The audit was conducted to determine the propriety of contracting and valuation of the NORTHRAIL Project, Phase I, Section 1contracted taking into consideration the paid accomplis

Special Audits Office Report No. 2012-002

Special Audit

NORTHRAIL Project Phase 1, Section 1

North Luzon Railways Corporation

Republic of the Philippines Commission on Audit

Special Services Sector SPECIAL AUDITS OFFICE

Commonwealth Avenue, Quezon City Philippines Tel. No.: (+632) 931-7455 / Telefax No.: (+632) 931-9235

August 7, 2013 MR. CONRADO K. TOLENTINO President North Luzon Railways Corporation MWSS Compound, Katipunan Road Balara, Quezon City Sir: We are pleased to transmit the report on the special audit of the NORTHRAIL Project, Phase 1, Section 1 covering selected transactions, activities and operation up to June 2011. The audit was conducted from September 19, 2011 to May 2012 pursuant to COA Office Order No. 2011-563 dated August 15, 2011. The audit was conducted to determine the propriety of contracting and valuation of the contracted NORTHRAIL Project, Phase I, Section 1 taking into consideration the paid accomplishments as of June 30, 2011 and the recent decision of the Supreme Court. The audit scope, however, excluded the item of work “Right-of-Way Expenses and Public Utilities Diversion” which will be covered by a separate report. The draft report containing the results of the audit was forwarded to that Office on September 25, 2012 for comment. The comments submitted were evaluated and incorporated in the report, where appropriate. We look forward to the implementation of the audit recommendations contained in the report and we would appreciate being informed of the actions taken thereon within 60 days from receipt hereof. We acknowledge the cooperation and assistance extended to the team by the officials and employees of that Office. Very truly yours, By Authority of the Chairman: SUSAN P. GARCIA Director IV

TABLE OF CONTENTS

Title Page

List of Tables Part I Executive Summary 1

Introduction 2 Audit Objective 4 Audit Scope and Methodology 5 Audit Findings 6 Management’s Comments 9 Team’s Rejoinder 10 Recommendations 10

Part II About NORTHRAIL 12

Introduction 13 Board Composition 14 Organizational Structure 15 Personnel Compliment 16 Corporate Operating Budget 16 Major Projects Undertaken 17

Part III About the NORTHRAIL Project 19

Introduction 20 The Phases of the Northrail Project 21 The Contract 22 The Funding Source 23 The Partner Agencies 24 The Contract Status 25 Reported Project Accomplishments 27

Part IV Audit Observations 31

On valuation of SINOMACH’s reported and

paid accomplishments 32

On contract provisions 36

TABLE OF CONTENTS

Title Page

On design and build contractual scheme 43

On NORTHRAIL expenses 44

On payments to Project Management Support Team (PMST) 46

On funding source of PMST 50

Part V Recommendations 53

Part VI Annexes 55

Annex A - Project Evaluation Report 56

Annex B - Management’s Comments and Team’s Rejoinder on Project Evaluation Report 65

Annex C - Management’s Comments and Team’s Rejoinder on Contract Provisions and

Contractual Scheme 81

Annex D - Management’s Comments and Team’s Rejoinder on Project Management Support Team 85

List of Tables

No. Title Page 1 Incorporators of NORTHRAIL 13 2 Board Composition as of June 2011 14 3 NORTHRAIL Personnel Complement 16 4 Corporate Operating Budget, CYs 2005-2011 17 5 Phases of the Northrail Project 21 6 Scope of Works of the Original and Amended CNMEG

Contracts 22

7 Funding Source 23 8 NORTHRAIL’s Partners 24 9 Reported Project Accomplishments as of May 31, 2010 27

10 Pictures of Project Accomplishments 28 11 Tabulation of Unit Costs of the Same Pay Items 32 12 Tabulation of Variances in Unit Costs 33 13 Comparison of Unit Costs of Items with the Same

Components 33

14 Tabulation of Items of Different Designs but the Same Unit Cost

34

15 Project Evaluation 35 16 Tabulation of Payments to CNMEG 35 17 Tabulation of Disadvantageous Contract Provisions 38 18 OGCC’s Comments on the Contract Provisions 40 19 VAT Charged by Local Sub-contractors and Suppliers 42 20 Contracts Entered into by NORTHRAIL 45 21 Expenses Excluded from PDC 46 22 Summary of NORTHRAIL Expenses as of December 31,

2011 46

23 Comparison of Payments to PMST and CNMEG Project Accomplishments

47

24 PMST Billings During Project Suspensions 48 25 Payments for Additional PMST Staff and Extended

Services 49

26 Tabulation of Payments to SES-JV 52

1

Part I

Executive Summary

EXECUTIVE SUMMARY

2

The North Luzon Railways Corporation (NORTHRAIL), a subsidiary of the Bases Conversion and Development Authority (BCDA), was incorporated on August 22, 1995 to develop, construct, operate, and manage a railroad system to serve Metro Manila, Central and Northern Luzon and to develop, construct, manage, own, lease, sublease, and operate establishments and facilities of all kinds related to the railroad system. Since its creation, it has entered into a number of Memoranda of Understanding (MOU) and Memoranda of Agreement (MOA) for the development of a rail system in the Northern Luzon. On December 30, 2003, NORTHRAIL entered into an agreement (“Original CNMEG Contract”) with the China National Machinery and Equipment Corp. (Group) [CNMEG, now China National Machinery Industry Corporation or SINOMACH], a corporation of the People’s Republic of China (PROC), for the implementation of the Northrail Project. This Original CNMEG Contract was connected to the Loan Agreement entered into on February 26, 2004 by the Department of Finance (DOF) with the Export-Import (EXIM) Bank of China, for US$400 million, which was re-lent by DOF to NORTHRAIL to fund the Northrail Project. The Original CNMEG Contract provides that the same shall become effective upon signing of the Loan Agreement by the EXIM Bank of China and the DOF of the Philippines, and upon receipt by CNMEG of the five percent down payment, among others. On the other hand, conditions precedent to the effectivity of the Loan Agreement include, among others, the receipt by the lender of a certified true copy of the Original CNMEG Contract duly executed by NORTHRAIL and CNMEG, and a letter from CNMEG evidencing that NORTHRAIL has paid to CNMEG the down payment required under the Original CNMEG Contract. This Contract emanated from an MOU entered into by NORTHRAIL with the same Group on September 14, 2002 wherein CNMEG was to undertake a study on the feasibility of the Northrail Project. In the said study, it was provided that CNMEG shall use the Chinese Government Fund, through a Chinese government bank, to provide overseas development assistance to NORTHRAIL by way of undertaking the Project with the most favorable terms and conditions acceptable to both parties. In a letter dated October 1, 2003, Mr. Wang Chungui, Ambassador of PROC to the Philippines, informed the then Secretary of the DOF, that CNMEG had been designated as the prime contractor for the Northrail Project.

INTRODUCTION

EXECUTIVE SUMMARY

3

The Original CNMEG Contract calls for the construction of Phase I, Section 1 of the Northrail Project covering alignment from Caloocan City to Malolos, Bulacan in the total amount of US$421.050 Million, with US$400 Million to be sourced from the loan from EXIM Bank of China and the balance from a loan to be arranged by the Development Bank of the Philippines (DBP). On February 13, 2006, complainants from various sectors filed a Complaint for Annulment of Contract before Regional Trial Court (RTC) Branch 145, National Capital Judicial Region, Makati City, alleging that the Original CNMEG Contract and the Loan Agreement were void for being contrary to (a) the Constitution; (b) Republic Act (RA) No. 9184, otherwise known as the Government Procurement Reform Act; (c) Presidential Decree (PD) No. 1445, otherwise known as the Government Auditing Code of the Philippines; and (d) Executive Order (EO) No. 292, otherwise known as the Administrative Code of the Philippines. CNMEG filed a Motion for the dismissal of the case arguing that the Court did not have jurisdiction on its person, as it was an agent of the Chinese Government, making it immune from suit, and the subject matter, as the Northrail Project was a product of an executive agreement. The Motion was dismissed by RTC Branch 145. CNMEG proceeded to elevate the case before the Court of Appeals (CA). The CA upheld the decision of RTC Branch 145. Thus, on January 21, 2009, CNMEG filed before the Supreme Court (SC) a Petition for Review on Certiorari with Prayer for the Issuance of a Temporary Restraining Order (TRO) and/or Writ of Preliminary Injunction (“CNMEG Petition”). While the case was pending in the SC, both parties negotiated for the resumption of the construction works which were suspended by CNMEG in February 2008. After a series of negotiations and meetings, CNMEG resumed work on December 21, 2008, and the contracting parties amended the Original CNMEG Contract on September 29, 2009 increasing the contract cost from US$421.050 Million to US$593.880 Million and modifying the mode of project implementation from turnkey basis to design and build scheme (“Amended CNMEG Contract”). The increase in the contract amount was supposed to be funded by the National Government. However, as of audit date, no funds were allocated for this purpose. Due to budgetary constraints and operational and project implementation issues, the parties agreed on March 23, 2011 to suspend the implementation of the Amended CNMEG Contract to mitigate losses being incurred by both parties and resolve the technical, financial and legal issues of the project.

EXECUTIVE SUMMARY

4

During this period, the NORTHRAIL President raised the issue of validity of the Amended CNMEG Contract to the Undersecretary of the Department of Transportation and Communications (DOTC) and the Office of the Government Corporate Counsel (OGCC). In reply, DOTC informed NORTHRAIL that the then NORTHRAIL Chairman had no authority to enter into the Amended CNMEG Contract and that it is wholly void considering the absence of appropriation and Certificate of Availability of Funds (CAF). On the other hand, the OGCC, in its Opinion No. 167 dated July 14, 2011, declared that the implementation of the Northrail Project should have complied with the mandatory requirement of public bidding under RA No. 9184, failing in which and in the absence of the required certification of appropriation and CAF, the Original CNMEG Contract, including the Amended CNMEG Contract, are void ab initio. This is a complete turnaround by the OGCC from its previous Opinion issued on November 13, 2003, which considered the designation of CNMEG as prime contractor to be not violative of RA 9184 and its Implementing Rules and Regulation (IRR) as the Original CNMEG Contract is considered as an executive agreement. On February 7, 2012, the CNMEG Petition was resolved by the SC where it held that CNMEG is not entitled to immunity from suit, and the Original CNMEG Contract is not an executive agreement. The prayer for the issuance of a TRO and/or Writ of Preliminary Injunction was denied and the case was remanded to RTC Branch 145, Makati City, for further proceedings on the validity of the Original CNMEG Contract. NORTHRAIL and CNMEG were not able to resolve the issues at hand. Thus, CNMEG (now SINOMACH), in its letter dated August 13, 2012, finally terminated the Amended CNMEG Contract. Subsequently, or on August 22, 2012, SINOMACH submitted to NORTHRAIL its formal Claim Report for the Northrail Project, Phase 1, Section 1, detailing its entitlements following the termination of the Amended CNMEG Contract.

The Audit was conducted to determine the propriety of contracting and valuation of the contracted Northrail Project, Phase I, Section 1 taking into consideration the paid accomplishments as of June 30, 2011 and the decision of the Supreme Court in the CNMEG Petition, “CNMEG versus Hon. Cesar D. Santamaria, et.al.”, G.R. No. 185572.

AUDIT OBJECTIVE

EXECUTIVE SUMMARY

5

1. Scope

The Audit covered selected transactions, activities and operations of NORTHRAIL up to June 2011 focusing on the implementation of Phase I, Section 1 of the Northrail Project except for the item of work “Right-of-Way (ROW) Expenses and Public Utilities Diversion” which will be covered by a separate report.

2. Methodology

To achieve the audit objective, the Team adopted the following audit techniques, among others:

• Studied the funds flow from loan availment/drawdowns to

release of funds to NORTHRAIL;

• Gathered data on funds released for the Northrail Project from various sources;

• Examined and analyzed financial and contract documents made available to the Team to assess the propriety and effectiveness of contracting of loans, utilization and management of loan proceeds, and contracting and implementation of the project;

• Conducted contract reviews to assess the propriety of contracting and reasonableness of contract/project cost and the contract provisions;

• Conducted interviews with concerned NORTHRAIL officials;

• Inspected and evaluated the physical project accomplishments; and

• Gathered and considered opinions issued by the OGCC and Supreme Court Decision under G.R. No. 185572 affecting the Northrail Project.

3. The Audit Team

The Audit was conducted by a Team composed of seven (7) members from the Special Audits Office and three (3) from the Technical Services

AUDIT SCOPE AND METHODOLOGY

EXECUTIVE SUMMARY

6

Office, both under the Special Services Sector, Commission on Audit. The Audit was conducted from September 19, 2011 to May 7, 2012 in compliance with COA Office Order No. 2011-563 dated August 15, 2011.

The Audit disclosed that the reported and paid project accomplishments of US$104.431 Million covering Progress Billings Nos. 1 to 16 of the Northrail Project, Phase I, Section 1 was excessive. The reported and paid accomplishments may be valued only at US$81.474 Million (See Table 15) using the unit costs of the Original CNMEG Contract less 10 percent contractor’s profit. This is granting that CNMEG/SINOMACH qualify for payment on the basis of quantum meruit. The Supreme Court declared that the Original CNMEG Contract is not an executive agreement. As this is considered an ordinary contract, the same should have been subjected to public bidding. The contract was, however, awarded without the benefits of public bidding as CNMEG was outright designated as contractor by the Ambassador of the PROC to the Philippines. The Contract, in the amount of US$421.050 Million, was eventually amended increasing the contract cost to US$593.880 Million. The reasonableness of both Original and Amended CNMEG Contract costs was, however, not established by NORTHRAIL and the interest of the government not protected under the provisions of both contracts as manifested below. Contract Costs • Despite repeated request by the Team, NORTHRAIL could not present

any evaluation report on both Original and Amended CNMEG Contract costs of US$421.050 Million and US$593.880 Million, respectively.

• The basis for assessment and payment of reported accomplishments was also not clear. A number of items were quoted in lump sum amounts, yet progress payments were allowed despite the absence of criteria and milestones for payment, and of unit cost analysis to establish the propriety of the claims.

• The contracted unit costs may also be considered questionable as structures with exactly the same material components, in the same

AUDIT FINDINGS

EXECUTIVE SUMMARY

7

quantity and weight, have different unit costs, while those of different components have the same unit cost.

Contract Provisions • NORTHRAIL was required to pay, in both Original and Amended

CNMEG Contracts, down and advance payments equivalent to 30 percent 7of the contract price, of which payments amounted to US$134.957 Million (See Table 16). Existing regulations only allowed mobilization fee for infrastructure contracts equivalent to 15 percent of the contract cost.

• NORTHRAIL assumed a number of construction risks and responsibilities that are normally assumed by the contractor, especially in a turnkey/design and build contractual arrangement (See Table 17). These included the following: o Assuming the responsibility of clearing of ROW and Public Utilities

Diversion when these were included in the Original CNMEG Contract as one of the contracted works.

o Committing to deliver a clear ROW within 150 days upon the effectivity of the contract and acquire additional ROW within 150 days from the date of final approval of the ROW requirements. The Original CNMEG Contract even provided that delay in the delivery of the ROW requirements would result in CNMEG’s entitlement to extension of the contract period and recovery of any resultant expenses.

o Assuming the responsibility of obtaining for the contractor all permits, licenses, approvals or privileges from the different Philippine Government authorities for the construction of the project and is still obligated to compensate CNMEG for any cost or loss arising from the delay of obtaining such permits.

The implementation of the Original CNMEG Contract was suspended on August 13, 2012. As of the time of contract suspension, NORTHRAIL has paid CNMEG, now SINOMACH, around US$210.489 Million (See Table 16) consisting of down, advance and progress payments for a reported accomplishments as of May 31, 2010 of US$104.431 Million. This already manifests excess payment of NORTHRAIL to SINOMACH of US$106.058 Million. As the reported accomplishment of US$104.431 Million is valued only at US$81.474 Million, the total overpayment further increases to

EXECUTIVE SUMMARY

8

US$129.015 Million. This is assuming that the SINOMACH is allowed to claim under the principle of quantum meruit. In any case, the total payment of US$210.489 Million is considered a potential loss in the event that any reported accomplishment will no longer be used. The turnkey/design and build contractual arrangement may not also be considered ideal for a project to be financed from foreign loans, with known ROW problems and obstacles on site, and a lot of responsibilities assumed by the government like in this case. As the resolution of ROW problems was delayed, the contract was amended and the construction period of 36 months equivalent to 1,080 days was extended by 856 days. It was, however, finally terminated after 1,048 days after the notice to proceed. The loan drawdowns were dependent on project accomplishments. Under the loan agreement, the DOF is required to pay the EXIMBANK commitment fees on the daily unutilized portion of the loan. As of September 30, 2011, commitment fees paid by the DOF amounted to P200.814 Million. Further, as the loan conditions were not complied with, the undisbursed amount of US$219.205 Million was cancelled by the EXIM Bank under its letter dated July 6, 2012 and the loan principal of US$180.795 Million and interest thereon were required to be paid in four equal installments within two years. The first repayment is due on September 21, 2012. The loan was originally scheduled to be repaid in 20 years, including 5 years grace period. For undertaking various activities since its creation in 1995 until December 31, 2011, NORTHRAIL has already spent, around P10.569 Billion (See Table 22) without attaining its purpose. NORTHRAIL was created for the purpose of constructing, operating and managing a railroad system and other related facilities. Any benefits to be derived from the investment at present is still uncertain. To assist NORTHRAIL in the evaluation of project accomplishment, it also entered into contract with SYSTRA-ESCA-SYSTRA Philippines, Inc. Joint Venture (SES-JV) as Project Management Support Team (PMST). The SES-JV Contract was also entered into despite inability of the SES-JV to secure funding source for the contract, which is required in the Invitation to Apply for Eligibility and to Bid. Thus, the SES-JV Contract was also declared void by the OGCC under its Opinion No. 240, Series of 2011 dated November 8, 2011. Moreover, payments by NORTHRAIL to SES-JV already reached 53.46 percent of the total SES-JV Contract when the project accomplishment it is supposed to evaluate, as of the same period, was only 17.58 percent of the

EXECUTIVE SUMMARY

9

Amended CNMEG Contract. Under its terms of reference (TOR), the PMST shall supplement the technical capabilities of the NORHTRAIL personnel to supervise construction and check CNMEG work accomplishments, among others.

