Construction delays are a very real risk. The UK’s National Audit Office recently advised that over a third of all major government projects due to be delivered in the next five years were already “unachievable” or “in-doubt”. The same institute had earlier warned in 2001 that 70%10 of UK government projects were likely to be delayed.

1. Project Finance: Construction Risk
Page 1 of 4June 2016
1
For example, www.timesofindia.indiatimes.com/topic/Power-Cut.
2
www.eskom.co.za
3
The World Bank, ‘Global Infrastructure Facility’.
4
World Economic Forum, ‘Strategic Infrastructure: Steps to Accelerate Public-Private Partnerships’, May 2013.
5
American Society of Civil Engineers, ‘2013 Report Card of America’s infrastructure’.
6
Organisation for Economic Co-operation and Development (OECD), ‘Financing Infrastructure – International Trends’, Della Croce and Gatti, 2014.
7
Thomson Reuters, ‘Global Project Finance Review first nine months of 2015’.
8
World Economic Forum, ‘The Global Infrastructure Gap’, 2013.
9
United Kingdom National Audit Office, ‘Delivering major projects in government: a briefing for the Committee of Public Accounts’, January
2016.
10
United Kingdom National Audit Office, ‘Modernising Construction’, 2001
Infrastructure Gap
Infrastructure throughout the world
is struggling to meet demand:
roads in many cities are at capacity,
countries such as India1
and South
Africa2
operate rolling blackouts as
they cannot supply enough electricity
to meet consumer need; and over
758 million people worldwide have
no access to clean water3
.
As reported by the World Economic
Forum4
, this infrastructure demand
results from various factors and is not
restricted to developing nations:
Infrastructure projects are
traditionally funded by governments
and development agencies; however,
growing demand combined with
insufficient investment has led to a
funding gap estimated to be over
US$1 trillion per year5
.
The American Society of Civil
Engineers advises that the USA faces
an infrastructure funding shortfall of
up-to US$3.6 trillion to 20206
.
Investment Opportunities
This gap has created investment
opportunities that have seen funding
shift from the public to the private
sector7
.
Within the first nine months of 2015,
the private sector invested over
US$113.3 billion in infrastructure
related projects. This was an increase
of approximately 7.1% over the same
period in 20148
.
Project finance and infrastructure
investment has found particular
favour with institutional investors,
looking for longer-term maturity with
lower risk profiles.
Furthermore, investment in
developing nations’ infrastructure
has a philanthropic appeal; helping
countries realise the economic
growth potential of their young
demographic population.
Project Finance Risk
Project finance is a specialised form
of lending where credit is extended,
on a non-recourse or limited recourse
basis, to a newly formed and poorly-
capitalised Special Purpose Vehicle
(‘SPV’).
The SPV’s ability to service debt is
likely to depend on the project’s
completion and the subsequent
realisation of its benefits.
TakeforexampleanSPVset-uptoown
and operate a toll road. It requires a
large capital investment to construct
the project; however, no revenue is
generated until the road opens and
tolls start to be collected. Until that
time, it has no ability to self-service
its debt obligation.
To reduce finance and project cost,
debt pay-down will be scheduled to
commence as close to road opening
as practicable.
In that case, both the SPV and lender
must have certainty that the project
will complete as forecasted. Delays
to the road’s construction and,
consequently the SPV’s revenue
stream, put at risk the ability to
service this debt as scheduled. In
that case, the funder faces a default
by an entity whose only asset is an
incomplete road.
Managing construction risk and, in
particular, minimising project delay
is clearly a matter that concerns both
the lender and SPV.
Construction Delays
Construction delays are a very real
risk. The UK’s National Audit Office9
recently advised that over a third of
all major government projects due
to be delivered in the next five years
were already “unachievable” or
“in-doubt”. The same institute had
earlier warned in 2001 that 70%10
of
UK government projects were likely
to be delayed.
“In developing countries, it is
driven by growing population,
economic growth, urbanization and
industrialization. In the developed
world, a particular concern is that
so much legacy infrastructure needs
maintenance and rehabilitation,
owing to the ageing of assets, stricter
environmental regulations and the
globalization of supply chains”.

2. Excusable Delays
Although delay to a project’s
completion is a matter of fact,
its contractual treatment differs
depending on who was responsible
(if anyone) for that delay.
In the event a delay is excusable
(i.e. due to an SPV risk event) the
contractor is entitled to additional
payment to compensate its
consequential loss and expense. In
addition, the SPV will be liable for
further delay related costs, which
may include (but are not limited to):
• Prolonged liability to pay its
project staff and consultants.
• The additional cost to extend
insurances and other financial
liabilities.
• Potential damages due to the
inability to fulfil contractual
obligations with other related
parties.
• Additional storage and other site
costs.
• Increased exposure to currency
exchange and interest rate risks.
If practicable to do so, the SPV may
attempt to recover the excusable
delay. This will require an agreement
with the contractor to ‘accelerate’
the project. Such agreement
incurs additional cost, often with
no guarantee that the delay will be
recovered.
