Government procurement: bank guarantee cancellation will provoke dumping and extortion at tenders

Government procurement: bank guarantee cancellation will provoke dumping and extortion at tenders
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Federal law ? 44, “On the federal contract system”, as amended in December 2014, restricts the area of banking guarantee applications in the government procurement sphere. Project owners are not allowed to ask contractors for contract guarantees on contracts with banking support (contracts of 10 bln dollars and over) and on small businesses contracts.

The legislator presumably wanted to do a favor for contractors working under crisis conditions. It’s really a very difficult time for them: expenses have grown disastrously due to the rouble’s fall, and the contract price cannot be increased.
Half of government procurement contracts were supported by false guarantees.
At first glance, one might think that the guarantee cancellation allows a contractor to save money. And, even better, not at the expense of the budget. But the legislators don’t seem to have considered all the consequences. In practice, a guarantee cancellation on government procurement will create a number of problems both for governmental customers and for proper contractors.
We all remember the time of the ‘94 Federal Law operation, when dozens of companies participated in a tender even though the greater part of them had no intention of fulfilling the governmental contract: their participation was solely in order to extort money from real candidates threatened with dumping at the auction.
Bank guarantees were required, but they were not of great value due to the excessive number of “grey” guarantees – that is, counterfeit ones obtained with no effort. More than half of all government and municipal contracts were supported by counterfeit guarantees, according to information from the Federal Anti-Monopoly Service. It was difficult to bring them to light because the contractor had little time and few rights.
It was this that allowed jobbers to take part in the tenders and brought about groundless dumping at the auctions. Federal Law ?44 put an end to this. A unified register for bank guarantees was set up and it excluded the use of counterfeits.
Preliminary qualifications of tender participants excluded “grey” applicants
The demand for government tender participants to have a real bank guarantee turned out to be the main achievement of Federal Law ?44. In fact, this introduced preliminary qualification requirements for the tenders’ participants, the necessity of which had been much discussed. Preliminary qualifications carried out by governmental customers would have been expensive and biased, not to say corrupt. The banks’ preliminary qualification in the form of a tender participant check while granting a guarantee has become independent and objective, because banks are fully responsible for the financial side of the decision on granting the guarantee.
While granting a guarantee, banks check the company’s credit standing and construction experience including that of objects similar to those which are being tendered for. They also check if the company’s operation is real – a firm demand of the Central Bank of Russia that prevents granting a guarantee to fly-by-night companies. Three bank services - security, credit and risk evaluation – are at work in this area.
It has resulted in the reduction of the number of governmental tender participants and their dumping. The companies that are not ready to take bank testing do not take the risk of participating in tenders.
The legislator’s decision to restrict the number of banks with the right to grant guarantees in government procurement sphere works as follows: a bank must have existed for at least five years, and its own capital (bank property exceeding its liabilities) must be at least 1 bln roubles. So only reliable banks can grant guarantees in the government procurement sphere, and almost 2/3 of all financial institutes lack this right.
There are also general requirements according to which the guaranteed sum, granted by one bank to one company, cannot be more than 25% of the bank’s own capital, and the total amount of all granted guarantees cannot exceed the bank’s own capital by more than 10 times. These restrictions prevent the banks from granting guarantees they cannot cover.
More than 70% of all the guarantees are granted by the 10 largest banks. In case of a contractor’s bankruptcy, the banking guarantee is the only way for the customer to recover losses and receive punitive damages.
A banking guarantee is both a preventive and a compensatory measure
A banking guarantee provides for a customer’s recovery of losses resulting from a contractor’s poor quality work, which may only become evident much later, by which time the contractor may be out of reach.
In 2014, banks paid 50 bln roubles in guarantees. Only after the guarantees granted to LLC Scientific Development and Production Center “Mostovik”, did payments top 5 bln roubles. 40% of all payments occurred in the 4th quarter of 2014. That was the result of real guarantees granted according to Federal Law ? 44. As far as guarantees of Federal Law ?94, “On state procurements”, are concerned, the customer usually didn’t manage to get anything from the bank.
Thus, banking guarantees in the state procurement system have two functions:
A preventive function: to stop financially invalid and fly-by-night companies taking part in the tenders, to prevent dumping and to delegate work only to companies able to manage it.
A compensatory function: inescapable recovery of losses to the governmental customer, the recovery of advance payments and punitive damages.
In the current crisis, construction activity, including state procurement, has gone down significantly, but the number of construction companies has not decreased. Many of them are searching for any contract or any other way of earning money.
If the requirement for guarantees is cancelled it will cause a disastrous increase in the number of tender participants and, consequently, dumping, pay-off extortion and other negative things. It must not be countenanced.

Stanislav Matselevich, Director General of the NCP SRO “The First constructors’ craft union”