The draft Report was forwarded to Mr. Conrado K. Tolentino, President, NORTHRAIL, on September 25, 2012 for comments. Two sets of management’s comments were submitted on October 24, 2012, one from the present Board and Management, and one from the NORTHRAIL Managers who have, in one way or another, been part of the project implementation. The comments submitted were evaluated and incorporated in the Report, where appropriate. The present Board and Management claimed that billing Nos. 12, 14, 15 and 16 of SINOMACH and billing Nos. 42 to 46 of SES-JV were paid upon review and clearance by the DOTC. They believed, though, that both the CNMEG and SES-JV Contracts are void. On the other hand, the NORTHRAIL Managers generally accepted the Audit Team’s observations but claimed that: • The lump sum contract was evaluated on a per billing basis

considering that despite repeated requests from the contractor, the unit cost analysis was not submitted. They also explained that, had the contract been completed, the over or under payments during project implementation will not be an issue since this will automatically be settled. They believed, however, that the assessment would be different under a pre-terminated contract.

• Both the Original and Amended CNMEG Contracts are compliant with the Law of the Philippines as the contract is an executive agreement and the cost adjustment is due to delayed implementation of the project.

• The detailed design is not available at the time of contracting as the contract includes the conduct of detailed engineering design.

MANAGEMENT’S COMMENTS

EXECUTIVE SUMMARY

10

Considering that the Head of the Agency is held primarily responsible in ensuring that funds are efficiently and effectively utilized to prevent losses to the government, NORTHRAIL should not merely depend on the review and evaluation of other offices. All its actions should primarily be based on legal grounds and as results of its own evaluation and assessment. As to the comments of the NORTHRAIL Managers, the very act of contracting without complying with RA 9184 is already prohibited. Moreover, this was aggravated by the NORTHRAIL Managers’ failure to determine the reasonableness of the unit costs and settled deliverables upon submission and processing of the 1st progress billing claim. Despite absence of evaluation as to costs, billings were continuously paid when the unit costs remained unevaluated and the scope of work of each item was not established. Moreover, as the NORTHRAIL Managers believed that the Original CNMEG Contract is an executive agreement, they are all the more duty bound to require CNMEG to submit unit cost analysis or conduct its own cost analysis.

Considering the status of the project at present, the audit team recommended to NORTHRAIL, under Part V of the Report, a number of courses of action. Overall, the Team recommended the following:

• For future projects, and to avoid the occurrence of the same problems, ensure that contracting is compliant with RA No. 9184 and all applicable laws, rules and regulations; that project costs are properly evaluated and established to be reasonable; and that interest of the government is protected under the contract at all times.

• Establish liabilities of responsible officials and employees for the inefficient and ineffective implementation of the Northrail Project and take appropriate actions thereon.

TEAM’S REJOINDER

RECOMMENDATIONS

EXECUTIVE SUMMARY

11

• Make representation with RTC Branch 145, Makati City for the early resolution of all pending NORTHRAIL project-related cases to guide them in its actions.

• Settle all ROW-related issues and problems including consigning payments in Court, before starting any project, to ensure smooth implementation of the project.

12

Part II

About NORTHRAIL

_________________________________ ABOUT NORTHRAIL

13

In June 1995, a Joint Venture Agreement (JVA) was entered into by BCDA, Philippine National Railways (PNR), Spanish Railways Group (SRG) and Euroma Development Corp. (EUROMA) defining among others, the responsibilities of each member in the implementation of the double track railway system. Among the responsibilities of the BCDA under the JVA is to establish and incorporate a corporation to be known as NORTHRAIL with the primary purpose of constructing, operating and managing a railroad system and the related facilities. NORTHRAIL was incorporated and registered with the Securities and Exchange Commission (SEC) on August 22, 1995 under SEC Reg. No. AS095-008215. Its initial authorized capital stock was P100 Million divided into 1,000,000 shares with par value of P100 each.

Of the total initial authorized capital, P50,000,000 consisting of 500,000 shares was subscribed and paid up, with the BCDA subscribing 499,991 shares worth P49,999,100. The balance of nine shares equivalent to P900 were subscribed by the following nine incorporators at one share each or P100:

Table 1: Incorporators of NORTHRAIL Name Shares

1. Victor A. Lim 100 2. Rogelio L. Singson 100 3. Victorino A. Basco 100 4. Roberto A. Flores 100 5. Teodoro B. Javier 100 6. Jaime Y. Ladao 100 7. Nestor S. Mangio 100 8. Asteya M. Santiago 100 9. Jose M. Villegas 100 Total 900

The JVA was amended on February 6, 1996 to include D.M. Consunji, Inc. (DMCI) as a strategic partner to the joint venture (JV). On July 17, 1996, the NORTHRAIL Board approved the increase in the authorized capital stock of NORTHRAIL from 1,000,000 shares, with a par value of P100 per share, to

INTRODUCTION

_________________________________ ABOUT NORTHRAIL

14

12,500,000 shares with same par value per share. Subsequently, in August 1996, Fort Bonifacio Development Corporation (FBDC) also joined the JV with shares booked as deposits for future subscription. On March 13, 1997, NORTHRAIL withdrew its application for increase in authorized capital stocks with the intention to re-file the same upon resolution of other corporate matters. Such plan to re-file the application to increase its capital stock did not materialize. On July 14, 2000, FBDC and DMCI informed BCDA that they are withdrawing their participation in the NORTHRAIL Project and seeking reimbursement of their principal investment plus interest. This was followed by a board meeting conducted on March 5, 2001 whereby FBDC and DMCI board members expressed their intention to withdraw their investments from NORTHRAIL. They maintained their position that the advances are mere deposits for future subscription and should be returned since the original plan of converting their deposits to equity was not implemented. NORTHRAIL, on the other hand, argued that their deposits represent their contributions to the JVA and that they also have to share in the expenses incurred by NORTHRAIL. As reflected in the Notes to Financial Statements (FS) as of December 2011, the share of FBDC has been reclassified from “Deposits for Future Subscription” to “Due to Parent/Subsidiaries”. On the other hand, the investments made by DMCI, and SRG remained under the account “Deposits for Future Subscription”. The NORTHRAIL’s authorized capital stock of P100 Million, divided into 1,000,000 shares, is also reflected in the Notes to FS as fully subscribed and paid by the BCDA as of December 31, 2011. The NORTHRAIL Board of Directors has 11 seats. As of June 2011, the following are the members of the Board as reported in the list provided by NORTHRAIL:

Table 2: Board Composition as of June 2011 NAME POSITION DATE ELECTED

Jose Martin O. Aliling Chairman January 14, 2011 Conrado K. Tolentino President December 2, 2010 James G. Lorenzana Member July 11, 2002 Gregorio B. Macalintal, Jr. Member February 21, 2005

BOARD COMPOSITION

_________________________________ ABOUT NORTHRAIL

15

Table 2: Board Composition as of June 2011 NAME POSITION DATE ELECTED

Jose Andres D. Bautista Corporate Secretary December 2, 2010 Filemon T. Berba, Jr. Member

Edgardo G. Flores Member Daniel L. Henares Member

January 14, 2011 Vitaliano N. Nañagas II Corporate Treasurer Jesus Enrico Moises B. Salazar Member

The organizational framework of NORTHRAIL is presented below:

*Source: Organizational Chart provided by the management

ORGANIZATIONAL STRUCTURE*

Board of Directors

Chairman

Corporate Secretary

President

Corporate Services Group

Railways Operations Group & PMO

Special Concerns Group

Administration Services Office

Finance Services Office

Operations Support Department

Corporate Legal Services Office

Management Information Services

Corporate Affairs and Public Relations Office

Construction Division

Railways Planning & Development Division

Human Resources Management Office

Engineering Division

_________________________________ ABOUT NORTHRAIL

16

PERSONNEL COMPLEMENT

The NORTHRAIL personnel, composed of regular and project-based hires, as provided by NORTHRAIL, are distributed to the following offices/divisions for the years indicated:

Table 3: NORTHRAIL Personnel Complement OFFICE 2007 2008 2009 2010 JUNE 2011

Office of the Chairman 2 Office of the Chief of Staff 1 1 Office of the President 1 4 5 4 2 Office of the Vice President 1 Office of the Vice President for Corporate Service Group

2

Office of the Corporate Secretary 1 Administration Services Office 10 13 41 42 25 Business Development Group 1 6 Construction Division 7 49 46 12 Corporate Legal Services Office 5 9 13 6 Corporate Public Affairs Office 1 6 6 2 Corporate Service Group 1 1 Engineering Division 8 13 31 23 12 Finance Services Office 3 5 7 7 7 Human Resources Mgt. Office 1 2 7 6 3 Management Information Services 1 6 6 4 Operations Support Department 14 12 13 Railways Planning & Dev’t.Division 8 1 Railways Operations Group and Project Management Office

2 2

Special Concerns Group 4 4 Total 24 54 188 182 90

NORTHRAIL operated yearly with a corporate budget ranging from P4.138 Billion to P44.740 Billion during CYs 2005 to 2011 as tabulated below:

CORPORATE OPERATING BUDGET

PERSONNEL COMPLEMENT

_________________________________ ABOUT NORTHRAIL

17

Table 4: Corporate Operating Budget – CYs 2005-2011

Particulars 2005 2006 2007 2008 2009 2010 2011

( In Billion P)

Capital Expenditures

Cumulative Obligations 0.020 0.045 1.198 1.078 0.024 1.894 5.505

Additional Requirements 11.628 4.015 Section 1 14.307 23.108 14.460 19.335 15.406 Section 2 10.996 11.762 21.030 21.756 12.564 Financing Charges 0.697 1.060 1.363 0.751 Contingent Liabilities .094 0.094

Sub-total 11.648 4.060 26.595 36.739 36.574 44.348 34.226

Operating Expenses

Personal Services 0.018 0.029 0.039 0.044 0.184 0.178 0.181

MOOE 0.030 0.031 0.063 0.058 0.157 0.180 0.142

Capital Outlay 0.016 0.018 0.011 0.010 0.086 0.034 0.016

Sub-total 0.064 0.078 0.113 0.112 0.427 0.392 0.339

Total 11.712 4.138 26.708 36.851 37.001 44.740 34.565

The need for the construction of a two-way railway system from Manila to the former Clark Air Base with a branch line extended to Subic Bay, for the purpose of creating a mass transport system, was envisioned by the BCDA as early as August 1994. This is in support of the proposed establishment of an International Aviation Complex to be located at the former Clark Air Base. In line with this objective, the BCDA entered into MOU with Construcciones y Auxiliar de Ferrocarriles, S.A., in cooperation with four other Corporations, all organized and existing by virtue of the laws of Spain. Under the MOU, the Spanish Railways Group (SRG) shall prepare a detailed proposal for the construction of a two-way railway system from Manila to the former Clark Air Base which will include supply of all the facilities related to the project. The SRG shall prepare, at its own cost, a feasibility study that will lead to the completion of a detailed proposal containing, among others, the technical,

MAJOR PROJECTS UNDERTAKEN

_________________________________ ABOUT NORTHRAIL

18

pricing, financial, organizational and environmental impact assessments. Should the detailed proposal by the SRG be adopted by the BCDA, the latter, subject to the requirements of existing laws, agreed to enter into a contract or arrangement with the SRG for the implementation of the project through the Build, Operate and Transfer (BOT) scheme or similar arrangement. If not adopted, the BCDA has no obligation, except to return to the SRG the said proposal including all documents, plans and drawings. Subsequently, on March 30, 1995, the BCDA and the PNR entered into a MOA with the SRG to pursue the project. The Project shall have the following components: • Construction and rehabilitation of a double-track railway system

from Metro Manila to the proposed Clark International Airport. The railway system shall be in commercial operation on or before June 1998.

• Design, development, construction, installation and operation of a railway system and other allied commercial activities.

• Maintenance of the railway lines. As provided in the MOA, the project shall be implemented through a JVA. Immediately upon signing of the JVA, the detailed engineering and architectural design of the project shall be conducted by the consortium at a cost not exceeding 7.5 percent of the estimated construction cost of the Project. Under the MOA dated December 10, 1995, the entire Engineering Procurement and Construction Contract (EPC) of Phase I-A, covering Monumento to Clark Route shall be conducted at a cost of US$325.0 Million. As reflected in the calendar of events forwarded by NORTHRAIL, the SRG backed-out from the project and the contract was terminated in August 1998 due to the failure of raising funds for its construction. Eventually, NORTHRAIL entered into contract with CNMEG, a corporation of the PROC.

19

Part III

About the Northrail Project

ABOUT THE NORTHRAIL PROJECT

20

INTRODUCTION In July 2002, the inception of the current Northrail Project became one of the priority undertakings of former President Gloria Macapagal-Arroyo and was included in her eight-point agenda. In line with this undertaking, NORTHRAIL entered into MOU with CNMEG on September 14, 2002 whereby CNMEG shall undertake a study on the feasibility of the project within 120 working days for its own accounts, and at no cost to NORTHRAIL. It was provided under Item I.1.4 of the MOU that NORTHRAIL shall not be bound whatsoever by the results and conclusions of the study and reserves the right to evaluate and reject, or utilize the same, for its own purposes without any liability whatsoever. Under this provision, it is clear that NORTHRAIL is not under obligation to accept the results of the study and enter into contract with CNMEG. The foregoing provision is, however, somewhat negated by and in essence inconsistent with Item II.2.1 of the MOU where it provides that as soon as possible, after completion and presentation of the study and in compliance with necessary governmental laws, rules, regulations and procedures required from both parties, the parties shall commence the preparation and negotiation of the terms and conditions of a contract for the implementation of the project to be entered into within 120 days from CNMEG’s presentation of the study. Under this provision, therefore, NORTHRAIL is under obligation to accept the results of study and enter into contract with CNMEG. In May 2003, NORTHRAIL, using, among others, the studies of CNMEG, Pacific Consultants, Inc./Asia Halcrow and SRG, prepared and submitted for the approval of the National Economic Development Authority (NEDA), its in-house Feasibility Study (FS). The said FS used the financing scheme offered by CNMEG. The proposal, covering Phase 1, Section 1 (Caloocan to Malolos), was conditionally approved by NEDA - Investment Coordination Committee (NEDA-ICC) in August 2003. The project is to be financed from a Preferential Buyer’s Credit extended by the EXIM Bank of China in the amount of US$400 Million. On December 18, 2003, the NEDA-ICC approved the Northrail Project, Phase I, Section 1 which was confirmed by the NEDA Board on December 22, 2003. On December 30, 2003, NORTHRAIL entered into contract with CNMEG for the implementation of the Northrail Project.

INTRODUCTION


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As reflected in the FS dated December 2008, the Northrail Project aims to build a world class railway system capable of traveling at 100-130 kph, and with upgrading potentials for higher speeds and capacities. It was intended to provide efficient transport service for passengers and goods between Metro Manila, and Central and Northern Luzon, particularly between various former military bases which have been converted from military to civilian uses (Fort Bonifacio, Clark Air Base, Subic Naval Base, and Poro Point). This project is also expected to further enhance the development and growth potential of the said areas. The Northrail Project is divided into four phases as follow:

Table 5: Phases of the Northrail Project Phase Coverage

I Caloocan City to Clark Special Economic Zone (CSEZ), Pampanga II Branch Line to Subic Economic Freeport Zone

III Extension to Bonifacio Global City IV Extension to San Fernando, La Union

Phase I of the Northrail Project was born out of a plan to reactivate rail service to the north to support the further development of the former Clark Air Base, now known as the Clark Special Economic Zone, particularly the Diosdado Macapagal International Airport, as Asia-Pacific’s regional hub for logistics. This rail system is deemed necessary to make the airport accessible to the National Capital Region (Metro Manila). The Northrail Project, Phase I, which will be traveling within the ROW of the PNR, was envisioned to be implemented in two principal sections as follow: • Section 1 – Caloocan to Malolos, Bulacan • Section 2 – Malolos to CSEZ, Mabalacat, Pampanga

The implementation of the project started with the 32-kilometer Section between Caloocan and Malolos, Bulacan.

