Wednesday, July 27, 2005

The Asian Development Bank Report


ASIAN DEVELOPMENT BANK (The Report)

MELAMCHI WATER SUPPLY PROJECT, NEPAL
BRIEFING PAPER
ON
INTEGRITY DIVISION INVESTIGATION

The Asian Development Bank's preparation or distribution of this document
does not constitute a waiver of its privileges and immunities.
15 July 2005

ABBREVIATIONS
AAR - Adit Access Roads
BER - Bid Evaluation Report
CIAA - Commission for the Investigation of Abuse of Authority
JBIC - Japan Bank for International Cooperation
JV - Joint Venture
ITB - Instructions to Bidders
Lama - Lama Construction Company
MLD - Million Liters per Day
MPPW - Ministry for Physical Planning and Water Works
MWSDB - Melamchi Water Supply Development Board
MWSP - Melamchi Water Supply Project
NDF - Nordic Development fund
NPR - Nepal rupee
NVC - National Vigilance Center
OAGI - Integrity Division of the Office of the Auditor General
OPEC - Organization of Petroleum Exporting Countries
RCCC - Royal Commission for Corruption Control
Sida - Swedish International Development Cooperation Authority

Note
In this report, $ refers to United States dollars.

CONTENTS
Page
I. BACKGROUND 1
II. ALLEGATIONS 1
III. SCOPE OF INVESTIGATION 2
IV. RESULTS OF INVESTIGATION 2
A. Procurement Process / Financial Requirement Qualification 2
B. Engineer’s Estimate 4
V. CONCLUSION 5

I. BACKGROUND

1. The Melamchi Water Supply Project (MWSP) is designed to solve the chronic water supply shortage in the Kathmandu Valley with the diversion of 170 MLD water from the Melamchi River through a 26-km long tunnel. The Project comprises five parts: infrastructure development, social and environmental support, institutional reforms, project implementation support, and other studies.

 2. The total cost estimate of the Project is $464 million. ADB approved a loan of $120 million in December 2000 and it became effective in November 2001. The Project is co-financed by Japan Bank for International Cooperation (JBIC), Swedish International Development Cooperation Authority (Sida), Nordic Development Fund (NDF), the Organization of Petroleum Exporting Countries (OPEC) fund, and the Government of Japan. Implementation progress has been slow and is behind the target. A major and critical component of the Project is construction of a 26.6 km tunnel that will convey water from the Melamchi River into the Kathmandu Valley for urban water supplies. Work under this contract includes constructing the adit access roads (AAR) Sindhu and Gyalthum (total length 20 km) to provide access to the tunnel adits. Hence, this contract is on critical path to start and complete the construction of the tunnel and consequently for overall implementation of the Project. Although this contract is financed under the OPEC loan, responsibility for implementation is delegated to ADB and procurement shall be conducted in accordance with ADB’s procurement guidelines.

 3. This contract was originally awarded to Hanil-Koneco Joint Venture in October 2002 but was terminated in May 2004 due to the contractor’s non-performance. In July 2004, the ADB Procurement Committee approved a recommendation for rebidding under postqualification procedures and a slight repackaging of the original contract, covering only Sindhu and Gyalthum AARs. On 13 January 2005, the Melamchi Water Supply Development Board (MWSDB) awarded contract MDS/AAR/02 to CCECC-Sharma-Lama JV, the lowest evaluated substantially responsive bidder.

II. ALLEGATIONS

4. In February 2005, the Royal Commission for Corruption Control (RCCC) began to investigate concerns that the project cost estimate may have been inflated to allow collusion and that the current contractor did not meet the financial qualification requirement, as defined in the Instruction to Bidders (ITB).

 5. On 30 April 2005, OAGI received an anonymous email, alleging that the contract has been awarded at exorbitantly inflated cost allowing collusion.

 6. In April and May 2005 a number of individuals associated with MWSP were arrested. Some of these individuals have been released, while others declined to post bail and, as far as we have been informed, remain in custody.

 7. RCCC, based on calculations of its consulted experts, estimates the construction costs for AARs Sindhu and Gyalthum should be NPR 644,782,188, while the project engineering consultant (the consultant) projected costs of NPR 972,002,755. RCCC believes that this difference may have given room for collusion.

8. RCCC has questioned whether CCECC-Sharma-Lama JV’s bid was responsive, because Lama Construction Company (Lama) only met the required working capital of $625,000 after submitting new, consolidated balance sheets during clarification.

