Significant suppliers – managing cash flows and adjustment regimes

1. On significant construction contracts, contractors in many instances need to procure from suppliers major supplies, often at significant cost. This presents problems. The usual approach is that the Principal will pay the Contractor for works performed. However, the Contractor will usually need to outlay a significant deposit with the supplier when it issues its purchase order. This can then place the Contractor in a cash flow bind, where the Contractor may be required to spend considerable sums downstream on a supplier, without having been paid by the Principal.
2. There are a couple of options available to contracting parties. The first is for the Principal to pay the Contractor before the Contractor pays the supplier, with the Contractor then providing the Principal with some security to the value of the downstream payment (i.e., a bank guarantee). If the Contractor does not wish to procure the bank guarantee, then in some instances a supplier’s bank guarantee will be acceptable to the Principal (so in effect, the Contractor is not out of pocket at all). The second option is to flip the scenario such that the Contractor pays the supplier downstream, but then obtains some form of “letter of credit” from the Principal, so the Contractor has some security from the Principal for the supplies procured.
3. The other cash flow issue which needs to be considered is adjustments for:
   1. Foreign exchange;
   2. Commodity prices;
   3. Shipping.
4. A Contractor who does not want to take any risk on any of these issues will seek to pass that risk to the Principal, usually by way of an adjustment regime.
   1. The foreign exchange adjustment regime will require the Contractor to note the foreign exchange rate at the date of executing the contract in the contract, and to include the appropriate foreign exchange rate adjustment calculation.
   2. Similarly, a commodity price adjustment regime will usually be pegged against the appropriate exchange. For example, for copper, the exchange rate will be pegged to the London Metals Exchange. The time at which the adjustment occurs will be the time at which the Contractor places the order downstream with the supplier; i.e., the time at which the Contractor locks in its downstream price with a supplier.
   3. Shipping can be a significant cost to Contractors and as such a regime can be included to adjust the value of shipping at the time the purchase order to the sub-supplier is issued.
5. These kinds of adjustment mechanisms protect the Contractor’s margin, but they can result in the Contractor increasing the value of the works or decreasing the value of the works. In either case, the Contractor’s margin should remain neutral and protected, provided these adjustment regimes have been properly implemented.