THE PHASES OF THE NORTHRAIL PROJECT


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As indicated in the contract entered into by Northrail and CNMEG (“Original CNMEG Contract”) on December 30, 2003, CNMEG has offered to provide Phase I, Section I of the Northrail Project, on a turnkey basis. This is inclusive of design, manufacturing, supply, construction, commissioning, and training of NORTHRAIL’s personnel. The project, with total contract price of US$421.050 Million, was intended to be completed in 36 months, from the commencement date of the contract to the date of taking-over, unless extension of time was allowed. The Full Notice to Proceed was issued to CNMEG by NORTHRAIL only on February 26, 2007 or after 38 months upon signing of the agreement which is even longer than the period of project completion of 36 months. The Original CNMEG Contract was amended (“Amended CNMEG Contract”) on September 29, 2009 increasing the contract cost from US$421.050 Million to US$593.88 Million, or an increase of US$172.83 Million, on account of a number of variations and price escalations. The project completion was, likewise, moved from February 2010 under the Original CNMEG Contract, counting from the issuance of full notice to proceed, to June 2012 under the Amended CNMEG Contract. A comparison of the scope of works of the Original and Amended CNMEG Contracts is shown below:

Table 6: Scope of Works of the Original and Amended CNMEG Contracts

Work Items

Amounts expressed in Million US$ Original (turnkey)

Amended (Design & build)

Increase/ (decrease)

Amount Weight Amount Weight Amount %

Survey, Site Investigation & Preliminaries

38.670 9.18 49.760 8.38 11.090 28.68

Survey & Site Investigation 7.760 10.007 2.247 28.96 Preliminaries 30.910 39.753 8.843 28.61 Civil and Track Works 248.860 59.10 416.863 70.19 168.003 67.51 Permanent Way (Track Work) 206.790 373.081 166.291 80.42 Stations 27.000 21.874 (5.130) (18.99) Depot & Other Facilities for Oper. 15.070 21.908 6.838 45.37 Signaling and Communications 26.550 6.31 39.199 6.60 12.649 47.64 Communications 4.100 5.412 1.312 32.00 Signaling 14.200 20.473 6.273 44.18 Ticketing System 3.640 4.831 1.191 32.72

THE CONTRACT


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Table 6: Scope of Works of the Original and Amended CNMEG Contracts

Work Items

Amounts expressed in Million US$ Original (turnkey)

Amended (Design & build)

Increase/ (decrease)

Amount Weight Amount Weight Amount %

Power Supply 4.610 6.082 1.472 31.93 ATP for cab signaling - 2.400 Rolling Stock 79.430 18.87 33.440 5.63 (45.990) (57.90) DMU & Spare Parts 79.430 33.440 (45.990) (57.90) ROW Expenses & Public Utilities Diversion

27.540 6.54 27.540 4.64 0.00 0.00

Contingencies - 27.078 27.078 Total 421.050 100.00 593.880 100.00 172.830 41.05

THE FUNDING SOURCE

The Northrail Project, Phase 1, Section I was to be financed from the following sources:

Table 7: Funding Source

Fund Source Nature

Contract

Conditions/Remarks Date Amounts in M US$

Original Amended

EXIM Bank of China

Preferential Buyer’s Credit Loan

2/26/04 400.000 400.000 Payable semi-annually in 20 years inclusive of 5 years grace period with financing charges of 3 percent per annum interest, 0.2 percent per annum commitment fee on the daily unutilized portion of the loan facility; management fee of 0.2 percent of the loan facility and all other charges and fees imposed in the Republic of the Philippines

Banco de Oro Universal Bank, Metropolitan Bank & Trust Company and Sumitomo Mitsui Banking Corporation (SMBC)

Syndicated Loan

5/21/04 22.000 21.052 Loan amount is US$22 Million payable in 90 days from the date of drawdown at the rate equivalent to 3 months London Interbank Offered Rate (LIBOR) as base rate plus spread of 2.75 percent per annum. Of the US$22 Million loan amount, only US$21.052 Million was used as down payment for the project.

Barclays Bank PLC

Credit Facility Agreement

2/14/08 25.925 Loan amount is US$90 Million payable within 10 years from the initial drawdown date with 4 years grace period and financing charges of 6 month LIBOR + USD Benchmark

THE FUNDING SOURCE


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Table 7: Funding Source

Fund Source Nature

Contract

Conditions/Remarks Date Amounts in M US$

Original Amended

Bond LIBOR spread + 1 percent, fund arrangement fee of 0.5 percent and guarantee fee of 1 percent. Based on the documents made available to the Audit Team, of the loan amount, only US$25.925 Million was programmed for Section 1.

National Government

Budget Support

146.903 Based on the letter to NORTHRAIL of DBM USEC Mario Relampagos dated June 7, 2011, there was no appropriation under the FYs 2009 – 2011 GAA for this project and that the DBM has not released any SARO and NCA for this purpose

Total 422.000 593.880

In order to implement the Northrail Project, NORTHRAIL entered into a number of MOA with various government agencies as follows:

Table 8: NORTHRAIL’S Partners Agency Participation/Role

PNR Make available for the Project its existing ROW and all available documents affecting ownership of rail ROW; Issue notices of relocation/eviction, if necessary.

National Housing Authority (NHA)

Prepare the relocation program, including related terms of reference, operational guidelines and timetable; Implement the relocation program; Assist in social preparation, counseling and actual relocation.

Housing & Urban Development Coordinating Council (HUDCC)

Act as lead agency of the relocation program, establish and chair a Joint Management Committee, and monitor the implementation and management (operation/ financial) of the program.

National Home Mortgage Finance Corporation (NHMFC)

Assist beneficiaries in organizing themselves into viable community associations eligible for financial assistance thru Community Mortgage Program (CMP).

Home Development Mutual Fund (HDMF)

Initially provide all housing units in its existing inventory in the City of San Jose Del Monte, Bulacan at a price not to exceed P160,000 per unit.

Home Guaranty Corporation (HGC)

Raise P2.0 Billion thru floatation of socialized housing bonds and securities to fund squatter relocation.

THE PARTNER AGENCIES


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Table 8: NORTHRAIL’S Partners Agency Participation/Role

Province of Bulacan Shoulder the expenses relative to the validation survey of the squatter families; Guarantee the relocation of the squatter families and endeavor to ensure that the affected families leave the subject property by December 31, 1997, but not later than June 30, 1998.

CONTRACT STATUS

On February 13, 2006, a complaint was filed by complainants from various sectors before RTC Branch 145, Makati City for the annulment of the Original CNMEG Contract and injunction with urgent motion for summary hearing to determine the existence of facts and circumstances justifying the issuance of writs of preliminary prohibitory and mandatory injunction and/or TRO against CNMEG, the Office of the Executive Secretary, the DOF, the DBM, the NEDA and NORTHRAIL. It was alleged that the Original CNMEG Contract and the Loan Agreement were void for being contrary to the Constitution, RA No. 9184, PD No. 1445, and EO No. 292. The case was docketed as Civil Case No. 06-203. On March 17, 2006, RTC Branch 145 issued an Order setting the case for hearing. On March 29, 2006, CNMEG filed an Urgent Motion For Reconsideration and before the RTC Branch 145 could rule thereon, CNMEG filed on April 12, 2006 a Motion to Dismiss arguing that the RTC did not have jurisdiction over (a) its person, as it is immune from suit as an agent of the Chinese government and (b) the subject matter, as the Nothrail Project was a product of an executive agreement. On May 15, 2007, RTC Branch 145 denied the said Motion to Dismiss. CNMEG then filed a Motion for Reconsideration which was also denied by RTC Branch 145 in an Order dated March 10, 2008. Thus, CNMEG filed on April 4, 2008, before the CA, a Petition for Certiorari with Prayer for the Issuance of TRO and/or Writ of Preliminary Injunction. The CA dismissed the said Petition on September 30, 2008 prompting CNMEG to file Motion for Reconsideration which was also denied by the CA in a Resolution dated December 5, 2008. CNMEG then filed before the SC a Petition for Review on Certiorari (CNMEG Petition) on January 21, 2009. As discussed earlier, the implementation of the Northrail Project was suspended by CNMEG on February 1, 2008, with construction works resuming only on December 21, 2008. On September 29, 2009, the contract

THE CONTRACT STATUS


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was amended revising the scope and project specifications, and increasing the contract amount to US$593.88 Million with the difference to be financed by the National Government. On November 12, 2010, Undersecretary Mario L. Relampagos, DBM, in his reply to the request of the DOTC for the issuance of Multi-Year Obligational Authority to cover the National Government’s counterpart fund for the Northrail Project, Phase I, from FY 2011 to 2014 disclosed that during the joint special Development Budget Coordination Committee (DBCC) meeting held on July 31, 2010, it was agreed that the current administration will not fund the previous contract entered into by NORTHRAIL for Phase I, Section 1. Likewise, in his letter to the NORTHRAIL President, dated June 7, 2011, he clarified that there was no appropriations in the amount of US$146.903 Million (computed based on the Amended CNMEG Contract) under the FYs 2009 to 2011 GAA as budget support from the Philippine Government for this project, and that the DBM has not released any SARO and NCA for this purpose. The construction works after the amendment of the Original CNMEG Contract hardly progressed due to a number of issues being resolved, among which are the validity of the Amended CNMEG Contract, and operational and project implementation issues. Thus, during a meeting between NORTHRAIL and SINOMACH, NORTHRAIL proposed, and SINOMACH agreed, to suspend the implementation of the Amended CNMEG Contract starting March 28, 2011. In a meeting conducted on August 8, 2011, it was decided by the parties to continue suspending the construction works until both parties have found a mutually acceptable solution to the issues or one party notifies in writing that he is terminating the work suspension. Meantime, the incumbent NORTHRAIL President, in his letters to the DOTC and OGCC dated May 13, 2011 and July 8, 2011, respectively, sought legal opinion/advice on the validity of the contract. Both the DOTC and OGCC replied on the negative. In a letter dated June 13, 2011, the DOTC opined that considering that there is no appropriation and CAF, it would appear that the previous NORTHRAIL Chairman had no authority to enter into the Amended CNMEG Contract. The OGCC, on the other hand, in its Opinion No. 167 dated July 14, 2011 explained that the implementation of the Northrail Project should have complied with the mandatory requirements of public bidding prescribed under RA No. 9184, failing in which and in the absence of the required certification of appropriation and CAF, the original, including the amended contract, executed between NORTHRAIL and CNMEG/SINOMACH are void ab initio. This is a complete turnaround from its previous Opinion,


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issued on November 13, 2003, wherein it considered the designation of CNMEG, as prime contractor, to be not violative of RA 9184 and its IRR as the same is considered as an executive agreement. The SC resolved the CNMEG Petition on January 21, 2009. In its En Banc decision under G.R. No. 185572, issued on February 7, 2012, it resolved that CNMEG is not entitled to immunity from suit, and that the original contract is not an executive agreement. Hence, the case was remanded by the SC to RTC Branch 145, Makati City for further proceedings as regards the validity of the contract. As the contracting parties were not able to resolve the issues at hand, SINOMACH, in its letter dated August 13, 2012, finally terminated the contract. Subsequently, or on August 22, 2012, it submitted its formal Claim Report for the Northrail Project, Phase 1, Section 1, detailing its entitlements following the termination of the contract. PROJECT ACCOMPLISHMENT

As of audit date, only the submitted claim for accomplishments as of May 31, 2010, covered by Progress Billing Nos. 1 to 16 in the total amount of US$104.431 Million was so far paid by NORTHRAIL. The Progress Billings Nos. 1 to 8 were based on the Original Contract amount while Progress Billings Nos. 9 to 16 were based on the Amended CNMEG Contract amount. The total reported accomplishments of US$104.431 Million, represents 17.58 percent of the amended contract price as tabulated below:

Table 9: Reported Project Accomplishments as of May 31, 2010

Item/Scope of Work Amount in Million US$ Payment as % of

contract cost Contract Payment

Pre-construction stage 49.760 33.510 67.34 Project Insurance Premium 1.219 0.741 60.79 Mobilization & Demobilization 1.266 0.691 54.58 Mainline Embankment 158.221 11.432 7.23 Bridge and Culvert 167.553 33.451 19.96 Temporary Facilities and Temporary Works 6.947 2.673 38.48 ROW Expenses & Public Utilities Diversion 27.540 21.932 79.64

Total 593.880 104.430 17.58

REPORTED PROJECT ACCOMPLISHMENTS


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The accomplishments as of audit date are depicted in the following pictures:

Table 10: Pictures of Project Accomplishments Item/Scope of

Work Pictures taken during inspection

Bridge and Culvert

Abutments A & B of Gov. Pascual Bridge @ Caloocan segment Panaka Frame Culvert

Abutments A & B, and Piers of Bocaue River Major Bridge

Abutments A & B, and Piers of Santol River Major Bridge @ Balagtas segment

Pier alignment of Guiguinto viaduct


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Abutments A & B, and Pier of Guiguinto Medium Bridge

Abutment 1 and Pier alignment of Malolos viaduct

Measurements of Pier height of Malolos viaduct

Temporary Facilities and Temporary Works

Exposed stocks of steel rails Temporary facilities @ Caloocan segment


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Exposed stocks of concrete sleepers

Temporary facilities and Batching/mixing plant @ Dalandanan

Temporary facilities, Batching/Mixing Plant and material aggregates @ Karuhatan

Girder fabrication, temporary facilities and batching/mixing plant @ NFA compound, Valenzuela

Office & Laboratory Buildings, stockpiled RSB and concrete sleepers @ NFA compound, Valenzuela

Material warehouse @ NFA compound, Valenzuela

Temporary facilities and batching/mixing plant @ Malolos segment

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Part IV

Audit Observations

________________________________________AUDIT OBSERVATIONS

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On valuation of SINOMACH’s reported and paid accomplishments 1. The SINOMACH’s reported and paid accomplishments of

US$104.431 Million was valued only at US$81.474 Million considering the actual validated accomplishments and the original unit costs. This is granting that it is allowed to be compensated based on quantum meruit. As NORTHRAIL has paid SINOMACH a total of US$210.489 Million, the SINOMACH was already overpaid by US$129.015 Million. The entire amount may even be considered a waste of government resources in the event that any accomplishment in the project will no longer be used.

To determine the reasonableness of both the Original and Amended CNMEG Contract costs, the Audit Team repeatedly requested NORTHRAIL for the submission of unit cost analysis and detailed cost breakdown for each pay item. In its reply, NORTHRAIL informed the Audit Team that there was none submitted by SINOMACH. Apparently then, while there was no clear basis for the lump sum cost adopted by SINOMACH, NORTHRAIL did not also prepare its own unit cost analysis to assess the reasonableness of the lump costs submitted by SINOMACH. Since the reasonableness of the unit costs was not established, the Audit Team assessed whether the amended unit costs were consistently applied. Evaluation of the selected amended unit costs disclosed that these were not also consistently applied. The same pay item of the different structures, with similar description and construction methodology has different unit costs. This is illustrated in the cases of Bridges and Viaducts with different unit costs for the same pay item as tabulated below:

Table 11 – Tabulation of Unit Costs of the Same Pay Items

Items of Work Viaducts Unit Cost (in US$) Bridges (in US$)

Unit Valenzuela Guiguinto Malolos Major Medium

Boring m. 441.89 441.89 439.51 439.51 387.08 Concrete for Foundation

m³

511.64 431.73 447.92 513.98 681.93 Concrete for Pile Cap 323.30 301.10 296.79 268.11 256.20 Reinforced Concrete for Piers & Abutment

738.58 698.93 745.81 854.24 982.09

Reinforced Concrete Girder

m. 7,006.86 7,656.62 7,656.62 6,528.13 6,018.01

Bridge Deck m³ 859.20 1,058.09 1,009.52 964.34 952.89


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Table 11 – Tabulation of Unit Costs of the Same Pay Items

Items of Work Viaducts Unit Cost (in US$) Bridges (in US$)

Unit Valenzuela Guiguinto Malolos Major Medium

Bridge Accessories m. 161.55 344.95 344.95 1,852.72 2,971.69

The differences in unit costs ranged from 14.16 percent to as high as 57.95 percent for major items and 1,739.49 percent for bridge accessories as tabulated below:

Table 12: Tabulation of Variances in Unit Costs

Items of Work Unit Range of Unit Costs (in US$) Variance

(%) From To

Boring m. 387.08 441.89 14.16 Concrete for Foundation

m³ 431.73 681.93 57.95

Concrete for Pile Cap 256.20 323.30 26.19 Reinforced Concrete for Piers & Abutment 698.93 982.09 40.51 Reinforced Concrete Girder m. 6,018.01 7,656.62 27.23 Bridge Deck m³ 859.20 1,058.09 23.15 Bridge Accessories m. 161.55 2,971.69 1,739.49

Further review of documents disclosed that the unit costs were apparently not based on the material components of the structures. For instance, in the case of Malolos and Guiguinto Viaducts, similar pay items with exactly the same weight of RSB and volume of concrete have different unit costs as shown below:

Table 13: Comparison of Unit Costs of Items With the Same Components

Item Structure Material Unit Cost

Per m³ (in US$) RSB (kg) Concrete (m³)

PIER Pier No. 2 Guiguinto Viaduct 14,315.60 39.80 698.93 Pier No. 5 Malolos Viaduct 14,315.60 39.80 745.81

PILE CAP Pier No. 2 Guiguinto Viaduct 9,764.79 100.32 301.10 Pier No. 2 Malolos Viaduct 9,764.79 100.32 296.79

On the other hand, two different items, abutment and pier, with different designs in terms of reinforced steel bars and volume of concrete were combined under one pay item, “Abutment and Pier”, for Guiguinto Viaduct and therefore using only one unit cost. These two different items


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have different quantities of RSB and concrete components as shown below:

Table 14: Tabulation of Items of Different Designs but with the Same Unit Cost

Item Materials Unit Cost – Pier & Abutment

(per m³ in US$) RSB (kg) Concrete (m³)

Abutment 1 7,788.04 194.87 698.93

Pier No. 30 16,293.30 47.40 For the abutment, the ratio of RSB to concrete is 39.97 kg/m³ of concrete, while for the Pier, it is 343.74 kg/m³ of concrete. This disparity indicates that the weight of RSB is not directly proportional to the volume of concrete for the two items. Thus, it is not proper to combine these two items under one pay item. In view of the noted discrepancies and the absence of detailed costs breakdown, the unit costs used in the Amended CNMEG Contract cannot be considered reasonable. Based on the documents presented, the unit costs were amended to consider price escalation, among others. Price escalation is specifically prohibited under R.A. No 9184 even for bidded contracts except under extraordinary circumstances and upon prior approval of the GPPB. There was, however, no documents provided manifesting that its price escalation was approved by the GPPB. Since the Amended CNMEG Contract was not considered reasonable, the Audit Team valued the project accomplishments using the unit costs of the Original CNMEG Contract, net of the contractor’s profit. The Team also considered the results of inspection with the assistance of representatives from NORTHRAIL in the valuation of accomplishments. Based on the SINOMACH’s submitted progress billings, the amounts being claimed were inclusive of 10% overhead, contingencies and miscellaneous (OCM) and 10% contractor’s profit. Results of evaluation disclosed that the reported and paid accomplishments of US$104.431 Million may be valued only at US$81.474 Million as computed below:


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Table 15: Project Evaluation

Items of Work

Amount (in Million US$) Remarks Paid to

SINOMACH COA’s

Evaluation Difference

Temporary Facilities and Temporary Works

2.673 1.521 1.152 The validated accomplishments were shorter than the reported accomplishments, thus, the differences in quantities as discussed in Annex A (a).

