Corruption Risks in Infrastructure Projects Using Design-Build Contracts

For over a decade, state and local governments in the United States have been moving to streamline the procurement of roads, bridges, and other public works.  Traditionally, they contracted with one firm to design the project, and then, though competitive bidding, let a contract to a second firm to build it. For many projects, public authorities are now replacing this design-bid-build method of contracting with the design-build method of contracting.  One contract is awarded, competitively, to a single firm both to design and to build the facility.

Design-build contracts offer several advantages over a design-bid-build contract.  Three are most important for public procurements. One, accountability is centralized. If a problem arises during construction of a design-bid-build project, the builder can claim the fault lies not with it but with the firm that designed the project.  Two, design-build contracts are usually fixed-price, meaning the price is set before work begins.  With a design-bid-build contract, the cost varies with the amount of materials used and often as a result of problems arising during construction.  Finally, design-build projects take less time to complete.  With design-bid-build, no work begins until after the design is finished.  With design-build, preliminary construction work – clearing the site, levelling the terrain – can begin while the project is being designed.

These advantages have not been lost on less developed nations and donor organizations.  The number and size of public infrastructure projects the World Bank, the Asian Development Bank, and the other development banks are financing that use design-build are on the rise.  According to its 2018 Annual Review of Procurement Activities, the largest contract the European Bank for Reconstruction and Development funded in 2017 was a € 274 million design-build contract for an ore enrichment project in Kazakhstan.

But donors and developing countries should not ignore the major disadvantage of design-build contracts compared to design-bid-build contracts: corruption.  Blame for what many consider the most egregious public corruption scandal in American history has been attributed to the abuses that arose from a design-build contract, and indeed, corruption concerns spurred the United States to replace design-build contracts for public works with the more transparent contracting method today known as design-bid-build.

Until the 1920s federal public works contracts had in effect if not name been design-build contracts, one contract to one firm to handle all phases of the construction process. Infrastructure spending grew rapidly in the latter half of the 19th century, and so did corruption in contract award and execution.  Most notorious is the Credit Mobilier scandal, a staple of American history texts. Exposed in 1872, the scandal arose from the award of the contract to build the Transcontinental Railroad, then largest public works project the nation had ever undertaken, to Credit Mobilier, a firm secretly owned by railroad company executives and politicians.  Reports that tens of millions of dollars had been siphoned off into the pockets of powerful members of the House and Senate and Grant’s Vice President not only upended American politics but sparked a movement to reform public contracting.

Reformers thought the root of the problem was the discretion public procurement agencies enjoyed in the award of contracts.  This, they contended, made the decision process vulnerable to kickbacks, favoritism, and other forms of corruption. A first step was a 1926 law limiting agencies’ discretion by requiring the design be completed and made public before construction, thus allowing interested parties and the public to see whether the project was “gold-plated” and whether the estimated cost of construction was reasonable. Subsequent legislation further constrained procurement authorities’ discretion, requiring that, absent well-defined exceptions, construction contracts be let competitively and awarded to the lowest responsible bidder.  These efforts to reduce corruption by squeezing the discretion out of the award decision produced what is now termed design-bid-build contracting.

Not all the corruption in 19th century infrastructure contracts is traceable to the use of design-build. Credit Mobilier won the contract to build the Transcontinental Railroad through run-of-the-mill, plain vanilla bribery combined with dollops of insider dealing and conflict of interest. What made its contract especially lucrative was that it contained a cost-escalation provision with no independent check on whether the additional compensation it frequently requested to cover alleged cost increases was justified.

No modern design-build contract countenances bribery, and all provide for oversight of contract execution, whether by an independent engineer as the  form contract found in the FIDIC Yellow Book does, or by an owner’s agent as the design-build model contracts issued by the American Institute of Architects, the Associated General Contractors, and the Design-Build Institute of America do.  Nonetheless, as Congressional reformers were the first to recognize, the greater leeway design-build affords a procurement authority compared to design-bid-build heightens the risk of corruption in contract award. It is also true, as the literature on design-build contracting makes plain, that there is a heightened risk of corruption in contract execution with design-build compared with design-bid-build.

For some projects that are funded by international donors, the operational advantages of design-bid over design-bid-build — shorter completion time, fixed or maximum price, greater opportunities for value engineering – will far outweigh the drawbacks from higher corruption risks.  Moreover, as with any procurement, corruption risks with design-build will vary with what is to be procured.  Just as there is less corruption risk in the purchase of an off-the-shelf good than in buying a custom made one, there will be less risk where the facility’s design and performance requirements are well defined and the type of detailed design and construction to be performed is widely offered by the industry. Examples would the procurement of roads and schools versus a petrochemical plant.

Like the corruption risks in any donor-funded procurement, there are ways to mitigate those associated with design-build. Many are similar to if not the same as those donors recommend that their national counterparts employ with design-bid-build contracts. Below is a first effort to these risks in design-build contracts and to suggest mitigants. COMMENTS SOLICITED.

Short-list selection

The short-listing process involves first a request that interested firms submit their qualifications for the project from which, as the design-build literature recommends, three to five firms will be selected to respond to a request for proposals.

As with design-bid-build, one risk is that not all qualified firms are notified of the opportunity to submit their qualifications, and a second, again like with design-bid-build, is that one or more qualified firms are pressured to refrain from submitting their qualifications.  Mitigants similar to those in design-bid-build tenders, ensuring the Request for Proposals (RFP) is widely publicized and there is a hot-line or other way a threatened firm can alert authorities to pressure tactics, would seem to address both risks.

