Legal and Regulatory Requirements

The owners of facilities naturally want legal protection for all the activities involved in the construction. It is equally obvious that they should seek competent legal advice. However, there are certain principles that should be recognized by owners in order to avoid unnecessary pitfalls.

Legal Responsibilities

Activities in construction often involve risks, both physical and financial. An owner generally tries to shift the risks to other parties to the degree possible when entering into contractual agreements with them. However, such action is not without cost or risk. For example, a contractor who is assigned the risks may either ask for a higher contract price to compensate for the higher risks, or end up in non-performance or bankruptcy as an act of desperation. Such consequences can be avoided if the owner is reasonable in risk allocation. When risks are allocated to different parties, the owner must understand the implications and spell them out clearly. Sometimes there are statutory limitations on the allocation of liabilities among various groups, such as prohibition against the allocation of negligence in design to the contractor. An owner must realize its superior power in bargaining and hence the responsibilities associated with this power in making contractual agreements.

Mitigation of Conflicts

It is important for the owner to use legal counselors as advisors to mitigate conflicts before they happen rather than to wield conflicts as weapons against other parties. There are enough problems in design and construction due to uncertainty rather than bad intentions. The owner should recognize the more enlightened approaches for mitigating conflicts, such as using owner-controlled wrap-up insurance which will provide protection for all parties involved in the construction process for unforeseen risks, or using arbitration, mediation and other extra-judicial solutions for disputes among various parties. However, these compromise solutions are not without pitfalls and should be adopted only on the merit of individual cases.

Government Regulation

To protect public safety and welfare, legislatures and various government agencies periodically issue regulations which influence the construction process, the operation of constructed facilities, and their ultimate disposal. For example, building codes promulgated by local authorities have provided guidelines for design and construction practices for a very long time. Since the 1970's, many federal regulations that are related directly or indirectly to construction have been established in the United States. Among them are safety standards for workers issued by the Occupational Health and Safety Administration, environmental standards on pollutants and toxic wastes issued by the Environmental Protection Agency, and design and operation procedures for nuclear power plants issued by the Nuclear Regulatory Commission.
Owners must be aware of the impacts of these regulations on the costs and durations of various types of construction projects as well as possibilities of litigation due to various contentions. For example, owners acquiring sites for new construction may be strictly liable for any hazardous wastes already on the site or removed from the site under the U.S. Comprehensive Environmental Response Compensation and Liability (CERCL) Act of 1980. For large scale projects involving new technologies, the construction costs often escalate with the uncertainty associated with such restrictions. 



by Chris Hendrickson, Department of Civil and Environmental Engineering, Carnegie Mellon University, Pittsburgh, PA l52l3 Copyright C. Hendrickson 1998
First Edition originally printed by Prentice Hall, ISBN 0-13-731266-0, 1989 with co-author Tung Au.
Second Edition prepared for world wide web publication in 2000.
Version 2.2 prepared Summer, 2008.

Financing of Constructed Facilities

A major construction project requires an enormous amount of capital that is often supplied by lenders who want to be assured that the project will offer a fair return on the investment. The direct costs associated with a major construction project may be broadly classified into two categories: (1) the construction expenses paid to the general contractor for erecting the facility on site and (2) the expenses for land acquisition, legal fees, architect/engineer fees, construction management fees, interest on construction loans and the opportunity cost of carrying empty space in the facility until it is fully occupied. The direct construction costs in the first category represent approximately 60 to 80 percent of the total costs in most construction projects. Since the costs of construction are ultimately borne by the owner, careful financial planning for the facility must be made prior to construction.

Construction Financing

Construction loans to contractors are usually provided by banks or savings and loan associations for construction financing. Upon the completion of the facility, construction loans will be terminated and the post-construction facility financing will be arranged by the owner.
Construction loans provided for different types of construction vary. In the case of residential housing, construction loans and long-term mortgages can be obtained from savings and loans associations or commercial banks. For institutional and commercial buildings, construction loans are usually obtained from commercial banks. Since the value of specialized industrial buildings as collateral for loans is limited, construction loans in this domain are rare, and construction financing can be done from the pool of general corporate funds. For infrastructure construction owned by government, the property cannot be used as security for a private loan, but there are many possible ways to finance the construction, such as general appropriation from taxation or special bonds issued for the project.
Traditionally, banks serve as construction lenders in a three-party agreement among the contractor, the owner and the bank. The stipulated loan will be paid to the contractor on an agreed schedule upon the verification of completion of various portions of the project. Generally, a payment request together with a standard progress report will be submitted each month by the contractor to the owner which in turn submits a draw request to the bank. Provided that the work to date has been performed satisfactorily, the disbursement is made on that basis during the construction period. Under such circumstances, the bank has been primarily concerned with the completion of the facility on time and within the budget. The economic life of the facility after its completion is not a concern because of the transfer of risk to the owner or an institutional lender.

Facility Financing

Many private corporations maintain a pool of general funds resulting from retained earnings and long-term borrowing on the strength of corporate assets, which can be used for facility financing. Similarly, for public agencies, the long-term funding may be obtained from the commitment of general tax revenues from the federal, state and/or local governments. Both private corporations and public agencies may issue special bonds for the constructed facilities which may obtain lower interest rates than other forms of borrowing. Short-term borrowing may also be used for bridging the gaps in long-term financing. Some corporate bonds are convertible to stocks under circumstances specified in the bond agreement. For public facilities, the assessment of user fees to repay the bond funds merits consideration for certain types of facilities such as toll roads and sewage treatment plants. [3] The use of mortgages is primarily confined to rental properties such as apartments and office buildings.
Because of the sudden surge of interest rates in the late 1970's, many financial institutions offer, in addition to the traditional fixed rate long-term mortgage commitments, other arrangements such as a combination of debt and a percentage of ownership in exchange for a long-term mortgage or the use of adjustable rate mortgages. In some cases, the construction loan may be granted on an open-ended basis without a long-term financing commitment. For example, the plan might be issued for the construction period with an option to extend it for a period of up to three years in order to give the owner more time to seek alternative long-term financing on the completed facility. The bank will be drawn into situations involving financial risk if it chooses to be a lender without long-term guarantees.
For international projects, the currency used for financing agreements becomes important.  If financial agreements are written in terms of local currencies, then fluctuations in the currency exchange rate can significantly affect the cost and ultimately profit of a project.  In some cases, payments might also be made in particular commodities such as petroleum or the output from the facility itself.   Again, these arrangements result in greater uncertainty in the financing scheme because the price of these commodities may vary.

 by Chris Hendrickson, Department of Civil and Environmental Engineering, Carnegie Mellon University, Pittsburgh, PA l52l3 Copyright C. Hendrickson 1998
First Edition originally printed by Prentice Hall, ISBN 0-13-731266-0, 1989 with co-author Tung Au.
Second Edition prepared for world wide web publication in 2000.
Version 2.2 prepared Summer, 2008.