Project Insurance Premium

0.742

0.000 0.742 Under Section 28 of the contract, insurance is the responsibility of SINOMACH and there was no provision that corresponding expenses will be reimbursed by NORTHRAIL. It may also be mentioned that under Section 62 of R.A. No. 9184, for the procurement of infrastructure projects, the contractor shall be required to put up a warranty security in the form of cash, bank guarantee, letter of credit, Government Service Insurance System bond, or callable surety bond. It is very clear then that insurance is the responsibility of the contractor.

Mobilization 0.691 0.633 0.058 The difference represents the disallowed 10% contractor’s profit.

Mainline Embankment

11.432 6.870 4.562 This represents the difference in the original and amended unit costs as discussed in Annex A (b and c). Bridge and

Culvert 33.451 28.036 5.415

Pre-construction stage

33.510 22.482 11.028 This represents disallowance on payment for designs billed but not yet approved as discussed in Annex A (d).

ROW Expenses & PUD

21.932 21.932 To be covered by a separate report.

This particular item was implemented by NORTHRAIL. Any deficiency in the implementation of this item will be covered by a separate report.

Total 104.431 81.474 22.957

While the total accomplishments as of May 31, 2010 is valued only at US$81.474 Million, total payments by NORTHRAIL to CNMEG as of audit date already amounted to US$210.489 Million manifesting overpayment amounting to US$129.015 Million as tabulated below:

Table 16: Tabulation of Payments to CNMEG

Particulars Date Amount (in M)

5% Down payment June 1, 2004 US$ 21.052 25% advance payment September 29, 2004 105.263 Additional advance payment upon contract amendment December 2009 8.642

Sub-total 134.957


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Table 16: Tabulation of Payments to CNMEG Particulars Date Amount (in M)

Net progress payments (16 PBs)

From 2006 to 2011 75.532 Amount billed (US$104.431M) Less: Recoupment (US$28.898 M) Sub-total 75.532 Total Payments 210.489 Value of Accomplishments as of May 30, 2010 81.474

Total Overpayment US$129.015 The validity of the Original CNMEG Contract and CNMEG’s recovery of the value of its accomplishment on the basis of quantum meruit is yet to be decided by the RTC Branch 145, Makati City. As discussed earlier, the SC declared under G.R. No. 185572 dated February 7, 2012, that the contract between CNMEG and NORTHRAIL is not an executive agreement and therefore, should have been subjected to public bidding as required under R.A. No. 9184. The Commission on Audit (COA), in its Resolution No. 86-58 dated November 15, 1986, considers it vital to adhere to a policy of disallowing recovery on the basis of quantum meruit where, among others, there is patent violation of the mandatory legal provisions relating to competitive public bidding. The detailed discussion on the deficiencies in the project implementation is integrally attached as Annex A while the comments of the NORTHRAIL and the Team’s Rejoinder is integrally attached as Annex B.

On contract provisions and contractual scheme 2. The interest of the government was not protected under the contract as

it contains provisions which are disadvantageous to the government. These include payments of advances equivalent to 30 percent of the contract cost and assumption of construction risks and responsibilities that should be assumed by the contractor under the turnkey/design and build contract.

As a general rule, it is the responsibility of the procuring entity to ensure that the most advantageous price for the government is obtained and that government’s interest is protected at all times. To ensure that these objectives are pursued, it was so provided under Section 10, Article IV of R.A. No. 9184, that all government procurements shall be done through


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competitive bidding, except on certain conditions set forth under Article XVI of the same R.A., wherein procurement through alternative mode is allowed. In the absence of public bidding, there was no assurance that the best price for the government was obtained and the best contractor was commissioned. NORTHRAIL, however, entered into contract with CNMEG without undergoing public bidding on the premise that the Original CNMEG Contract is an executive agreement. Nonetheless, this does not excuse NORTHRAIL from the duty to evaluate and assess the reasonableness of the original and amended contract costs. Despite repeated requests, NORTHRAIL could not provide unit cost analysis and any evaluation reports on the reasonableness of contract costs. The contract, which is originally on a turnkey basis, was later amended and modified into design and build contract. Evaluation of the contract provisions and pertinent documents supporting the contracts further disclosed that its terms and conditions were disadvantageous to the government. Both the Original and Amended CNMEG Contracts provide for 5 percent down and 25 percent advance payments which already exceeded the 15 percent advance payment allowed under existing rules and regulations. In addition, NORTHRAIL also assumed a great number of construction risks and responsibilities which should have been normally assumed by the contractor, especially under the turnkey/design and build contract. This is clearly illustrated in the NORTHRAIL’s assumption of the responsibility and the risk of delay in the clearing of ROW. Under Clauses 12 and 13 of the Original CNMEG Contract, NORTHRAIL was required to clear the ROW within 150 days from the effectivity date of the Original CNMEG Contract, and to acquire additional land within 150 days from the date of final approval for additional permanent ROW requirements. This is quite stringent considering the known ROW-related problems. Moreover, under Clause 6 of the same contract, NORTHRAIL assumed the responsibility of obtaining for the contractor all permits, licenses, approvals or privileges from the pertinent Philippine Government authorities in relation to the construction of the project and is still obligated to compensate SINOMACH for any cost or loss arising from the delay of obtaining such permits. The responsibilities assumed by NORTHRAIL, as well as the privileges granted to SINOMACH, and contract provisions which are prejudicial to the government are illustrated below (underscoring ours):


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Table 17: Tabulation of Disadvantageous Contract Provisions Original Contract Conditions Amended Contract Conditions

Clause No. Provisions Clause

No. Provisions

4.1 (c) If the Contractor suffers delay and/or incurs cost as a result of a failure by the Employer to comply with the requirements on provision of access to the site and clearing of ROW, among others, the Contractor shall give notice to the Employer and shall be entitled to an extension of the Time of Completion for any such delay, if completion is or will be delayed, under Clause 22. xxxx.

4.1 (d)

entitled to an extension of the Time of Completion and all costs or losses caused by the delay under Clause 22.

No Provision 4.11 Breach of any of these obligations in this Clause 4 of the Contract which causes the Contractor to suffer any delay and/or to incur any extra cost shall entitle the Contractor to an extension of the Time of Completion and extra costs xxxx.

6 “xxxx – In case of any delay in obtaining any permits, licenses or privileges, the Contractor is entitled to obtain the compensation for any cost or loss arising from such delay and extension to the Time of Completion accordingly from the Employer, xxxx” The Employer shall be responsible to obtain xxxx… licenses and such other authorization xxxx.. from local governments xxxx. The Employer shall indemnify and hold the Contractor harmless against and from the consequences of any failure to do so.

7.1 All taxes, duties and other charges levied by the Government of the Philippines shall be borne by the Employer.

7.1 Local taxes/charges levied by the Government of the Philippines shall be borne by the Employer.

7.2

“The Employer shall pay Customs duties, VAT or any other taxes/charges to ensure the timely Customs clearance. In case of any delay in such payment, the employer shall compensate the Contractor for any cost or loss arising from such delay and the Contractor is entitled to extend the Time of Completion accordingly xxx.”

None 7.3 VAT being charged by the local subcontractors and suppliers shall be borne by the Employer, through Tax Subsidy Availment Certificates (TSAC) xxxx…. upon the BIR’s issuance of the Revenue Regulation (RR). In the absence of the aforesaid RR or in the event that the TSAC are not yet available, the Employer shall reimburse the VAT charges to the Contractor, in cash, within 5 working days upon the receipt of the request for payment xxxx.

None 7.4 “xxxx – If the Employer fails to issue the aforesaid Certificate of Withholding Tax, the Employer shall be responsible for all liabilities incurred by reason thereof”.

11 Par. No 5

All bank charges or fees under the Contract that will accrue in connection with this payment/ loan disbursement inside Philippines shall be borne or cause to be borne by the Employer.

11.1 The down payment shall be 5% of 11.1 i. The down payment shall be paid in


39

Table 17: Tabulation of Disadvantageous Contract Provisions Original Contract Conditions Amended Contract Conditions

Clause No. Provisions Clause

No. Provisions

contract Price to be paid in U.S. dollar. “The Employer shall make a cash down payment equivalent to US Dollar 21,052,500.00 to the Contractor within 30 days upon signing of the Loan Agreement xxxx”.

two (2) tranches xxxx….

11.2 The advance payment/loan disbursement shall be 25% of the Contract Price. 11.2 Within 15 days upon effectivity of the Contract, the Employer shall make advance payment by

loan disbursement out of loan proceeds, for cost preparation, mobilization, relocation, etc. 11.4 If the contractor does not receive the due payment/loan disbursement in accordance with the

Contract, the Contractor shall be entitled to the following: (a) suspension of works; (b) financing charges xxxx (c) extension of Time Completion xxxx.

13 Par. No. 2

xxxx-Within 150 days from the date of final approval, the Employer shall accomplish the acquisition of additional land for permanent ROW. If the Employer fails xxxx, the Contractor shall be entitled to extend the Time of Completion.

None

22.3 If the delay is due to the Employer, xxxx the Employer shall compensate the Contractor, on an agreed basis, for extra cost.

23 “The Contract Price shall be adjusted to take account any increase or decrease in Cost resulting from a change in the laws of Philippines or in the judicial or official governmental interpretation of such Laws xxxx”. (a) If the Contractor suffers (or will suffer) delay and/or incurs (or will incur) additional Cost as a result of these changes in the Laws or in such interpretations, made after the date of signing Contract, the Contractor shall give notice to the Employer and be entitled to: (a) An extension of time for any such delay xxxx; (b) Payment of any such cost xxxx.

23.3 None If the Contractor suffers (or will incur) additional cost as a result of either case specified in Clause 23.1: (a) a change in the Laws of the Philippines; (b) any variation order; (c) “a change in macro economic climate xxx”, the Contractor shall give notice to the Employer and be entitled to: (a) An extension of time for any such delay; (b) Payment of any such cost, which shall be added to the Contract Price.

None

23.4.1 Price Escalation 23.4.2 Currency Adjustments

NORTHRAIL even provided warranty under Item No. 3 of the Amended CNMEG Contract that both the Original and Amended CNMEG Contracts are compliant with the law of the Philippines, when as early as February 2006, a case was already filed before RTC Branch 145, Makati


40

City, for the annulment of the contract for being contrary to law. The said agreement further provided that in the event that the contract shall be declared null and void by the appropriate authority or judicial entity, the party whose country nullifies the contract shall be deemed to have committed a substantial breach of the contract. In such event, the aggrieved party shall be entitled to legal and litigation expenses. The Audit Team also noted that both Original and Amended CNMEG Contracts were not subjected to review by the OGCC, NORTHRAIL’s counsel, prior to their signing. Based on OGCC Contract Review No. (CRN) 378, series of 2009, NORTHRAIL requested for the review of the Original CNMEG Contract only after this was already signed. Apparently, NORTHRAIL only considered the review of OGCC necessary and important as the CNMEG Contract is the subject of cases before the RTC, CA and SC. Based on the documents provided, NORTHRAIL submitted the following representations to the OGCC: • The signing of the agreement before OGCC’s review was done

out of exigency.

• SINOMACH, being fully aware of the legal procedures, has agreed to respect and adopt the comments to be made by OGCC.

• In case there are substantial amendments to be made as results of the reviews, both parties shall negotiate in order to reach an amicable settlement on the same.

• That revisions incorporated in the Amended CNMEG Contract were made in view of the conditions and terms imposed by other approving agencies like NEDA, DOF and DFA.

The OGCC’s review focused on the following provisions of the Amended CNMEG Contract:

Table 18: OGCC’s Comments on the Contract Provisions Par./ Sec Pertinent Provisions OGCC’s Observations and Comments

6 The Employer shall obtain all import permits, import clearance permits, Customs permits, as well as all other permits, licenses, approvals or privileges from the relevant Philippine authorities for this Project xxx.

We suggest that the duty to obtain permits, licenses, approvals and clearances, enumerated therein be vested primarily on the contractor and NORTHRAIL’s participation be limited to rendering assistance.

26.4 Subject to the event xxx, the The defects liability security was fixed at


41

Table 18: OGCC’s Comments on the Contract Provisions Par./ Sec Pertinent Provisions OGCC’s Observations and Comments

Contractor shall submit a Defects Liability Security in the form of a bank guarantee xxx in the amount corresponding to five percent (5%) of the Total Contract Price (less the amount of xxx) which is US$516,579,685.13, valid for the duration of the Defects Liability Period or any extension thereof.

5% of the total contract price only. There must be a provision on adjustment of this security in the event that the defects discovered are substantial.

26.5 The Defects Liability Period of the defects and damaged part of the Works shall be counted one (1) year from the date of the remedying such defects and damage. However, a Defects Liability Period shall not be extended by more than two (2) years. xxxx.

There should be a qualification such that said two year period limitation shall not apply in case there are substantial defects found after the two year period. In the alternative, the said maximum two year period can be altogether deleted.

28.1 The Contractor shall secure an open cover marine insurance policy, from a Chinese insurance company, covering all equipment during its transportation from places of manufacture up to the relevant places of destination for the installation/construction, against all risks. xxxx

State the beneficiaries of the proceeds of marine insurance.

33.2 All disputes or differences xxxx. The appointing authority shall be Hong Kong International Arbitration Center. The place of arbitration shall be in Hong Kong International Arbitration Center.

Considering that the party to a contract is a Chinese company, a neutral appointing authority and place of arbitration should be chosen in case of arbitration.

The OGCC further advised NORTHRAIL that the review did not pass upon the sufficiency or reasonableness of financial and technical aspects of the agreement, nor the necessity or propriety of NORTHRAIL entering into the same, which should be addressed to and determined by NORTHRAIL in the exercise of its sound business judgment and expertise.

The Amended CNMEG Contract, however, was not revised to consider the OGCC’s comments contained under CRN 378 as the provisions that were commented on by OGCC remained in effect.


42

Pursuant to Clause 7.3 (on VAT being charged by the local sub-contractors and suppliers) of the Amended CNMEG Contract, NORTHRAIL also reimbursed SINOMACH a total amount of P76.979 Million as VAT subsidy charged by the local sub-contractors covered by the following Check Vouchers:

Table 19: VAT Charged by Local Sub-contractors and Suppliers

CV No. Check (Amount in million) Sub-Contractor Name of Project

8587 208588 10/19/09 P11.701 Foundation Specialists, Inc. Malolos Viaduct 9932 217349 6/21/10 5.209

9933 217350 6/21/10 12.750 9369 216776 3/1/10 7.776

R-II Builders, Inc. Bocaue, Santol and Guiguinto River Bridge 9935 217351 6/21/10 7.999

10724 222346 12/17/10 2.929

9745 217157 5/18/10 19.201 HAIDEE Const. & Dev’t. Corp.

Guiguinto viaduct /Tabang bridge lowering & existing road rerouting

9933 217350 6/21/10 3.050 21th Const. Dev. Corporation

Medium bridge culvert Gov. Pascual Bridge & Culvert & RDK116+425 to RDK118+334.6

9930 217347 6/21/10 0.950

10741 222362 12/21/10 3.587 IPM Const. & Dev. Corp. RDK142+994 to RDK146+653.49

9935 217351 6/21/10 0.185 Dioneda Virata Design Architecture Bocaue Station Design

9930 217347 6/21/10 0.231 East Asia Petroleum Corp. Automotive Diesel Oil

9933 217350 6/21/10 0.297 Invinjon Mineral Resources & Trading Corp.

RDK117+759.28 & 1 - 2m culvert RDK 122+688.4

9933 217350 6/21/10 1.113 YOYO Trading Diesel Oil Total P 76.978

Clause 7.3 of the Amended CNMEG Contract provided that NORTHRAIL’s bearing the VAT charged to SINOMACH by the local sub-contractors and suppliers was supposed to be through Tax Subsidy Availment Certificates (TSAC) and upon BIR’s issuance of the Revenue Regulation (RR). In other words, there should be no government cash outlay for this purpose as this is supposed to be settled through TSAC. The Amended CNMEG Contract further provided that in the absence of the aforesaid RR or in the event that the TSAC are not yet available, NORTHRAIL shall reimburse the VAT charges to SINOMACH, in cash. Apparently, the BIR did not issue RR for this purpose as NORTHRAIL reimbursed SINOMACH in cash for the VAT charged by the local sub-contractors/suppliers. It is worthy to mention that this provision was not included in the Original CNMEG Contract.


