GREGORY LEE: Put government procurement funds into escrow

As Business Day reported recently, the Supreme Court of Appeal (SCA) has made a welcome ruling that government departments cannot procure services or goods unless they actually have the money to pay for the contracts (“Government contracts with no money to pay for them are unlawful, court rules,” January 2).

While a step in the right direction, this is not enough to solve the longstanding issue of government contractual nonpayment. Speak to almost any small or medium business that has done business with the government and they will relate exhaustive stories of either being jilted or strung along.

I was myself brazenly informed by the Passenger Rail Agency of SA (admittedly a state-owned enterprise [SOE], not a department) that it simply would not pay me for services rendered some years ago, knowing that it would not be worth my while to sue. So, I vowed never to do business with SOEs or the government again.

Government nonpayment for services has become a major economic inhibitor, creating enormous distrust between those who can do the work and the national imperatives for economic movement. 

The SCA’s ruling has several limitations though. It has no monitoring or enforcement mechanism at the point of contract or start of work, which is the key phase for such instances. Contractors to the government will generally have no real way of verifying that the money is, in fact, available and it is unlikely that they can get departments to verify this reliably. Tender systems are simply not set up for this sort of thing.

Money also gets moved around: funds that were present can get drained away to other sources in the course of the budget cycle, and this will only be known once the breach of contract has occurred. This is exactly the sort of thing that brought about the SCA case in the first place. 

What I have been advocating for years is that the government should be required to place project funding into escrow — that is into a protected account administered by accredited financial institutions (for example, Tradesafe and Paysho for more individual-level escrow, and Standard Bank’s offering).

In escrow funding, payment is guaranteed if the service is agreed by the buyer to have been provided adequately or if deemed to have been adequate by adjudication by a dispute adjudicator. Conversely, the funding would only be retained by the government entity if the provider of the service or goods is demonstrably in breach of contract. By ringfencing the amounts the uncertainty and defrauding of contractors by the government will be significantly reduced. 

It is true that escrow has complexities that need to be considered carefully. Most importantly, governance mechanisms would need to be in place to deal with disputes regarding contract or phase completion (for instance, if the government entity disputes quality or completion).

In individual escrow arrangements, the holder of the funds often adjudicates disputes, but financial institutions are not geared up for such disputes, which are often technical in nature. Bodies such as engineering councils, legal bodies and so on would need to be identified and agreed on to adjudicate disputes. This, in any case, would be a feature of a well-drafted contract. 

It would not be in the government’s interests, or indeed even possible, to ringfence the entirety of funds for large multi-phase projects. These types of projects can be divided into sensible phases, with funds required for each such phase and performance management defined accordingly. Again, metered funding should be part of normal contracting anyway. 

The escrow transaction costs (the cut paid to the financial services institution) would add to the net transaction costs of government business. However, smart contracting with these institutions should be able to come up with significantly reduced but reasonable fees given the enormous volumes involved.

An alternative could be for the National Treasury to create its own escrow service, although the cost of this would substitute for the fees and would not necessarily be desirable. As there is already a diversity of escrow service providers, they should compete for the work and can be vetted and substituted if necessary, or treated as a pool. 

The route to turning government business to an escrow model should not be judicial, it should be legislative. The Treasury really should consider the advantages of such a model, and through the minister propose appropriate legislation. In such sanity lies at least one key to unlocking our partially frozen economy. 

• Lee, an associate professor of digital business at Wits Business School, is co-author and editor of numerous books on the digital economy.