Title: FTA Procurement Regulations and Advanced Progress Payments
Phase(s): Pre-Preliminary Engineering
Date: March 2, 1998
The following lesson was learned regarding the Denver Regional Transportation District (RTD) and its procurement of 14 light rail vehicles from Siemens Transportation Systems, Inc. for its Southwest Corridor LRT project. RTD entered into a negotiated, sole source contract with Siemens in September, 1997. The contract price is approximately $28 million for 14 vehicles.
Article 22 of the General Terms & Conditions of the contract specifies the terms for progress payments. Basically, 20% of the contract price will be paid by RTD two months after Notice to Proceed (NTP) upon receipt of a Progress Schedule and Manufacturing and Delivery Plan. Another 30% will be paid four months after NTP upon receipt of Inspection and Test Programs and Procedures. Another 30% will be paid nine months after NTP upon the placement of orders by Siemens for long lead components. The remaining 20% of the contract price will be paid on a pro rata basis upon delivery and acceptance of the vehicles. Since the contract allows up to 2 years for delivery of the first vehicle, the accelerated payment schedule means that 80% of the contract price (i.e., $22.4 million) will have been paid well before the first vehicle is delivered. It is likely that RTD will not receive full commensurate value before it is required to make most of the payments specified in the contract.
RTD agreed to make advance payments because it received a lower price from Siemens in return. RTD intends to use local funds to make the stipulated advance payments to Siemens. RTD will not receive federal funds until later in the project and will not commit any federal funds towards the vehicle procurement until commensurate value is received from Siemens. RTD has arranged a financial transaction using Certificates of Participation whereby it will borrow money to pay for the vehicles. RTD will pay back the lender with federal funds after the vehicles are delivered and accepted by RTD and all costs have been incurred. RTD has also obtained a performance guarantee from the Siemens Corporation amounting to half of the contract's value. The performance guarantee, plus the fact that Siemens will incur some costs prior to receipt of payments by RTD, mitigates RTD's risk to some degree.
Initially, it appeared that RTD may have violated Article 12 of FTA Circular 4220.1 D which states:
1. Advance Payments. FTA does not authorize and will not participate in funding payments to a contractor prior to the incurrence of costs by the contractor unless prior written concurrence is obtained from FTA.
2. Progress Payments. Grantees may use progress payments provided the following requirements are followed:
a. Progress payments are made only to the contractor for costs incurred in the performance of the contract.
b. When progress payments are used, the grantee must obtain title to property (materials, work in progress, and finished goods) for which progress payments are made. Alternative security for progress payments by irrevocable letter of credit or equivalent means to protect the grantee's interests in the progress payments may be used in lieu of obtaining title.
After carefully considering the matter, the FTA determined that written consent was not required before RTD entered into its contract with Siemens because federal funds are not at risk. Purely local funds are being used to make the advance payments. When purely local funds are used, FTA does not have an interest; therefore, prior written concurrence is unnecessary. Where FTA does not have an interest, it considers it inappropriate to impose its authority by means of prior written concurrence.
In order to ensure that FTA funds do not get channeled into advance payments for the vehicles, FTA has asked RTD to set up a separate account to track advance payments. This will ensure that FTA funds for the Southwest Corridor LRT project as a whole are not commingled with local funds until fair value is received from the vehicle contractor.
2. The Lesson
A grantee is allowed to make advanced progress payments to a third-party contractor without obtaining prior consent from the FTA as long as purely local funds are at risk. The benefit of a reduced contract price through reasonable advance payment terms can be quite attractive given the grantee's ability to fund the payments and obtain a suitable performance bond. A measure of good judgment is needed in order to structure a payment schedule where each party to the contract assumes its fair share of risk. The FTA benefits because federal funds are not in jeopardy because federal funds are not involved in the payments to the contractor until commensurate value is received by the grantee.
In this particular case, RTD is simply adding onto a previous car order for more of the same vehicles it already has in revenue operations. Therefore, it does not appear that there would be much risk to RTD that the car builder will not deliver the finished product on schedule, as specified. However, when there is a new car procurement involving new subsystems, there could be considerable risk to the transit agency, if it were to agree to advance payments in exchange for a lower car price. Obviously, there is the risk, albeit to local funds only, that the contractor will not perform as required. The transit agency, having paid the contractor in advance, and would therefore be vulnerable to the negative impacts. This concern is mitigated to some degree by a performance bond, but the impact on the overall project could be significant. Grantees are, for that reason, cautioned to carefully consider all possible pitfalls before allowing advance payment terms in third-party contracts.