Non-Excusable Delays
Alternatively, when delay is caused
by the contractor, the SPV may
recover liquidated damages. These
are pre-estimates of loss, usually
capped to no more than 10% of the
construction contract price. There
exists, therefore, a significant chance
that liquidated damages will be
insufficient to cover the SPV’s losses.
Liquidated damages are usually
secured by a bond or cashable
guarantee provided by the contractor.
However, the funder should consider
that establishing liability for a delay
can be complicated and time-
consuming. In some jurisdictions11
if there is doubt that the delay was
factually caused by the contractor,
a bond call may be prevented as
unconscionable.
Further Funding for Delay?
Irrespective of who was responsible
for the delay; the consequential
increased cost may cause the SPV to
seek further capital to complete the
project. The funder must then decide
whether to extend more credit or risk
the project’s failure, the SPV’s viability
and, consequently, the return on its
investment.
Transfer of Construction Delay Risk
A common risk management strategy
is to transfer the risk to another,
more suitable, party. The SPV (and
by proxy the funder) may seek to
transfer the construction delay risk to
the contractor.
Normally, parties will use the
contract as the vehicle to allocate
risk in a transaction. In the context
of construction delay, it has been
suggested12
that the SPV may transfer
this risk to the contractor by letting
the project on a turnkey basis, for
example using an Engineering,
Procurement and Construction
(‘EPC’) contract.
This EPC contract strategy may appeal
to a funder as it seems to carry less
exposure. However, whether delay
risk is fully transferred is moot.
Particularly as some liabilities, such
as stakeholder management and land
acquisition usually rest with the SPV.
There may also be other
considerations that make this form of
contract unsuitable.
Contractors price EPC contracts at a
premium to account for their elevated
risk liability. Yet, they are only
obliged to design and construct to
meet the minimum output specified.
This is normally done in the most
economical way practicable for the
contractor, which may fall short of
the SPV’s expectations.
Variations to the project, whether
due to SPV revisions or in response
to external risk factors, also attract a
premium and so may incur significant
additional cost to the project.
Finally, like other construction
contract types, the SPV’s remedy
under an EPC contract in the event of
non-excusable delay lays in liquidated
damages, whose sufficiency cannot
be guaranteed.
Delay in Start-up (DSU) Insurance
The financial consequences felt from
construction delays have created a
demand for innovative insurance
products. These DSU policies cover
loss from project delays caused by
‘indemnifiable’ events.
Successful DSU claims usually have
three limbs13
:
• An event ‘indemnifiable’ under
the physical damage policy.
• The resultant delay exceeds the
DSU deductible.
• A resultant loss of the interest
insured (e.g. Gross Profit).
However, these policies exclude
delays caused by events not covered
by the physical damage insurance.
These include delays that result
from the contractor’s slow progress,
non-performance or late supply of
materials.
DSU insurers will undertake a detailed
investigation into any claim. The SPV
will likely need to evidence the actual
progress at the time of the insured
event, as-well-as other material facts
related to progress. Accordingly, the
claim’s success rests on the quality of
the project’s records, which can be
problematic14
.
Plainly, the funder and SPV cannot
rely on DSU insurance to absorb the
financial effect of project delay.
Funder’s Investigations
It is evident that the prudent funder
will factor project delay into its
financial modelling and due diligence.
It will either satisfy itself that the
project will complete on time or
determine the most likely completion
date and make provisions accordingly.
Page 2 of 4June 2016
Project Finance: Construction Risk
11
For example, Singapore and Malaysia.
12
For example see Fletcher and Pendleton, ‘Identifying and Managing Project Finance Risks: Overview (UK), Practical Law 5-564-5045.
13
The International Association of Engineering Insurers, ‘Delay in Stat Up Insurance’, 2012.
14
World Bank, ‘Why Records Management’

3. Page 3 of 4June 2016
Project Finance: Construction Risk
To do so, it is necessary to interrogate
the basis on which the project’s
timings are founded. From this, it
may assess the project’s likelihood of
timely success or, alternatively, the
potential for construction delays and
estimate their affects.
Project Programmes
Project timings are derived from
construction programmes usually
developed at various stages of the
project’s lifecycle.
A programme breaks down the
project into work tasks, each with
its own duration. These are usually
referred to as ‘activities’.
These activities are logically linked
to each other in a manner that
represents the project’s planned
sequence. For example, if Activity
A can only start when Activity B has
completed, then Activity B will be
logically linked to Activity A with a
‘Finish-to-Start’ relationship.
When all the activities are logically
linked, they form a network. A
delay to one activity may have a
consequential effect on its successor
activity and so on throughout this
network.
From the network the critical
activities can be identified. If delayed,
these will have a reciprocal impact to
the project’s completion, accordingly,
risks that impact on them should be
given the greater priority.
The funder will take further interest
in the programme as monetary value
can be attached to each activity – for
example, the cost of plant, equipment
and labour. From this, a cash-flow or
capital drawdown forecast can be
derived.