 9. Neither OAGI’s anonymous complainant, with whom OAGI has been able to communicate with, nor RCCC have provided to this stage evidence of collusion or any other corrupt or fraudulent activity, nor have any parties alleged such activity has actually occurred.

III. SCOPE OF INVESTIGATION

10. OAGI fielded a mission to Nepal from 29 May to 2 June 2005 and met with government officials, officials of the implementing agency (MWSDB), consultants, ADB staff involved in the Project, bidders, the RCCC, the Commission for the Investigation of Abuse of Authority (CIAA), and the National Vigilance Center (NVC), and the complainants.

 11. OAGI has reviewed the ITB, original bid documents submitted by the winning contractor including balance sheets submitted, the Bid Evaluation Report (BER) prepared by the consultant and MWSDB’s review, clarifications to bid, documents, correspondence and reports obtained from consultants, MWSDB, bidders, complainants, NRM and operations division, as well as ADB guidelines, including User’s Guide Prequalification of Bidders. OAGI has also taken note of the charges against individuals to the extent these have been made available to OAGI.

IV. RESULTS OF INVESTIGATION

12. We found no irregularities in the procurement process leading to the award of contract MDS/AAR/02, based on the documentation we have reviewed, and, in this context, noted that the award of the contract to the lowest evaluated substantially responsive bidder was in accordance with ADB’s guidelines for procurement and the loan documents. In particular, we have assessed that CCECC-Sharma-Lama JV, including joint venture partner Lama Construction, met the financial requirement as per Section 3.1, of Appendix 1 to the ITB. Also, OAGI has considered the relevance of the Engineer’s Estimate in the context of the procurement process leading to the contract in question, and has not identified any type of irregularity to indicate this particular component has led to any violation of ADB’s Anticorruption Policy.

 A. Procurement Process / Financial Requirement Qualification

 13. Paragraph 5.1 b) of the section Qualification of the Bidder in the ITB defines that “a bidder shall have the technical and financial capacity to undertake the contract”. Paragraph 5.1 c) states that “bidder shall meet all the minimum postqualifying criteria given in Appendix 1 to the ITB. The Compliance requirements are also given in the same Appendix. The criteria are all pass/fail criteria, and the bidder must pass all criteria to be determined postqualified.”

 14. Section 3.1. of Appendix 1 to the ITB requires a working capital of minimum $2.5 million and defines that each joint venture partner must meet 25 percent of the requirement. It requires the submission of audited balance sheets or, if not required by the law of the bidder’s country, other financial statements acceptable to the Employer (MWSDB), for the last three years to demonstrate the current soundness of the applicant’s financial position and its prospective long-term profitability, but it does not define that a bidder must meet the working capital requirement in all three years.

15. ADB’s User’s Guide on Prequalification defines the working capital as “the difference between current assets and current liabilities, and measures the firm’s ability to generate cash in the short term. Current assets are cash and other assets suitable for conversion into cash within one year. Current liabilities are monetary obligations that must be paid out within the current year.” (Emphasis added.)

 16. The working capital is that part of the capital of a business enterprise available for its operations. It measures how much in liquid assets a company has available to build its business and indicates the bidders financial ability to meet its short-term obligations and expenses related to a project. Thus the working capital only provides a short-term indication. While the working capital of the past may indicate a trend and financial soundness, previous working capital figures are of little value to indicate a bidders ability to meet its short-term (e.g., project-related) liabilities/expenses.

 17. The working capital may include credit lines and overdraft facilities. Many companies try to optimize their cash management and minimize cash balances and liquid assets and, if necessary, prefer to use credit lines and overdraft facilities instead. The consultant, to whom MWSDB delegated bid evaluation, considered credit lines and overdraft facilities, if substantiated, as an integral part of the working capital. In 2004, according to bank guarantees provided in CCECC-Sharma-Lama JV’s original bid, Lama enjoyed credit lines of $385,000.

 18. On 13 October 2004, CCECC-Sharma-Lama JV submitted its bid for the AARs Sindhu and Gyalthum and Form FIN 3.1. as per Appendix 1 of ITB, financial statements including those of its joint ventures over the last five years (1999 – 2003). In this summary (Form FIN 3.1.), however, it only included its own assets and liabilities.

 19. The consultant evaluated CCECC-Sharma-Lama JV as conditionally the lowest responsive bidder. During the clarification process, the consultant also requested Lama on 4 November 2004 to submit its latest balance sheets to confirm its continued soundness and prospective long-term profitability in 2004. This action was not to clarify the already submitted financial situation.