As with any short-listing process, there is a risk that one or more firms will be short-listed as a result of bribery, a conflict of interest, or favoritism.  One factor that may mitigate this risk is the time and expense needed to develop a response to the request for proposals.  Responding to a request to bid on a design-bid contract will almost always take significantly more time and effort than responding to a request to bid on the construction of a facility under a design-bid-build contract.  A firm would seem unlikely to try and buy its way onto a such short-list unless it was reasonably certain its proposal would be selected, a risk addressed in the following section

To motivate firms to compete for the project, some design-build contracts compensate the losing firms for the cost they incurred in preparing their proposal.  The Minnesota Department of Transportation pays somewhere between 0.2% and 0.4% of the estimated contract price to losing firms and pays bidders in some cases even if their proposal is non-responsive.  In return, the losing firms must turn over all their work papers and transfer any rights they have in the design or other intellectual property created in responding to the department.

If firms are to be compensated for submitting a proposal no matter whether it is chosen, a new risk of fraud and corruption risk is introduced.  A firm may seek to be short-listed simply to be paid for a submission of little or no value. – for example, one prepared for another project that is not responsive to the request for proposals. Or a compensated firm might not turn over all its work product.  The type of project and the differences in design-construction packages offered might be such that the risks are minimal.  But donors and their financiers should be sure they consider the risk and its likelihood.

Contract award

One reason the public authority seeking proposals on a design-bid contract might decide to compensate losing firms is to mitigate an operational risk that carries with it a corruption risk.  The design-bid literature notes that it can be difficult to find firms willing to compete for design-bid contracts because of a lack of experience with such contracts or a reluctance to assume the additional risks that design-bid transfers to the contractor. This may especially be the case with firms that compete for business in some developing nations.

The less the competition, the greater the risk of bid rigging.  On the other hand, bid rigging is far more common where the competition is for a simple, well-defined product – the economists’ widget or, in construction, a contract where the only variable is price.  Where the product is heterogeneous, as in a contract to both design and build, an agreement among competing firms to agree on a bid-rigging scheme is harder to reach and harder to enforce.

As with design-bid-build contracts, there are a number of ways to mitigate the risk of bid-rigging – from careful evaluation of submissions to identify tell-tale signs of coordination (sequentially numbered bid guarantees, identical drawings for onsite facilities) to precise cost-estimates that make it easy to spot unusually high prices.  (This 2011 World Bank study of corruption in road contract suggests additional mitigants.)

As the American experience illustrates, the risks of fraud and corruption in the selection of a design-build contractor are greater than with design-bid-build.  Those choosing the contractor have to make judgements about the merits of different designs and the trade-offs involved in the cost of building and operating the facility.  Splitting the design work from the construction work introduces a degree of subjectivity in the award decision not present when it turns solely on lowest price.

How much greater the fraud and corruption risks are in the design-build selection process depends upon how much of a judgement call is involved.  With a simple rural road, a warehouse, or other project where design and performance requirements are well established and the government and donor have experience with the required design and construction work, criteria to reduce the degree of judgement required in award selection will be available. An fine paper on design-build by Charles N. Juliana, Alann M. Ramirez and Brian J. Larkin identifies six different methods, with varying degrees of criteria to help reduce the scope for subjective judgements.

Besides introducing as many objective indicators into the evaluation process as possible, other mitigants, as with design-bid-build, are having one or more independent observers attend the meetings of the selection panel and conduct a post-award review of the submissions.  The existence of a robust bid protest system is also an important mitigant. The difference between application of these mitigants to a design-bid-build contract and to a design-build one is that design-build contracts demand more resources for the mitigant to be effective. While it may suffice for a single engineer knowledgeable about construction to be an independent observer of a design-bid-build selection process, it may require one schooled in design and another in construction to provide adequate oversight of the design-build selection process.   Claims made under the bid protest will likely be more complex and thus more difficult to evaluate as well.

Contract execution

The fraud corruption risks present in the execution of a design-bid-build are virtually the same as those present in a design-build contract. A contractor may use a lower quality or cheaper product than the design specifies.  The drawings may call for 14-gauge wire, but the contractor may use cheaper, 18-gauge wire instead. Or it may skimp on the type or thickness of the insulation the building requires or otherwise substitute lower-grade materials or not follow the design to increase its profits.

On the plus side, design-build contracts can lessen another common risk of fraud and corruption in contract execution: unnecessary change orders.  Design-build contracts shift the completion risk to the contractor as they are lump-sum, fixed-price, or cost-plus with a guaranteed maximum.  These provisions limit if not remove entirely the risk the contractor will increase the price through fraudulent or corruptly secured change orders. At the same time, though, this means that where a contractor seeks to dishonestly increase profits, its inability to submit false change orders raises the chances it will use substandard materials or otherwise deviate from the design specifications.  Calling for more careful oversight as construction progresses.

The principal way to mitigate fraud and corruption risks in the execution of any construction contrast is random, unannounced checks by the public agency’s staff, donor staff, the engineer that will be hired by the public agency to oversee the project, and by an engineer entirely independent of the agency.  Perhaps one hired by the donor and accountable only to it.  It will likely cost more to achieve the same level of risk reduction in a design-build than in a design-bid-build contract. This is because under design-build the contractor’s personnel are responsible for the design, and the contractor thus has an information advantage over overseers.  It will know the design far better than any entity overseeing it. The overseers, whoever they are, will first see the design as the project unfolds. By contrast, with design-bid-build they will have learned about the design as it was developed and put out for tender.  In fact, in many cases the engineer the public agency hires to supervise the contractor may know far more as it is common practice that the firm which developed the design is hired to oversee project construction.

 

Corruption is a risk in any public infrastructure contract.  Whether the project is to be built using a design-bid-build or a design-build contract, there are ways to mitigate it if governments and donors are alert to the risks and willing to commit the resources needed to prevent it.

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