Programme Model Quality
The project’s programmes are
invaluable management tools;
however, they must be given their
proper context: they are forecasts,
based on an assumption that these
future activities will be performed in
the sequence and times planned.
The prudent funder will test this
model’s veracity. A poor quality
programme will distort subsequent
financial and risk assessments, which
undermines the basis for lending.
Various standards and methods exist
to assess whether a programme is
of sufficient quality to be used for
financial and risk modelling. These
assessments can be provided by
specialist consultants.
Once deemed sufficiently robust, the
programme can be used to model
construction delay risk. Specifically,
the probabilistic likelihood that the
project will complete on time or,
alternatively, the completion date
that the funder believes is likely to be
achieved.
Duration Uncertainty
As noted earlier, the programme
shouldbeconsideredaforecast,based
on planned future performance. It
is, therefore, not possible to state
with certainty that an activity will
be performed within its estimated
timetable. Instead, this duration
should be considered as a distribution
between three timeframes: the least,
most likely and maximum amount
of time that activity will take to be
performed (Figure 1).
Statistical analysis tools can model
this duration uncertainty and its
effect on the project’s completion
dates.
Risk Analysis (QSRA & QCRA)
In addition to duration uncertainty,
it is necessary to assess how
external factors, such as risks and
opportunities, may influence the
programme and the project’s
completion date and cost.
These risks and opportunities can
be valued and assessed in various
ways. Arguably the most robust is the
Quantitative Schedule Risk Analysis
(QSRA) and Quantitative Cost Risk
Analysis (QCRA). These techniques
are particularly favoured by the Oil
and Gas industry, where they have
been successfully used for many
years.
As the name suggests, these analyses
require a quantitative assessment for
each risk or opportunity. In particular,
a probabilistic likelihood that it will
occur and, in that event, the effect it
may have in terms of both time and
cost.
As a modelled form of assessment,
the QSRA and QCRA’s reliability is
dependent on the accuracy of the
quantitative values included. Care
should be taken to validate and
benchmark the information prior to
its use in the risk analysis.
Figure 1 – Historic data can be graphically presented to identify the minimum, most
likely and maximum durations similar activities have historically taken.

4. Once this quantitative data has been
verified;theriskoropportunitycanbe
attached to the effected programme
activity(ies). Thereafter, statistical
analysis tools, such as a Monte Carlo
Simulation, model their likely effect
on the project’s completion (Figure 2)
and outturn cost.
From the QSRA and QCRA results, the
funder can determine the level of risk
posed by project delays.
Example
Consider a simple coal-fired power
station project for which an SPV has
been established to build and own
the project. This entity is owned by
three established parties, but is not
well capitalised and has no other
assets.
The SPV has entered into a series of
contracts: an EPC contract with an
internationally renowned contractor
to construct the power station, a
favourable coal supply contract with
a local mine and a generous take-
off agreement to sell the generated
electricity.
The SPV requires funding for the
project. It estimates the project will
take four years before it achieves
its Commercial Operational Date
(‘COD’).
At this point, the project seems a
reasonable proposition.
To support its application, the SPV has
provided a preliminary programme
for the construction works.
On closer inspection the programme’s
logic is found to be incomplete.
Furthermore, when duration
uncertainty is factored, the forecast
completion appears overly optimistic.
In fact, the revised probabilistic
completion is now estimated at four
years and five months with the cost-
to-complete increased by 15%.
In addition, a risk and opportunity
register was prepared, quantified and
validated against experience gained
from similar projects. A QSRA was
performed, which estimated the
completion date, with an 80% chance
of success (P80 date), was four years
and eleven months. Likewise, the
QCRA forecast an increased cost-to-
complete of 23% above the original
budget.
Does the proposition still seem
attractive? n
This article is written by Lee Baker,
Director, Hill International, Inc.
Disclaimer: This article does not constitute
advice, legal or otherwise, and is provided only
as general commentary. Appropriate professional
advice should always be obtained before taking or
refraining from taking any action in relation to such
information and/or the application of applicable
law. This article and the materials contained in it are
provided on the basis that all liability for any loss or
damage, whether direct or indirect, arising out of
or in connection with any use or reliance upon this
article is excluded to the fullest extent permitted by
law.
Project Finance: Construction Risk
Page 4 of 4June 2016
Hill International, with over 4,600
professionals in 100 offices worldwide,
provides programme management,
project management, construction
management, construction claims and
other consulting services primarily
to the buildings, transportation,
environmental, energy and industrial
markets. As a pioneer of the construction
claims industry, we have a thorough
understanding of what can go wrong on
a construction project or programme
as we have helped avoid or resolve
problems in almost every market sector
for nearly four decades. Our approach to
project management is to minimise risk
from the earliest stages of a project and
to provide our clients with independent
and objective guidance from concept
through completion.
Figure 2 – The QSRA registers the completion date observed over one thousand
‘What-if?’ scenarios. These can be graphically represented and probabilistic values
derived. In this example, the contracted completion date was 11 December 2015,
which was only achieved 15% of the time. Whereas, there is an 80% chance that the
project will complete by 17 December 2015.
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