43

3. The design and build contractual scheme is not also suitable for projects financed from foreign loans with known ROW problems and obstacles. Under the Northrail Project, unresolved ROW issues contributed to the extension of the contract period resulting in payment of commitment fees of around P200.814 Million.

Considering the problems encountered in the implementation of Northrail

Project, the turnkey/design and build contractual arrangement may be considered not suitable for projects financed from foreign loans, and with known ROW-related problems and obstacles on site which were expected to take long time to be cleared such as in this case. As the clearing of ROW, acquisition of additional ROW and finalization of project design, among others, encountered a number of problems, the project implementation was temporarily and unilaterally suspended by SINOMACH effective February 2008. Upon the resumption of the construction works on December 21, 2008, the Original CNMEG Contract was subsequently amended on September 29, 2009 increasing the contract cost from US$421.050 Million to US$593.880 Million. As may be discerned from the exchange of communications between the contracting parties, the amendment was made on account of, among others, delays in the implementation of the project due to the following: • Delay of the NORTHRAIL in the approval of preliminary

design and constant changes in parameters and locations affecting the design scheme and overall alignment design;

• Delay or inability of the contractor to submit engineering designs;

• Unjustified failure of the contractor to commence construction works; and

• Inability of NORTHRAIL to complete the relocation of informal settlers and other obstacles within the project site and to acquire additional ROW.

As discussed earlier, the Amended CNMEG Contract was eventually terminated by SINOMACH on its August 13, 2012 letter to NORTHRAIL claiming that NORTHRAIL is in substantial breach of both the Original and Amended CNMEG Contracts and has not taken steps to remedy its breaches. In view of the termination of the Amended CNMEG Contract, the loan with the EXIM Bank of China of US$400.0 Million was terminated with


44

only US$180.795 Million drawdown as of June 2011, and total payment of around P200.814 Million for commitment fees as of July 21, 2011 on account of slow drawdown. As the loan conditions were not complied with, the undisbursed amount of US$219.205 Million was cancelled by the EXIM Bank under its letter dated July 6, 2012 and the loan principal of US$180.795 Million and interest thereon were required to be paid in two years in four equal installments, with the first repayment due on September 21, 2012. The loan was originally scheduled to be repaid in 20 years, including 5 years grace period. The Comments of NORTHRAIL and the Team’s Rejoinder are integrally attached as Annex C.

On NORTHRAIL expenses

4. As of December 31, 2011, NORTHRAIL had so far spent P10.569 Billion, for its operations and other initial and on-going undertakings without attaining its purpose yet. As it is, the main purpose for creating NORTHRAIL which is to construct, operate and manage a railroad system and related facilities has not been served after 17 years of existence.

On March 30, 1995, prior to the incorporation of NORTHRAIL and the execution of the JVA among BCDA, PNR, SRG, DMCI and FBDC, the joint venture partners approved the scope and started the pre-construction activities on the first phase of the railroad project, otherwise known as the Manila-Clark Rapid Railways System (MCRRS) Project. The project was intended to cover a length of the railway line from Fort Bonifacio to Clarkfield, Pampanga. In September 1998, the Office of the President issued a Memorandum affirming the flagship status of the then MCRRS Project.

Since the said affirmation of MCRRS Project, NORTHRAIL was pre-occupied with preliminary activities such as engineering studies, basic design, securing permits and environmental clearances, squatter relocation and packaging the project for financing by international institutions. Among the contracts/agreements executed by NORTHRAIL with other parties during these periods are as follows:


45

Table 20: Contracts Entered into by NORTHRAIL Parties Title Subject Date

NORTHRAIL and PNR MOA Mechanics on lease and use of ROW and all land properties of PNR

2/15/96

NORTHRAIL and DOTC

MOA

Common Alignment of the DOTC LRT-5 project

2/16/96

NORTHRAIL and SRG Engineering, Procurement and Construction (EPC) Contract

11/5/97

NORTHRAIL, Province of Bulacan and Alto Projekt Asia, Inc. (APAI)

Bulacan Housing Agro-Industrial (BUHAI) Project – relocation and industrial project

3/7/99

NORTHRAIL, HUDCC, PNR, NHA, HDMF, and HGC

Development and use of the existing ROW of PNR and relocation of informal settlers

5/11/00

NORTHRAIL and Clark Development Corporation (CDC)

Squatters Relocation Program 12/6/00

NORTHRAIL and SINOMACH MOU Feasibility of the project with the intention of employment of SINOMACH as the Contractor

9/14/02

NORTHRAIL, HUDCC, and NHA

MOA Relocation of 18,000 informal settlers 3/27/03

NORTHRAIL and NHA Additional P30 Million for Relocation 9/10/03 Following the Original CNMEG Contract entered into on December 2003, NORTHRAIL entered into a number of MOA and other types of agreements/contracts with various groups/organizations covering health insurance for employees, security services, site preparatory works, demolition and clearing of obstructions, survey and site investigation, office lease, appraisal of ROW, project management support team, among others.

As a matter of policy, NORTHRAIL was accounting all project related expenses under account “Project Development Cost (PDC)”, and other related and operating expenses under account “Pre-Operating Expenses (OPEX)”. While the loan interest, commitment fees and other charges also formed part of the PDC, the same is separately accounted as “Capitalized Financing Charges”. As of December 31, 2011, these accounts reflected total balance of P9.273 Billion. The PDC is also net of the total amount of P1.296 Billion incurred relative to the following costs which were reclassified as a debit to Retained Earnings under Journal Entry Voucher (JEV) No. 06-04-0015


46

dated April 30, 2006 as the outputs from the said expenditures were deemed no longer be of use to the new project:

Table 21: Expenses Excluded from Project Development Cost

Particulars Amount (in Million)

Basic Design Cost - SRG P 866.260 Capitalized Financing Charges 77.339 PNR-Appraisal Fee .150 Consultancy fee – technical 134.493 Consultancy fee – management/financial 56.579 Consultancy fee – legal 5.208 Squatter relocation 156.191 Total P 1,296.220

In effect then, the total expenditures incurred by NORTHRAIL since it started developing the railway system already amounted to P10.569 Billion as tabulated below:

Table 22: Summary of NORTHRAIL Expenses as of December 31, 2011

Account Title Balance as of Dec. 31, 2011 (In B)

Project Development Cost P 5.517 Pre-Operating Expenses 0.568 Capitalized Financing Charges 3.188

Sub-Total P 9.273 Add: PDC reclassified in 2006 1.296

Total P 10.569 As it is, as of December 31, 2011, NORTHRAIL has already incurred P10.569 Billion without attaining its objective. There was still no railway systems developed and operating after its 17 years existence. Any potential benefits from any investment at present cannot yet be established at this point.

On Project Management Support Team 5. Payment for the PMST as of May 2010 reaching 53.46 percent of the

total consultancy contract cost may not be considered commensurate to the project accomplishment as of the same period of only 17.58 percent of the Amended CNMEG Contract.


47

In relation to the turnkey/design and construct contract entered into by NORTHRAIL with SINOMACH, NORTHRAIL engaged the services of SES-JV as PMST. Under the TOR, the PMST shall supplement the technical capabilities of NORTHRAIL personnel and perform various services such as construction supervision, assistance in ROW acquisition, utilities diversion and checking of work accomplishments of SINOMACH with a minimum number of 83 staff. To cover one year post-construction activities of the project, the PMST was contracted for 48 months as the project construction period is 36 months. It is clear that the activities and works of SES-JV were intended to validate the accomplishments of SINOMACH. The 48 months consultancy services commenced on February 1, 2007 and officially ended on January 31, 2011. As the Northrail project was not yet completed as of January 31, 2011, the PMST contract was renewed, on a monthly basis, from February 2011 until August 2011. As of May 2010, the period covered by the last paid billing of SINOMACH, total payments to PMST covered by billing nos. 1 to 40 for services rendered during the period February 2007 to May 2010 already amounted to around P230.563 Million. This represents 53.46 percent of the total PMST contract of P431.285 Million. The billings were based on the number of personnel deployed plus reimbursable cost incurred by PMST for the covered period. The Audit Team, however, noted that such payment may not be considered commensurate with the reported project accomplishments by SINOMACH of only 17.58 percent of the Amended CNMEG Contract as of May 2010, as tabulated below.

Table 23: Comparison of Payments to PMST and CNMEG Project Accomplishments

Stage Contract Duration (in mo.)

Cost Allocation Payment % of Payment

(b/ a) % of Proj. Accom.

(amended contract) (in M P) (in M P) (a) (b)

Pre-construction 4 92.024 15.824 3.67 5.64 Construction 28 305.139 214.739 49.79 11.94 Post-construction 16 34.122 0.000 0

Total 48 431. 285 230.563 53.46 17.58 As may be noted, total payments to SES-JV as of May 2010 for construction phase is already equivalent to 49.79 percent of the total PMST Contract when the project accomplishment under the construction stage was only 11.94 percent. This shows the wide discrepancy between


48

the billed and paid PMST services in relation to the extent of project accomplishments that such services should have supposedly supervised. As mentioned earlier, the PMST’s major responsibility is to supervise the construction of the project by SINOMACH. The discrepancy in accomplishments is graphically presented below.

11.7019.0420.83

37.6141.15

46.61748.75 50.65 51.56 52.5553.46

6.53 7.17 8.21 9.12 11.43 12.7213.97 15.6716.44 17.58

8.28 10.01

5.8 5.92 6.49

0102030405060

Aug. 0

7

Sept.

07

Oct. 07

Feb.

08

Mar.

08

Mar.

09Ju

n. 09

Oct.09

Dec.09

Feb.

10

Mar.

10

Apr. 10

May

. 10

Period Covered

%of

Cum

ulat

ive

Am

ount

Pa

id O

ver

Con

trac

t Cos

t

SES-JV

CNMEG

The continuous billings by and payments to the PMST during the period of unilateral suspension of works by SINOMACH from February 1 to December 21, 2008 greatly contributed to this condition. It was noted that during this period, the PMST billed NORTHRAIL and was paid in the following amounts:

Table 24 : PMST Billings During Project Suspension and Extended Services Billing No. Amount Billed Period Covered (2008)

13 P8,327,348.32 February 14 7,729,600.68 March 15 7,012,951.79 April 16 5,888,031.80 May 17 6,668,275.00 June 18 5,697,322.11 July 19 4,624,945.91 August 20 7,239,999.44 September 21 4,740,175.55 October 22 4,541,465.48 November 23 6,999,561.67 December

P69,469,677.75


49

It was also noted by the Audit Team that in CYs 2009 and 2010, the PMST deployed additional staff, presumably to optimize the utilization of the PMST budget. Services of PMST staff with fully consumed man-months allocation were extended using unused man-months allocated to other local staff. Total payments for additional staffs and extended services amounted to P20.943 Million as presented below, which contributed to the above variance.

Table 25 : Payments for Additional PMST Staff

Additional staff/staff with extended services Realigned Position

Position with unused man-

months allocation

Payments (in Million

Pesos) Remarks

Zosimo Y. Dayandayan Quality Control Engr. Foundation/ Geotechnical Engineer

0.725 Newly hired

Ruel A. Ramos Construction QA/QC Signaling/ Telecom Engr. 1.630

Extended Jerry C. Sison

Quality Control Engineer

Resident Civil & Trackworks Engineer

1.962 David Resuma 1.518

Newly hired

Domingo R. Basa 0.698 Anacleto Rosario 0.872 Mellington Lao

Site Structural/ Foundation Engineer

1.198 Oscar Ramon Palaganas 0.160

Oscar Panganiban 1.410 Eduardo Naco Geodetic Engineer 0.975 Elmo Ramon P. Colasito

Laboratory Technician

Junior Engineer 1.398

Rizalde C. Calvario Junior Engineers/ Constructions Inspectors

0.955 Noel Suarez 0.779 Edwin T. Crisostomo 0.176 Fidel O. Montenegro 1.353 Extended Eric G. Siron

Document Controller

1.336

Newly hired

Alexander M. Cahilog/ Jesus Fernandez 1.224

Reynaldo Rebucas Soil Material/QC

Utilities Coordinator 1.507

Edgardo Ocampo 1.067 Extended Total 20.943

Evaluation of the reports submitted by the PMST from February 1, 2007 to January 31, 2011 disclosed that its activities covered, among others,


50

design review, site inspection, and witnessing of construction works and field testing undertaken by SINOMACH. The Audit Team also noted that the works covered in the TOR such as construction supervision, assistance in ROW acquisition, assistance in PUD, checking of contractor’s work accomplishments, evaluation of requests for additional payment/time extension and assistance in any dispute, claims or controversy, among others, were eventually assumed by the NORTHRAIL without corresponding reduction in the PMST contract cost. It is worth mentioning that these activities were primarily the very purpose for hiring PMST.

6. The PMST contract was also pursued despite inability of the consultant to secure funding source, a requirement in the bid tender. As of November 8, 2011, the PMST contract was declared void by the OGCC due to the absence of appropriation and CAF at the time of contract execution.

The Audit Team further noted that one of the conditions in the Invitation to Apply for Eligibility and to Bid is for the participating bidders to arrange financing for the consultancy services. Thus, each interested proponent shall include in its bid, an offer for acceptable financing to cover the international and local components of its offer. In response to such invitation, 13 consultancy firms submitted documents for eligibility, of which the following four (4) were declared eligible by the NORTHRAIL: • Joint Venture of Louis Berger Phils. and Louis Berger, Inc.

(Louis Berger) • Joint Venture of SMEC International and Schema (SMEC) • Joint Venture of TUV, DE Consult, PCI Intl., PCI Phils. & JF

Cancio & Associates (TDPPI) • Joint Venture of Systra S.A., ES De Castro and Associates, and

Systra and Associates, and Systra Phils., (SES-JV)

Eventually, the first two bidders withdrew their bids while the third bidder was disqualified outright due to the submission of bid bond not callable on demand. Thus, only the SES-JV was subjected to technical evaluation and post-qualification by the NORTHRAIL Technical Working Group (TWG). After evaluation and post qualification, SES-JV was declared as the highest rated responsive bidder with the BNP Paribas and First Metro Investment Corporation (FMIC), as the consultant’s funding institution.


51

The NORTHRAIL Board of Directors, in its Resolution BD No. 08-31-06-004 dated August 31, 2006, approved the award of the PMST-Consultancy Services contract to the SES-JV. The award of the contract was temporarily deferred under BD No. 09-14-06-002 dated September 14, 2006 due to complaints from the losing bidder, TDPPI Joint Venture, but was later pursued under BD No. 12-14-06-005 dated December 14, 2006. The Notice of Award was issued on December 15, 2006 and conformed by SES-JV on the same date. As disclosed in the said notice, the consultancy contract is a condition precedent to the loan facility being offered by the consultant and made part of its bid, and that all payments to be made as a consequence of the contract shall be dependent on the loan facility that may be concluded between NORTHRAIL and the consultant’s funding institution. The consultancy contract was signed on January 30, 2007 and the Notice to Proceed was issued by NORTHRAIL on January 31, 2007 for Work Order Nos. 1 to 7 to be undertaken for the period February to August 2007. Unfortunately, the loan negotiations with FMIC failed due to its refusal to accept the guarantee proposed by Trade and Investment Development Corporation (TIDCORP). Despite failure of loan negotiation and the SES-JV’s failure to secure funding, NORTHRAIL pursued the contract with SES-JV. NORTHRAIL also issued the CAF on May 31, 2007 amounting to US$0.208 Million and P16.352 Million for foreign and local components, respectively, equivalent to 23 percent of the 15 percent total project cost covering Work Orders Nos. 1 to 03-A. It may be noted that the CAF issued covered only the partial funding requirement for the PMST contract and was issued four months after the signing of the consultancy contract and issuance of the Notice to Proceed. The PMST started billing NORTHRAIL for works undertaken from February to April 2007 with payments sourced from the P152.09 Million released by BCDA to NORTHRAIL sometime in April 2007 for its operating expenses. The NORTHRAIL then looked for alternatives and eventually accepted the financing proposal of the DBP in December 2007. While the alternative source of fund was only finalized in December 2007, NORTHRAIL has been paying SES-JV billings which amounted to P18.548 Million as of July 16, 2007, broken down as follows:


52

Table 26 : Tabulation of Payments to SES-JV JV/Check Billing

Period Covered Amount (in Million P) No. Date Date No.

2048562 7/13/07 Advance Payment-Local 9.319 07-07-06 7/16/07 Advance Payment-Foreign 5.001 2048498 6/26/07 2/15/07 1 Feb. 2007 1.582 2048499 6/26/07 5/15/07 2 March 2007 0.998 2048553 7/12/07 5/17/07 3 April 2007 1.648

Total 18.548 As discussed earlier, the proposal of the DBP as an alternative source of fund was accepted by NORTHRAIL only in December 2007. The use of DBP loan as an alternative source of fund was earlier raised by some sectors as an issue. Thus, NORTHRAIL posed a query to the OGCC on the legality of accepting the alternative proposal of the DBP to finance the consultancy contract. The said query was earlier ruled in the affirmative by the OGCC in its Opinion No. 143, series of 2007, dated July 16, 2007. However, in its latest issuance under Opinion No. 240, series of 2011, issued on November 8, 2011, the OGCC declared the contract between NORTHRAIL and SES-JV void in view of the absence of the requirements of existence of appropriation and CAF. The comments of NORTHRAIL and the Team’s Rejoinder are integrally attached as Annex D.

