% of claims (~2.5 years for full claim settlement) compared to average claims settlement time of 7 years in past.

Move towards EPC contracts from the conventional item rate contracts will also help lower disputes. Under the item rate contract, the project authority provides the detailed design and quantity of estimates for different items of work based on which payment is to be made. Item rate contracts are more prone to disputes, particularly from the non-scheduled/extra items of work.

Table 1: Key measures announced and their expected impact

(Source: Press Information Bureau - Government of India, ICRA research)

Table 2: Status of Claims in NHAI projects

(Source: ICRA research, NHAI DRHP Oct/Dec 2015)