 20. The consultant determined that Lama met the required working capital, because the company demonstrated current soundness of its financial position and its prospective long-term profitability through a positive trend in working capital, and that the bidder passed the criteria for the working capital in the last year (even though Lama failed to meet the criteria in the third and second year). As the working capital is short-term as outlined in paragraph 15 above, and without explicit ADB guidelines or instructions to the contrary, the consultant’s assessment is not incorrect.

 21. On 8 November 2004, upon the consultant’s request, Lama submitted latest balance sheet, for 2003/2004, which had not been available at the time of bid submission. This time Lama submitted a consolidated balance sheet, including its joint venture participations and also submitted consolidated balance sheets for 2001/2002 and 2002/2003. Additionally, Lama provided a revised Form FIN 3.1, listing its consolidated assets, but it did not replace or alter the previously provided balance sheets.

 22. Based on the consolidation of the originally submitted balance sheets, ADB’s guidelines on prequalification and its definition of working capital, the consultant’s bid evaluation
methodology and explanations and MWSDB’s endorsement, Lama met the required working capital in 2002/2003 as defined in Section 3.1. of Appendix 1 to the ITB. Including the guaranteed credit lines and overdraft facilities, Lama would even meet the requirement on its own.

 B. Engineer’s Estimate

 23. The Engineer’s Estimate primarily serves as a tool for budgeting purposes and as a tool for the Executing Agency together with the Consultant, to determine whether a bid is reasonable. If bids substantially defer from the Engineer’s Estimate it may be that either the estimate is inaccurate or that the bidding documents have not provided a sufficiently clear basis for the bidders to prepare the bids. According to the Guidelines for Procurement under Asian Development Bank Loans, paragraph 2.48, the borrower may reject all bids if there is evidence of lack of competition or where all bid prices substantially exceed the cost estimate.

 24. In cases where the lowest bid is substantially lower than the Engineer’s Estimate, there is a good reason to seek clarifications from the bidder in question, and to carefully assess what the reasons for the difference between the Engineer’s Estimate and the bid price might be, and in particular to assess whether the bidder may have underestimated the resources required, and therefore risking that the works will not to be able to be completed in accordance with the contract.

 25. A bid that is substantially lower than the Engineer’s Estimate, may be disqualified if the bid or subsequent clarifications by the bidder, explaining how the low bid price has been reached, does not meet the Executing Agency’s (and ADB’s) satisfaction. In some jurisdictions a bidder, whose bid is substantially lower than the Engineer’s Estimate, may be required to support the bid by additional performance security to compensate for the risk associated with allowing such financially uncertain bid to be awarded the contract.

 26. An estimate “implies a judgment, considered or casual, that precedes or takes the place of actual measuring, counting or testing out.”1 Under the procedures of International Competitive Bidding (ICB), all eligible bidders have equal opportunities to submit their bids based on the actual bidding documents.

 27. As such the Engineer’s Estimate is usually not part of the bidding documents, which was the case for the Sindhu and Gyalthum Adit Access Roads, and does not affect the bid prices other than as described above.

 28. In the 1999 final design study carried out under the Project, the cost of the Sindhu and Gyalthum Adit Access Roads was estimated at NPR 672,000,0002. The original contract that included these two roads and other works was awarded in 2002 to Hanil Koneco JV for its bid price at NPR 456,182,1533, compared to the Engineer’s Estimate for the total package of NPR 888,767,550. As mentioned in paragraph 3, the original contractor did not complete the works, and the contract was terminated in May 2004.

1 Merriam-Webster’s Collegiate Dictionary.
2 Equal to USD 9.2 million in the final design study 1999, excluding contingencies and VAT.
3 Excluding NRP 10.8 million estimated cost of expected increase in transport and excavation; plus 10% for contingencies.

29. The Consultant prepared a third estimate in 2004 for rebidding purpose, estimating the costs of the two roads alone at NPR 972,000,000.

 30. Based on the evolution of the Engineer’s Estimate over the five-year period from 1999 to 2004, and taking note of the first contractor’s inability to perform its obligations under the contract at a bid price that was substantially lower than the 1999 and 2001 Engineer’s Estimate, the latest estimate from 2004 does not seem to be inappropriate.

V. CONCLUSION

31. Based on the assessment of the documents in its position and the interviews carried out, OAGI has not found or received any evidence of collusion or other corrupt or fraudulent practice among those involved in the bidding process for the MDS/AAR/02 contract.

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