53

Part V

Recommendations

RECOMMENDATIONS________________________________________

54

Considering the present status of the project, it is recommended that NORTHRAIL make representations with the Regional Trial Court of Makati for the speedy resolution of all pending NORTHRAIL-related cases, the decision of which can be used by NORTHRAIL as guide in its arbitration with the SINOMACH. In order to avoid the occurrence of similar problems in the future NORTHRAIL’s projects, it is recommended that:

NORTHRAIL ensure that its contracting is compliant with RA No. 9184 and all applicable laws, rules and regulations;

NORTHRAIL ensure that the interest of the government is protected by the provisions of the contract in all cases at all times;

Project costs be properly evaluated prior to entering into contract to ensure that the cost is reasonable and fair to all parties;

NORTHRAIL settle all ROW-related issues and problems including acquisition of all required ROW prior to entering into contract for the implementation of another project; and

Payments for consultants, like PMST, be closely monitored vis-à-vis the payments for activities for which the consultant was hired.

In view of the deficiencies noted in the implementation of the project, it is further recommended that the liabilities of officials and employees responsible for the inefficient and ineffective implementation of the Northrail Project, be established and appropriate actions taken thereon.

RECOMMENDATIONS

55

Part VI

Annexes

SAO Report No. 2012-02 ANNEX A

56

ANNEX A

Project Evaluation Report Original and Amended CNMEG Contracts

Audit of NORTHRAIL

a) Temporary Facilities and Temporary Works This item was reported 82.33 percent accomplished valued at US$2.673 Million under PB No. 5, covering the period October 1 to 31, 2007. It has an unaccomplished balance of US$0.574 Million. The remaining works, in addition to temporary bridge, which were not accomplished, refer to maintenance works of the following items:

Item Description Amount in US Dollars

Contract Amount

Accomplishment PB No. 5 Balance

Temporary Road for Vehicles 0.343 0.287 0.056 Temporary Bridge for Vehicles 0.292 0.000 0.292 Temporary Lines for Electric Power 0.265 0.209 0.056 Temporary Pipes for Water Supply 0.195 0.134 0.061 Material Warehouse 0.049 0.046 0.003 Storage Yard for Rails 0.117 0.114 0.003 Batching & Mixing Plant 0.428 0.428 0.000 Site Compound 1.558 1.455 0.103 Total 3.247 2.673 0.574

While these work items were already reported accomplished under Progress Billing No. 5 which is prior to the amendment of the contract on September 29, 2009, the same were still subjected to price adjustment and included in the Amended CNMEG Contract in the amount of US$6.947 Million. The amended amount was, however, not accepted and paid by NORTHRAIL.

Inspection of the reported and paid accomplishments disclosed the following deficiencies amounting to US$1.152 Million:


57

Item Description

/Unit

PB Nos. 1-16 Team’s Evaluation

Remarks Amount in T US$

Qty. Amount Qty. Amount Cost Diff.

Site Preparation /m²

36,156

27.117 14,378.13 9.885 17.232 Some areas identified in the plan as temporary road are also part of the alignment of the main track, and therefore already included in the cost of soil stabilization works.

Excavation/ m³

12,267 .

38.518 0.00 0.000 38.518 The details and specifications of these items were not reflected in the submitted layout, hence, any accomplishment cannot be quantified.

Soil Compaction /m³

29,840

202.614 0.00 0.000 202.614

Maintenance /mo.

7 18.804 0.00 0.000 18.804 The temporary road is part of the main line track, hence, maintenance no longer necessary.

Temporary Lines for Electric Power High voltage- Intake/each

8 1.873 8.00 1.717 0.156 Disallowed contractor’s profit.

- pole/each 14 2.475 14.00 2.269 0.206 34.5 KV Switch-gear install./each 10 0.901 10.00 0.826 0.075 Transformer Installation - 300 KVA /set

4 1.463 4.00 1.341 0.122

- 225 KVA /set 4 1.463 4.00 1.341 0.122 400V low-voltage distrib. room /each 6 19.335 6.00 17.724 1.611 High Voltage lines - GJL-70 /set 4,310 40.643 1,729.00 14.944 25.699

Overstated quantities considering the plan and actual inspection.

- 4 wires /m. 13,770 114.842 5,335.96 40.793 74.048 Low voltage pole /unit

69 6.204 0.00 0.000 6.204 Not reflected in the layout plan.

Grounding Device /unit

7 0.913 0.000 0.000 0.913

Maintenance /mo.

7 18.672 1.00 2.445 16.227 With accomplishment only for the month of October 2007.

Temporary Pipes for Water Supply


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Item Description

/Unit




Cold Waterline Installation / m.

1,682 66.338 1,436.56 51.936 14.402 Overstated quantity at NFA Section considering the plan and actual inspection.

Maintenance /mo.

7 20.419 1.00 2.674 17.745 With accomplishments only for the month of October 2007.

Temp. drainage system /m.

839 35.842 839.00 32.855 2.987 Disallowed 10% contractor’s profit.

Water well /pc. 3 9.628 3.00 8.826 0.802 Water tank installation - 30m3 /pc.

2 0.717 2.00 0.657 0.060

- 10m3 /pc. 2 0.506 2.00 0.464 0.042 Material Warehouse - 1 / m² 2,717 27.088 2,493.31 22.787 4.302 Overstated quantities

considering the plan and actual accomplishments.

- 3 / m² 919 15.531 563.04 8.722 6.809

-2/ m² 154.5 2.236 154.50 2.049 0.186 Disallowed 10% contractor’s profit.

Maintenance/ mo.

7 0.957 1.00 0.125 0.832 With accomplishment only for the month of October 2007.

Storage Yard for Rails - NFA-1/ m² 1,364 13.599 383.00 0.263 13.336 Overstated quantities

considering the plan and actual accomplishments. The area needs only site preparation works. Hence, the Team used unit cost of US$0.75 per sq. m.

- NFA-2/ m² 1,625 16.201 1,625.00 1.117 15.084 - NFA-3/ m² 585

5.832 585.00 0.402 5.430

- NFA-4/ m² 3,330 77.865 3,330.40 2.290 75.575

Maintenance/ mo.

7 0.834 0.00 0.000 0.834 Unnecessary.

Set up mixing plant - 35cu.m./h /set 2 139.168 2.00 127.571 11.597

Disallowed 10% contractor’s profit.

- 60cu.m./h /se 2 154.688 2.00 141.797 12.891 - 25cu.m./h /se 2 132.794 2.00 121.727 11.066 Calibration 1.707 0.00 0.000 1.707 Should be borne by the

contractor. Site Compound (office, living facilities, track laying base) Clearing & Preparation/m²

23,541 17.657 8,283.20 5.695 11.961 Overstated quantities considering the plan


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Item Description

/Unit




Excavation/ m³

12,366 38.829 0.00 0.000 38.829 and actual accomplishments.

Backfilling & Compaction /m

19,778 134.293 0.00 0.000 134.293

Concrete/ m³ 519 36.797 0.00 0.000 36.797 Rebar/ kg. 2,440 2.245 0.00 0.000 2.245 Office/ m² 1,560 407.659 1,417.10 339.457 68.202 Conference Rm. /m²

234 61.149 90.00 21.559 39.590

Kitchen/ m² 145 33.005 108.00 22.534 10.471 Gasoline Store-house /m²

131 20.833 0.00 0.000 20.833

Dormitory/ m² 2,113 379.896 2,113.00 348.238 31.658 Disallowed 10% contractor’s profit. Bathroom/ m² 199 46.381 199.00 42.516 3.865

Elevated Fuel Tank -10m3 /pc.

1 1.345 0.00 0.000 1.345 Per verification, the fuel tank was owned by the sub-contractor.

- 20m3 /pc. 2 3.794 0.00 0.000 3.794 Septic Tank /m²

110 13.586 40.00 4.529 9.057 Overstated quantities considering the plan and actual accomplishments.

Girder Fabrication Plant/m²

8,008 223.503 4,564.35 116.775 106.728

Maintenance /mo.

7 34.173 0.00 0.000 34.173 Unnecessary.

Total 2,672.934 1,520.854 1,152.080

b) Mainline Embankment

A total of US$11.432 Million was already paid for this item under PB No. 16 equivalent to 7.23 percent of the amended contract amount. As discussed earlier, the difference of US$4.562 Million or 39.91 percent of the amount paid for this item was due to the Audit Team’s adoption of the original contract unit costs and disallowance of the contractor’s profit on the following items:

Item Description unit Qty.

Amounts in T US$

PB Nos. 1- 16 Team’s


High pressure jet grouting pile m 18,990.54 857.423 458.527 398.896 Crushed stone cushion m³ 397.00 12.001 8.552 3.449


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Item Description unit Qty.

Amounts in T US$

PB Nos. 1- 16 Team’s


Immersiable soil m³ 155.55 4.609 2.008 2.601 Open excavation - road cut m³ 16,981.94 95.546 72.697 22.850 General embankment const. m³ 44,824.64 581.024 361.174 219.849 Crushed Stone Pile m 139,749.70 2,412.080 2,211.073 201.007 Cushion of sand w/ crushed stones m³ 4,180.19 88.536 81.158 7.378

Cement mixing piles (dia=0.5m) m 186,626.45 7,381.076 3,674.675 3,706.401 Total 11,432.295 6,869.864 4,562.431

c) Bridge and Culverts

Bridge and culverts were valued in the amended contract cost at US$167.553 Million, of which US$33.451 Million or 19.96 per cent was already paid under PB No. 16. All payments were based on the amended contract costs, thus, the Audit Team recomputed the cost of reported accomplishment using the original costs minus 10% contractor’s profit. Comparison of the payments with the recomputed amounts resulted in cost difference of US$5.415 Million.

Item Description Unit

Original Unit Cost

(in US$)

COA Evaluation (Amount net of 10% profit) In T US$

Quantity Amount

(in T US$) Total

Payments Difference

Guiguinto Viaduct 8,304.086 9,871.574 1,567.488 Boring m 439.51 10,850.00 4,371.293 Concrete for foundation m³ 184.97 8,521.57 1,444.882 Concrete for pile cap m³ 149.01 2,508.00 342.574 Reinf. concrete for piers & abutment m³ 158.33 919.10 133.394 Reinforced Steel Bars (RSB) kg. 1.20 1,829,038.89 2,011.943 Malolos Viaduct 16,426.610 19,442.299 3,015.689 Boring m 439.51 20,952.00 8,441.230 Concrete for foundation m³ 184.97 16,281.35 2,760.598 Concrete for pile cap m³ 149.01 5,918.88 808.474 Reinf. concrete for piers & abutment m³ 158.33 1,453.65 210.976 RSB kg. 1.20 3,823,029.04 4,205.332 Major bridges (four) 2,616.145 3,279.666 663.521 Boring m 439.51 3,486.00 1,404.454 Concrete for foundation m³ 184.97 2,738.35 464.304 Concrete for pile cap m³ 149.01 1,012.32 138.275 Reinf. concrete for piers & abutment m³ 158.33 80.38 11.666 RSB kg. 1.20 543,132.34 597.446 Medium bridges (three) 618.838 707.672 88.834


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Item Description Unit

Original Unit Cost

(in US$)

COA Evaluation (Amount net of 10% profit) In T US$

Quantity Amount

(in T US$) Total

Payments Difference

Boring m 439.51 726.00 292.494 Concrete for foundation m³ 184.97 570.11 96.665 Concrete for pile cap m³ 149.01 147.84 20.194 RSB kg. 1.20 190,440.82 209.485 Culvert (Panaka) 70.354 149.351 78.997 C20 concrete (culvert body) m³ 97.92 16.60 1.490 Sand cushion (culvert body) m³ 30.33 23.30 0.648 C15 concrete (culvert body) m³ 117.41 4.30 0.463 C30 concrete (culvert body) m³ 155.08 98.34 13.980 C15 concrete (retaining wall) m³ 117.41 131.60 14.163 C30 concrete (coping stone) m³ 155.08 3.22 0.457 C15 concrete (discharge bed) m³ 117.41 9.20 0.990 Sand cushion (discharge bed) m³ 17.50 1.20 0.019 M10 Mortar rubbles (water proofing layer)

m³ 53.01 1.60 0.078

M10 Mortar rubbles (pave) m³ 53.01 52.10 2.532 Broken stone course m³ 33.88 10.20 0.317 Excavation work m³ 13.62 570.00 7.116 Backfilling work m³ 4.05 410.00 1.523 Disposal of excess soil m³ 5.00 160.00 0.733 Demolition of existing culvert m³ 33.88 119.90 3.724 M10 Cement Mortar slab stone m³ 53.01 5.80 0.281 RSB kg. 1.20 19,854.21 21.840

Total 28,036.033 33,450.562 5,414.528

d) Pre-Construction Works (Survey, Site Investigation and Preliminaries) Based on the original scope of work, this item was quoted in lump sum amount of US$38.67 Million broken down into:

Description Amount (in M US$)

Survey and Site Investigation 7.76 Preliminaries 30.91 Total 38.67

Of the total pre-construction cost of US$38.67 Million, US$33.51 Million or 86.66 per cent was already paid under PB No. 16. The billings were not supported with detailed breakdown of the amount being


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billed. In succeeding billings, the lumpsum costs were eventually allocated for each item/structure as follow:

Particulars Amount in M US$ Allocated Cost

as % of Contract Cost

Original Const. Cost

Allocated Pre-Const. cost

Items of work needing design Mainline Track (horizontal) 22.346 3.123 13.9736 Mainline Track Embankment (vertical) 98.153 3.406 3.4705 Bridges & Culverts (including viaducts) 81.365 8.516 10.4665 Station, Building/Station Track including Temfacil 29.513 2.271 7.6948 Depot 15.070 1.703 11.3020 Signaling 14.200 2.271 15.9925 Telecommunications 4.100 1.419 34.6180 Ticketing/AFC 3.640 1.987 54.5899 Power Supply (system) 4.610 0.852 18.4729 Rolling Stock 2.271 2.8590 Total Preliminary and Detailed Design 272.997 27.819 10.1902 Scheme Design (Lump Sum) 3.091 Survey & Site Investigation 7.760 Total Pre-Construction Works 38.670

As may be noted, the percentage of allocation of pre-construction cost to each item/structure needing design varies widely as it represents 2.86 percent to as high as 54.59 percent of the original construction cost of each item/structure. The Ticketing/AFC with total cost of US$3.640 Million was allocated US$1.987 Million for the design equivalent to 54.59 percent of the cost which may no longer be considered reasonable. The amount allocated is further divided into the following activities:

Pre-construction Stage Percentage allocation (%)

Preliminary Design 66.66 Upon Submission 44.44 Upon Approval 22.22 Detailed Design 33.33 Upon Submission 33.33

Thus, even if the submitted preliminary/detailed design were not yet approved, these were just the same included in the billing and paid. This


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practice is not in line with the rule that only items/services accepted by the procuring entity should be paid. In the absence of any justification for the unequal distribution of pre-construction costs, the Audit Team allocated the design cost to each item/structure using the average percentage of 10.1902 representing the total allocated cost for the design taking into consideration the original construction cost for each item/structure (US$27,819,000 ÷ US$272,996,698). The results of the Audit Team’s re-calculation are tabulated below.

Particulars Pre-Const. Cost Allocation

As billed Re-calculation

Mainline Track (horizontal) US$ 3,122,541 US$ 2,277,105 Mainline Track Embankment (vertical) 3,406,408 10,002,038 Bridges & Culverts (including viaducts) 8,516,020 8,291,210 Station building/Station Track 2,270,939 3,007,395 Depot 1,703,204 1,535,663 Signaling 2,270,939 1,447,008 Telecommunications 1,419,337 417,798 Ticketing/AFC 1,987,071 370,923 Power Supply (system) 851,602 469,768 Rolling Stock 2,270,939 0 Total Preliminary and Detailed Design US$ 27,819,000* US$ 27,818,908* * difference due to rounding off

Considering the recomputed allocation for the design, the original construction cost for each item/structure, the approved design and 10% contractor’s profit, the total billed and paid accomplishments is considered excessive by US$11.028 Million, as tabulated below.

Particulars Amount in M US$

Design Status/ Remarks Recomputed

Allocation Total

Payments COA Evaluation

Allowed* Disallowed

Mainline Track (horizontal) 2.277 3.153 2.087 1.066 Detailed design

was considered approved. Mainline Track

Embankment (vertical) 10.002 3.440 3.153 0.287

Bridges & Culverts (including viaducts)

8.291 8.974 7.600 1.374

Station Building/Station Track including

3.007 1.011 0.000 1.011 Preliminary designs were submitted but


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Particulars Amount in M US$

Design Status/ Remarks Recomputed

Allocation Total

Payments COA Evaluation

Allowed* Disallowed

Temfacil not yet approved. Depot 1.534 0.758 0.000 0.758 Signaling 1.447 1.011 0.000 1.011 Telecommunications 0.418 0.632 0.000 0.632 Ticketing/AFC 0.371 0.885 0.000 0.885 Power Supply (System) 0.470 0.379 0.000 0.379 Total Preliminary & Detailed Design 27.819 20.243 12.840 7.402

Scheme Design (LS) 3.091 3.127 2.834 0.293 Twice claimed under PB Nos. 1 & 7.

