In a move aimed at providing liquidity relief to the construction sector and cushioning banks’ exposure to disputed government projects, the government has framed new rules to pay out 75 per cent of arbitration awards secured by developers even if the department overseeing the project has challenged the outcome of the arbitration.
“In cases where the Ministry or Department has challenged an arbitral award and, as a result, the amount of the arbitral award has not been paid, 75 per cent of the arbitral award (which may include interest up to date of the award) shall be paid by the Ministry/ Department to the contractor/concessionaire against a bank guarantee,” the Department of Expenditure said in an order dated October 29.
A new rule — 227A — has been inserted in the General Financial Rules, 2017 for the purpose.
Limited bank guarantee
The bank guarantee will only be for 75 per cent of the arbitral award and will not cover the interest, which would be paid only if the subsequent court order requires refund of the amount.
“The payment shall be made into a designated escrow account with the stipulation that the proceeds will be used first for payment of lenders’ dues, second for completion of the project, and then for completion of other projects of the same Ministry or Department as mutually agreed or decided,” the order added.
Experts said the move would help a number of projects across the infrastructure sectors, with a large number of projects in railways and highways stuck in arbitration. Companies such as HCC and Reliance Infra will benefit from the move. However, there are practical challenges, they cautioned.
“This is a welcome step for government contracts, where a large amount of money is stuck in the arbitration process. However, there is a practical problem for its implementation as banks generally provide bank guarantees only with 100 per cent of the margin money,” said Tejas Karia, Partner and Head - Arbitration, Shardul Amarchand Mangaldas & Co.
“This is a welcome move which will allow better quality contractors to work on these projects. But a key challenge is implementation. Faster payout of arbitral awards will depend on how soon departments adopt these, and whether officials overcome their concerns in taking quick decisions,” said Manish Agarwal, infrastructure expert and Co-Founder, AskHowIndia.org.
The new rules come following decisions by the Cabinet Committee on Economic Affairs in November 2019 and August 2016 on initiatives to revive the construction sector.
“Over the last few years, an increasing number of infrastructure projects in the construction sector have been/are subject of prolonged legal proceedings,” the CCEA approval from November 2019 had noted, adding that a substantial number of these projects go into arbitration.
Challenge of the award defers the payment of the funds and leads to a severe liquidity constraint in the construction sector. It also leads to a ripple effect throughout the financial ecosystem, impacts the repayment of debt to lenders, and leads to higher NPAs, the approval added.