Prelim Design for Section 2

0.000 2.692 0.000 2.692 Outside of the contract coverage.

Survey & Site Investigation

7.760 7.449 6.808 0.641 Overbilling and over-payment of indirect cost (IC) w/c is computed based on direct cost (DC). DC was only 95.70% while IC was 100% billed and paid.

Total Pre-Construction Works 38.670 33.510 22.482 11.028

* Net of 10% contractor’s profit

SAO Report No. 2012-02 ANNEX B

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ANNEX B

Management’s Comments and Team’s Rejoinder Project Evaluation Report

Original and Amended CNMEG Contracts Audit of NORTHRAIL

Management’s Comments Team’s Rejoinder

Present Management It was mentioned that the amount already spent on the NORTHRAIL Project could be a waste of government resources. NORTHRAIL completely agrees with this observation if the government finally decides not to develop a commuter train using the PNR-ROW. However, DOTC was mulling over the possibility of using the PNR-ROW for commuter train while the NLEX would be for the Airport Express Rail from NAIA to Clark International Airport.

Even if the same alignment will be used, significant amount could still be considered wasted as the project would definitely require another feasibility study and other pre-construction activities. As it is, as early as 2006, prior years’ expenses amounting to P1.296 Billion were already reclassified by NORTHRAIL as direct expenses since the outputs from the said expenditures were deemed no longer relevant to the recently terminated project.

NORTHRAIL Managers To date, the National Government is yet to issue a definite policy direction for the reconfigured NORTHRAIL Project. One of the options being considered in the on-going study being undertaken by the Japan International Cooperation Agency (JICA) in coordination with DOTC and NORTHRAIL, is a commuter service railway system using the PNR-ROW alignment. If the administration will not opt to implement the said option, then the P10.569 Billion will really be a total waste of government resources. In addition, if the project was only completed as originally envisioned and planned, the project would be a very vital infrastructure providing transportation service to the public. This could be the reason also for the approval of this project

The team agrees that this is a vital infrastructure that would impact in the development of the area. However, the implementation of project, no matter how vital it may be, is subject to certain laws, rules and regulations. In view of non-


66


by the appropriate government agencies, e.g. NEDA ICC/Board, during its conception and implementation stage. The policy direction keeps on changing and its impact should be carefully studied for a previous contract implemented under a different policy direction. The NORTHRAIL project, as a commuter system, seems to be part of the development agenda of the government but the timing of implementation, as in the case of the new policy direction, would be another question. The existing completed structures and some of other accomplishments of the Project could still be used if a commuter rail system will be implemented in the future.

compliance by NORTHRAIL with certain laws, rules and regulations, the implementation of the project was affected. As borne by records, the project was terminated primarily due to a number of unresolved problems on account of non-compliance with existing laws and regulations more than due to changes in policy direction.

Based on records, the Original Contract had implementation problems and for it to proceed, some remedies/relief had been proposed such as price adjustments due to inflation and foreign currency fluctuations.

Price adjustments are subject to existing rules and regulations.

The records show that the Original Contract was signed as early as December 2003. Partial NTP, particularly for works involving investigation and design, had been issued in April 2005 but the full NTP was issued in February 2007. Works were unilaterally suspended by SINOMACH in January 2008 due to pending confirmation of preliminary engineering design and delay in the acquisition of additional right-of-way requirements, with accomplishments of less than 10%. The Contractor issued Notice of Termination because of alleged contract breaches in July 2008, which is almost five (5) years from the contract signing.

The problems may be due to, among others, the project site not being completely available for the project and the contract cost details being unclear. These problems should have been considered in the amended contract. However, the contract was amended without resolving these problems.


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The direction then was to continue the project up to completion, which led to a series of workshops and discussions on how to address the supposed issues. It should be pointed out that the Contractor also submitted, based on their letter dated 13 May 2008, a Notice of Claim on Extra Costs and Price Adjustments. The conditions then showed that price adjustments are inevitable if NORTHRAIL wanted to continue the project considering the elapse of about 5 years.

Contract price adjustments are subject to existing rules and regulations, and estimates should be clearly established. In this case, the computation for the amended contract cost cannot be provided to the team.

The adjustment in project cost was not done at once because it had to comply with elaborate government requirements and procedures. Documents showed that the project was re-endorsed to NEDA and ICC for which the merit of the request is considered, particularly on the adjustment of project cost. The revised project cost, considering price adjustments, was approved by NEDA Board, showing that appropriate authorities confirmed the increase. It should be emphasized that without this approval, the project will not continue and could have been terminated as early as 2008.

The proposal should not have also been approved by NEDA without detailed unit cost analysis and evaluation on the reasonableness of contract costs.

It can be construed that under extra-ordinary condition, justice and equity dictates that project cost maybe adjusted, as can be noted in the earlier government approval. Without this basis, the project’s progress billings will not be paid as presented.

On the other hand, what had been applied in the Amended Contract technically is price adjustment and not price escalation. Price escalation, based on the provisions of GPPB Resolution approving the Revised Guidelines for Contract Price Escalation (Attachment 1-A), e.g. item

NORTHRAIL cannot apply the provisions of P.D. No. 1594. This law was already considered inoperative upon the approval of R.A. No. 9184 in 2003. On the other hand, the amendment was made in 2009. Price Escalation is defined, under GPPB


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nos. 5.4 and 8, refers to the adjustment applied to completed works. Whereas, the adjustments applied in the NORTHRAIL contract were made as a result of delayed implementation of the project, and was approved even prior to completion of any specific work. This adjustment seems to qualify and also consistent with the spirit of Section IB 10.11, item no. 2, of PD 1594, citing among others the difference of price adjustment and price escalation (see Attachment 1-B).

Resolution 07-2004 dated July 22, 2004 prescribing the Guidelines on Contract Price Escalation, as an increase in the contract price during contract implementation on the basis of the existence of “extraordinary circumstances” as determined by the NEDA and upon prior approval of the GPPB. It may be mentioned that the amendments, including price adjustments, have no prior approval of the GPPB as required in the abovementioned GPPB issuance. Besides, as discussed earlier, NORTHRAIL cannot present unit cost analysis to prove the reasonableness of the unit costs.

The amount of US$210.489 million includes advanced payment/down payment and not only paid accomplishments of US$104.431 million, which are all consistent with contract provisions during that time.

This amount is clearly discussed in the report as consolidated payments.

Endorsements for payment and actual payments were also based on the presumption accorded by law on the validity of the contracts.

Granting that the contract is valid, NORTHRAIL is still under obligation to establish the reasonableness of the contract cost.

It is known that just like any other construction contract, down payment and advance payment are granted to Contractor at the start of the project. And since AP/DP are only recouped every progress billings, an overpayment, if it will be called overpayment, in the amount of unrecouped AP/DP normally exists throughout the project duration, except when the project is pre-terminated, in which case, the overpayment will be realized. But as long as the project progresses, the contract provision in the payment of billings shall be followed. Advance Payment and Down Payment

The Audit Team agrees that down and advance payments will remain until recouped. However, considering that the contract was already terminated, all payments in excess of the value of actual accomplishments, including unrecouped advances may be considered part of overpayments. Moreover, the grant of down and advance payments equivalent to 30 percent of the contract cost is no longer in accordance with existing rules and regulations, and not advantageous to the government.


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were considered since Contract was valid then. Similarly, as in the case of ordinary construction contract, even governed by FIDIC Conditions of Contract and the local RA 9184, provision for price escalation seems not equated with the amount of AP/DP released. In the absence of such provision equating the amount of AP/DP with price escalation, NORTHRAIL simply complied with the provision of the contract. For Progress Billing Nos. 1 to 8, since Original Contract is effective, the Bill of Quantities of the Original Contract was used in the payment of billings. Since Amended Contract was already effective in the payment of Progress Billing Nos. 9 to 16, the effective BOQ and unit prices of the Amended Contract were used in the payment of billings.

While this is not specifically provided under RA No, 9184, this issue was already passed upon by the Supreme Court. The Supreme Court’s pronouncement under GR No. 188866, “PEZA vs Green Asia Construction and Development Corporation” that the cost of materials to which the advance payment has been applied will not be subjected to price escalation is very clear. There is therefore a direct relation between price escalation and advance payment.

Paying Billing Nos. 9-16 at the original contract unit prices is without basis during that time because of the approved Amended Contract. In fact, when DOTC conducted Due Diligence Review (Mid-Term Review) of the NORTHRAIL Project, Billing Nos. 12 to 16 were coursed through DOTC and that office even recommended the payment of Billing Nos. 12, 14, 15 and 16, as submitted which is by then based on Amended Contract.

The NORTHRAIL should have assessed first the items for escalation before submitting project proposal to NEDA for approval.


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NORTHRAIL simply followed the provisions of the effective contract covering the period of billing as submitted, based on the presumption accorded by law on the validity of the contracts, since no court ruling/decision was issued nullifying the contracts. For Billings Nos. 1 to 8, the Original Contract was used while for Billings Nos. 9 to 16, the Amended Contract was adopted. Under this premise, and in the exercise of due diligence, NORTHRAIL continuously rejected payment for adjustments of Billings Nos. 1 to 8 as submitted by the Contractor because Billings Nos. 1 to 8 are covered by the Original Contract, even if they claimed that the adjustments were part of the adjustments of the Amended Contract. But for works completed under the Amended Contract, NORTHRAIL cannot deny payment.

Presumption of validity is not an excuse for failure to exercise due diligence. NORTHRAIL did not ensure that the interest of the government is protected under the contract.

The fact is no unit cost analysis was indeed submitted as requirement of the lump-sum SINOMACH contract.

The NORTHRAIL should have imposed the submission of unit cost analysis for its evaluation. In the absence of which, it should have at least prepared one for its guidance in evaluating the billing.

Based on the Amended Conditions of Contract Cl. 11 (Terms of Payments), payment of the Project shall be made on the basis of the lump sum Contract Price. Under a lump sum contract, the contractor will prepare and submit monthly pay estimates based on progress as a percentage of the lump sum prices. Furthermore, under Sub Cl. 15.2 of the Amended Conditions of Contract, it states that although estimated quantity of works in the Bill of Quantities (BOQ) may be different from the final actual quantity of works, payments will be made per lump sum amount as described in the BOQ.

This is one provision that may be considered disadvantageous to the government.


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The Bill of Quantities (BOQ) was however required under the contract, based on Clause 18.3.1:

“18.3.1 The Contractor shall prepare the Preliminary Engineering Design and Technical Specification based on its Engineering Survey.

A complete set of design document shall comprise the Preliminary Engineering Design Drawings with the report, the Bill of Quantities, the Project Implementation Schedule and all relative documents.”

This provision clearly shows the requirement for the submission of the Bill of Quantities. Upon determination of the need for this breakdown, records showed that NORTHRAIL in a number of instances required the submission of unit cost analysis of the Project, including detailed breakdown of lump-sum items. The submittal was envisaged by NORTHRAIL as basis for monitoring the progress of work and for processing of progress billings, among others. This is supported by the following letters: a. Letter to Ms. Hao Ping, SINOMACH,

dated 06 November 2007 b. Letter to Mr. Zhang Chun,

SINOMACH, dated 10 April 2008 c. Letter to Mr. Zhang Chun,

SINOMACH, dated 14 May 2008 d. Letter to Mr. Zhang Chun,

SINOMACH, dated 13 June 2008

The submission of bill of quantities alone would not ensure reasonableness of the contract cost as in addition to review of quantities, NORTHRAIL had to review the corresponding unit costs.

To resolve the issue, it was included as one of the agenda in the meeting held on 19-22 August 2008. In the attached Minutes of the Meeting, item (1.4) shows the following agreement between and among NORTHRAIL, SES-JV and

It is very clear from the agreement that the government’s interest was not protected as payments will be made based on estimated quantity instead of on actual accomplishment. There was also no agreement on the determination of unit


72


SINOMACH, viz:

Quantity of Works. NORTHRAIL Comments: NORTHRAIL states that the Quantity of Works refers to the Bill of Quantities (BOQ) which is intended for monitoring progress, billing, evaluating variation orders, and compliance with Commission on Audit (COA).

Both Parties agreed on the following:

1. This project is a lump sum project

based on the original scope of work as defined in the Contract.

2. BOQ shall be the reference- for monthly billings. Estimated percentages of quantities as described in the BOO, instead of actual measurements, will be the basis for the monthly billings.

3. Although estimated quantity of works in BOQ may be different from the final actual quantity of works, payments will be made per the lump-sum amount as described in the BOQ.

4. NORTHRA1L shall be responsible for compliance with Commission on Audit (COA), SINOMACH will assist in providing documents as indicated in the approved billing check list. Two parties will discuss the detailed requirements in Manila.

cost. It is also agreed that the NORTHRAIL is responsible in complying with COA requirements.

NORTHRAIL Comments: NORTHRAIL agrees that level of breakdown shall vary at different stages of design. At Preliminary Engineering Design, lump sum prices and quantity are sufficient. But at the construction drawing level, breakdown of lump sum into detailed

NORTHRAIL agrees that unit cost analysis is not required unless both parties deemed it necessary when contract change happens. However, even when the contract was amended and the contract amount changed, just the same, NORTHRAIL agreed to an amended contract without any


73


quantities as well as unit cost analysis are appropriate. Both Parties agreed on the following:

1. The level of breakdown shall vary at

different stages of design. 2. All Preliminary Engineering Design,

lump sum prices and quantity are sufficient. Depot facilities, power supply, AFC are the only items that need to be' broken down (SINOMACH will provide end of Sept 2008), as NORTHRAIL has already agreed on the breakdown of other items submitted by SINOMACH.

3. Unit cost analysis is not required

unless that both parties deem it necessary when contract change happens.

The above agreements were subsequently adopted in the Amended Contract as provided in Clause 15.2 which states that:

“15.2 BOQ shall be the reference for monthly progress billings. Estimated percentage of quantities as described in the BOQ will be the basis for the monthly progress billings. Although estimated quantity of works in the BOQ may be different from the final actual quantity of works, payments will be made per lump-sum amount as described in the BOQ.”

This BOQ became the basis for processing of progress billings of the Contractor (see Attachment 1-C).

unit cost analysis.

In the absence of unit cost analysis, the Despite repeated requests, however,


74


presentation of unit cost in the BOQ was never questioned by NORTHRAIL and SES-JV. Billings were evaluated based on the lump-sum nature of the contract, not as a unit-cost type of contract which is very different.

NORTHRAIL cannot provide documents on how the progress billings were evaluated using the lump sum contract costs.

Meanwhile, upon approval of the construction drawings for the civil works, NORTHRAIL conducted its own internal validation of actual quantities based on approved design and even prepare the unit price analysis of contract pay items for its own internal consumption and reference. The NORTHRAIL estimates were based entirely on its own judgment and interpretation of the items, under local conditions, without discussing the methods of computations and construction methodologies with the Contractor. It was treated as a study of the cost and quantity of the project since no price analysis was presented by the Contractor.

This only shows that the contract is not clear even to the contracting parties. NORTHRAIL then has to prepare its own detailed cost analysis based on its interpretation which may not necessarily be the intention under the contract. Moreover, while NORTHRAIL claimed to have prepared detailed unit cost analysis, such documents were not forwarded to the Audit Team despite repeated requests. The results of such analysis were also not discussed in any of the documents forwarded to the Audit Team.

While NORTHRAIL continuously requested the submission of unit cost analysis in the past, the lump sum nature of the contract, as provided in Clauses 11 and 15.2, prevailed. This was also consistent with the agreement reached during August 2008 meeting.

However, in the processing of billings, NORTHRAIL treated each submittal as interim, and can be corrected in the succeeding billings or when deficiencies were found. The billings were processed, based on the lump-sum contract, and on the premise that the project will be completed.

This has been the case as the NORTHRAIL agreed to such arrangement, when it could have enforced otherwise to protect the interest of the government.

The premise by which COA Special Team evaluated the billings differs with the conditions for which the billings were

The quantities should not have differed as while the Audit Team adopted the original unit costs, it computed the quantity


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submitted, evaluated and processed by NORTHRAIL. The COA Team evaluated the billings based on the BOQ of the Original Contract while the billings were evaluated based on the effective contract during the time of processing of billings. It should be noted that breakdown of items in the Original Contract BOQ is not the same as that of the Amended Contract BOQ. In order to have comparable items, and with emphasis on the quantity derivation, NORTHRAIL wishes to present Attachment 1-D which shows comparison of quantities based on (a) Paid Progress Billings (Original and Amended Contract); (b) COA Team Evaluation Report (Original Contract only), and (c) NORTHRAIL further assessment (based on Original Contract only).

Further review of the COA evaluation showed that the significant amount of discrepancies/ disallowances lie in the use of Original Contract unit cost, instead of Amended Contract unit cost for Progress Billing Nos. 9-16. Generally, in the case of civil work, quantities of approved billings did not vary significantly as against the COA evaluation, as shown in Attachment 1-D (Summary and Detailed Calculation).

estimates based on actual accomplishments and plans which presumably was also the basis of NORTHRAIL in its computation.

Project Insurance is under Item No 13 (Other Costs) and is presented as pay item in the approved Bill of Quantities (BOQ). Since BOQ is the basis for payment of billings, pursuant to Clause 15.2 of the Contract, once it is proven that said item was delivered, the same will be included in the billing. If this item will not be presented as pay item, the Contractor will easily integrate this cost into other item of works. Besides the contract is a lump-sum contract.

Again, while the contract provides that insurance is the responsibility of the contractor, NORTHRAIL again agreed to include this item in the BOQ as another pay item.


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Pre-Construction Stage On the premise that Contracts are valid, payments were based on a lump sum cost. However, for billing purposes, SINOMACH, upon instruction from NORTHRAIL, submitted a breakdown of Bill of Quantity (BOQ) for Preliminaries (Attachment 1-I). NORTHRAIL confirmed SINOMACH’s proposal of allocating percentage of payment on different stages of design where submission of design documents on Preliminary Engineering Design (PED) comprised 44.44% of the total design cost for each item or structure. Accomplishments were paid based on such confirmation, and on the assumption that designs will be completed on schedule.

Again, it is very clear that NORTHRAIL did not protect the interest of the government. It agreed to pay 44.44 percent of the total design cost upon submission of preliminary design and allocated only 33.33 percent for detailed designs. As it is, substantial amounts were paid only upon submission of preliminary design. As a general rule, only designs approved and accepted by the procuring entity should have been paid. In addition, it apparently agreed to uneven allocation of pre-construction costs without justifiable reason.

The evaluation and payment of billings corresponding to the design works followed certain processes and passed through a rather rigid billing guidelines and procedures, as can be shown in a number of times that billings were returned to the Contractor. Consistent with the lump-sum contract provisions, breakdown of items shall be submitted as basis of billings and since the said payment scheme was confirmed, the same was followed in billing evaluation. In the event of termination, as in this case, payments shall ONLY be made if, and only if, the submitted designs are Approved. However, computation of amounts to be recovered shall be as reflected in the billing, and not by adopting an average for all items of design which is contrary to the agreement in the confirmation of design breakdown.

The claimed rigid processing and evaluation were not documented. The Audit Team was not even provided copy of agreement to this effect.


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NFA Compound Elevated Fuel Tank – only one fuel tank was found during the inspection. As per SINOMACH representative, the other unit was removed by the supplier last year. Please note also that the fuel tank is owned by the supplier of SINOMACH. Please see attached photocopy of SINOMACH and NORTHRAIL letter.

In such case then, and considering that fuel tanks were owned by the supplier of SINOMACH, there is no basis for the payment thereof by NORTHRAIL.

Storage Yard for Rails in NFA No. 1 - The proposed location (based on submitted lay-out) is more than 1364 sq. m. with no improvements (Cogon grass were observed during the time of inspection). However, the old PNR rails were noticed at different location. Please see attached pictures.

Considering that this has no improvement, the Audit Team adopted only the unit cost for site preparation of US$0.75 per square meter and only for the area outside the PNR rail alignment.

Storage Yard for Rails in NFA No. 3 – only small area with improvement (approx. 5.7m x 18m concrete slab) was found during the inspection. No concrete slab on the remaining area.

Considering that around 482.40 sq.m. has no improvement, the Audit Team adopted unit cost for site preparation of only US$0.75 per sq. m.

Caloocan Area Elevated Fuel Tank – No Fuel tank was found during the inspection. However, previous pictures showed that the said fuel tank was installed (attachment to Progress Billing No. 5). Based on the picture, the previous location of the removed fuel tank is the same as the location of the NORTHRAIL PMO Staff House in Caloocan Area. NORTHRAIL presumed that the removed fuel tank was transferred to NFA compound. And considering that 2 units of fuel tank were pulled out by the supplier of SINOMACH, by record, it shows that there are 3 units of fuel tank provided for the project.

The alleged fuel tank could not be considered as the same is not owned by SINOMACH but by its supplier.

Maintenance of these facilities was The documented accomplishment was only


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assessed to be seven (7) months because it covers the period from the time that the Notice to Proceed was issued and when the Temporary Facilities were put up, and this was not only accomplishment for the month. Please take note also that while the billing covers the month of October 2007, this billing was submitted and processed in March 2009. Other than this billing, the Contractor did not have any other billings for temporary facilities.

It is noteworthy also that with the approval of Amended Contract, Billing for Adjustments of these activities was requested by the Contractor but were not considered by NORTHRAIL because these activities were already completed and even paid under the Original Contract.

Other temporary facilities were constructed in other sectors but were not billed since it was understood that the allocation for the item of temporary facilities was significantly exhausted. In fact, additional requirements for fuel tank had been installed by the Contractor but those were no longer billed due to the lump sum nature of the contract.

for one month, hence, only one month was considered by the Audit Team.

Mainline Embankment At the time of processing of billings, NORTHRAIL used the effective contract in the evaluation of submitted billings. Progress Billing Nos. 1 to 8 were processed based on Original Contract while Progress Billing Nos. 9-16 were processed based on Amended Contract. It should be noted that based on records, there is no issue of termination and/or validity of the contract during that time. And, processing of billings using Original Contract is without basis.

The validity of the contract is not the reason for the difference in costs but the failure of the NORTHRAIL to submit proof of the reasonableness of the contract cost.

Bridge and Culvert It was stated earlier that based on records,


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there was no issue of termination nor validity of contract was raised at the time of billing processing and payment nor any provision in the contract that equate price adjustments with the amount of Advance Payment/Down payment (AP/DP) released. The records showed that the price adjustment was even approved by the proper authorities as the project undergone the required government procedures and requirements, e.g. ICC-NEDA Board approval. This paved the way for the approval of the Amended Contract. With this approval, works were accomplished and billings were processed, evaluated and paid based on Amended Contract conditions and unit costs. Using Original Contract unit costs is without basis during that time. While COA observations are understood and accepted, it is believed that the evaluation is rather applicable in a unit-cost contract. If the contract is a unit-cost type, NORTHRAIL could have evaluated it also based on the requirements and parameters of a unit cost contract which is rather easier since it is more conventional. For this type of contract, and in the exercise of due diligence, the following evaluation parameters were considered in the processing of progress billings: 1. Progress Billings are treated as interim

and therefore self-correcting. Succeeding billings maybe evaluated to correct the deficiencies of previous billings even if paid.

2. The indicated quantities in the BOQ

served as limit of the work and therefore will not be exceeded at all times. In fact, the total quantities of the accomplished work are not yet

As a general rule, contracts in lump sum amount, can be paid only upon completion of the project. In this case, however, NORTHRAIL allowed payment of progress billings, although the contract did not provide for the criteria and milestone for payment, and even without thorough evaluation as there were no documents submitted to manifest the extent of evaluation undertaken. This cannot be adopted as under existing rules, payment should be based on actual accomplishments. While it may be true that the BOQ is the ceiling, again, payment shall be based on actual accomplishment.


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exhausted up to Billing 16. 3. The breakdown per lump-sum pay item

was submitted as required by NORTHRAIL to facilitate the billing and as basis for payment, consistent with Clause 15.2 of the Amended Contract which states that “BOQ shall be the reference for monthly progress billings.”

4. Since the BOQ is treated as lump-sum,

the total cost of a pay item cannot be billed and paid unless the work is 100% completed and is compliant with all the requirements for acceptance.

5. Clause 15.2 of the Amended Condition of Contract states that although estimated quantity of works in the BOQ may be different from the final actual quantity of works, payments will be made per lump sum amount as described in the BOQ. Once the major pay item was completed, regardless of quantity overrun or underrun, the full payment of the item will be considered.

6. At no time will billing payments exceed

the value of actual physical accomplishments of the contract.

7. To this date, significant amount of

accomplishments are not yet paid which may be used to correct the discrepancies of paid billings, including disallowances, if any.

In the case of a pre-terminated contract, the assessment would be different and it will not conform entirely with the evaluation made when the contract is active and existing.

This breakdown was not submitted to the Audit Team despite repeated demand. In such case, and had this agreement been observed in all items quoted in lump sum amount, then any progress payment could not have been paid unless the work covered by each item is fully delivered/accomplished. Again, this provision of the contract is not considered advantageous to the government. The Audit Team’s evaluation disclosed otherwise. This is not possible considering that accomplishment is not even sufficient to cover the advance and down payments made by NORTHRAIL. The evaluation would still be the same, except for the contractor’s profit which will not be considered in the computation.

SAO Report No. 2012-02 ANNEX C

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Annex C

Management’s Comments and Team’s Rejoinder Contract Provisions and Contractual Scheme

Audit of Northrail Project


NORTHRAIL Managers By virtue of OGCC Opinion No. 144, series of 2004, that the contract is in the nature of and can be likened to a contract of adhesion and as a matter of official government policy, the contract format for foreign-funded projects should follow the prescribed form required by the Lender. Section 7 (d) of E.O. No. 109-A expressly provides that the governing law for Government Contracts financed wholly or partly with Official Development Assistance funds shall be governed among others, by R.A. No. 4860, as amended, which authorizes the President of the Philippines to obtain such foreign loans and credits upon such terms as may be agreed upon.

As clearly stated in the comments of NORTHRAIL Managers, the authority of the President is to obtain foreign loans and credits and not to enter into contract for the implementation of projects irrespective of the terms mandated in the contracts. It is emphasized that under the law, responsible government officials are also mandated to protect the interest of the government at all times. In addition, as discussed in the Report, the Supreme Court has already resolved that the Original CNMEG Contract is not an executive agreement.

You may also wish to note that OGCC issued Opinion No. 123 Series of 2004, dated 29 June 2004 stating that they have no objections on the following alternate provisions that previous management opted in lieu of the surety bond, etc. for the advance payment:

i. Performance Bank Guarantee for an amount of US$42,105,000 representing 10% of the contract price; and

ii. Increase in the percentage of recoupment from 15% as required by the Implementing Rules and Regulations (IRR) of R.A. No. 9184 to 30% from their progress billings.

The granting of advance and down payments equivalent to 30 percent proved to be disadvantageous to the government.

As provided under Clause 11 of the Original Contract, all payments/loan disbursements

We agree that these taxes are over and above the contracted amount as the same


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shall be free and clear of any Philippine Tax or other deductions or withholdings of any nature. As such, all taxes due on the implementation of the contract are really over and above the contracted amount. These taxes and duties due on the implementation of the NORTHRAIL Project, similar with other Government Projects funded from an ODA Loan, are subsidized by the National Government. The grant of the tax subsidy for the project is included in the approval of NEDA dated 31 March 2012.

are to be subsidized by the National Government. However, the tax subsidies should not result in actual cash payment by the NORTHRAIL to the contractor as in these cases.

The main reason why NORTHRAIL reimbursed SINOMACH VAT subsidies charged by their sub-contractors is the Revenue Regulation (RR) which is supposed to give guidelines on the utilization of the tax subsidies issued by the National Government have not been issued by the DOF/BIR. This scheme was adopted from the tax subsidies and Revenue Regulation issued for the SCTEX Project in 2005.

The said Revenue Regulation is specifically intended for the implementation of SCTEX Project in 2005 and not for general application. Under this case, NORTHRAIL assumed the risk of unnecessarily having to shell out cash from the proceeds of its loans.

If the contract implementation was pursued and the RR was issued, these reimbursements should have been recovered by NORTHRAIL in a form of a tax credit from the BIR. The foregoing has actually the same impact to SINOMACH in so far as their VAT returns are concerned because with the reimbursements from NORTHRAIL, the net Output Tax of SINOMACH becomes higher as the VAT charged by its sub-contractor which is an input tax of SINOMACH and is a deduction from its Output tax was reduced because it was already paid by NORTHRAIL.

It is very clear that under the policy of the government, only tax credit is being issued. There should be no actual cash outlay on the part of the government. The NORTHRAIL, however, directly reimbursed the contractor as subsidies for the VAT charged by the sub-contractors.

The provisions for price escalation and In almost all cases, however, the currency


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currency adjustments both covers the increases and decreases on prices and currencies, thus it is fair to both parties. In the case of NORTHRAIL Project, it seems that what had been applied was price adjustments and not price escalation, since price escalation is normally applied for works already completed, pursuant to the definition stipulated in Section 5.4 and 8 of the Revised Guidelines for Contract Price Escalation. While the basis for computation maybe the same, e.g. inflation and currency fluctuations, the timing of application was different. The adjustments applied in the NORTHRAIL contract were made as a result of delayed implementation of the project, and was approved by proper government authorities even prior to implementation of affected work items.

adjustment is always intended to increase the cost. Moreover, the provisions under the Original CNMEG Contract allows adjustment in contract price only in case of the following:

• A change in the Laws of the Philippines or in the judicial or official governmental interpretations of such Laws made after the date of signing the contract.

• If upon completion of site survey, sub-soil investigation and Preliminary Engineering Design, there are significant changes/ variations compared with the existing technical scheme in terms of scope and quantity of works.

There were, however, no documents to prove the presence of these conditions to warrant changes in contract amount.

Present Board The present NORTHRAIL Board and Management consider the Original and the Amended Contracts void. In view of this position, a complete 180o turn about from the position of the past NORTHRAIL Administration, we cannot comment on the findings of COA for items 1 to 3 of the draft report. Moreover, the work accomplishments, which are the subject of the COA observations, were undertaken before the assumption of the present Management and NORTHRAIL Board. Likewise, payments to Sinomach were made by the past Management, except for those billings 12, 14, 15 and 16.

The present NORTHRAIL Board assumed the responsibility under this project as the present Officers, hence, the request for them to comment on the results of the Audit. Besides, a number of billings, using the Amended CNMEG Contract, were approved and paid by the present administration.

NORTHRAIL Managers For a design and build contract, the scope of the contract includes the conduct of detailed engineering design and there is no way that the detailed design is already

This being the case, the design and build contract is indeed not appropriate for projects with a number of risks assumed by the government and financed out of


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available at the time of contracting for design and build contract.

loan. As the ROW requirements could only be determined upon completion of the design, the site would most likely not be available at once. Moreover, any delays in project implementation would definitely impact on the loan terms and conditions.

Even the Guidelines for the Procurement and Implementation of Contracts for Design and Build Projects, as approved under GPPB Resolution No. 22-2007 provides for requirements in the implementation of similar project, the cost of which may be calculated based on the approximate quantities of work of the conceptual design, from standardized designs or from cost records of previous projects of similar kinds (Section 4a). In addition, Section 8.1 provides that “the winning bidder shall be responsible for the preparation and submission of all necessary detailed engineering investigations, surveys and designs…”

As it is, NORTHRAIL is required under the said regulations to calculate costs based on conceptual design which was not undertaken by NORTHRAIL as there were no documents provided to the Audit Team to this effect. It is also informed that the said GPPB Resolution was not attached to these comments.

In the case of NORTHRAIL Project, the basis of the project cost was the most recent feasibility study of the Project. In order to provide basis in the evaluation of accomplishments, included in the contract documents are the technical description of the project and specifications, for performance evaluation.

As indicated in the GPPB Resolution cited by NORTHRAIL Managers, the cost should be based on conceptual design and not on Feasibility Study where there was no approximate quantity of works. The Audit Team was, however, not provided copy of the evaluation conducted by NORTHRAIL despite repeated requests. In addition, only the quantity requirements can be evaluated based on conceptual design and not the reasonableness of cost.

Previous NORTHRAIL management was of the belief that the procedures it adopted conform with the spirit of Design and Build Contract, pursuant to GPPB Resolution No. 22-2007. The contract for the NORTHRAIL Project does not fall under R.A. No. 7718.

Under the design and build contract, all risks and responsibility, including financing of the project are assumed by the contractor which is not true in the case of NORTHRAIL Project.

SAO Report No. 2012-02 ANNEX D

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Annex D

Management’s Comments and Team’s Rejoinder Project Management Support Team

Audit of Northrail Project


NORTHRAIL Management

We cannot comment on the observations of COA in so far as the contract with SES-JV is concerned as they are about the activities that happened prior to the assumption of the present NORTHRAIL Board and Management. Just like in our stand relative to the observation of COA on the Sinomach contracts, the present Board and Management are not in the position to explain the actions of the previous Board and Management.

The Report is being presented to the present NORTHRAIL Management for comments as well as for its information.

Please be informed, however, that SES-JV billings 42, 43, 44, 45 and 46, were paid during my tenure. I would like to emphasize, however, that these billings were forwarded for review and evaluation of the DOTC Task Force that was conducting the “Due Diligence Review of the NORTHRAIL Project,” pursuant to the DOTC Department Order (DO) No. 2010-26, dated 31 August 2010. These billings were paid only after being cleared for payment by the DOTC Task Force and approved by the then DOTC Secretary. We would like to reiterate further, that as early as January 2011, when the issue on the extension of the SES-JV contract was being deliberated on by the present Board, questions were raised on the mismatch between the low percentage accomplishment of SINOMACH and the high percentage of payment already made to SES-JV. This led the present Board to decide during the succeeding Board

As discussed earlier, the head of the agency is primarily responsible in ensuring that funds are safeguarded against loss and used efficiently and effectively. This responsibility cannot be passed on to anybody or any office.


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meeting in February 2011 to drastically reduce the manning of SES-JV from 24 personnel to only four people. At that time also, NORTHRAIL was not certain whether the implementation of the contract with SINOMACH would be continued or stopped. As such, the Board decided to extend the contract of SES-JV on a month to month basis only from February 2011 to August 2011. It was on August 22, 2011, while reviewing the events related to the SES-JV contract in relation to the DOTC DO No. 2010-26, dated August 31, 2010, where DOTC had ordered NORTHRAIL to pay SES-JV from its PMST contract for the consultancy work performed by SES-JV in the “Due Diligence Review of the NORTHRAIL Project,” that it was noticed that there was no CAF for the whole amount of the SES-JV contract all along. Thereupon, on the same day, August 22, 2011, I requested for OGCC’s legal opinion on the validity of the SES-JV contract. On November 8, 2011, OGCC stated that the NORTHRAIL contract with SES-JV for PMST is considered void. Since then, NORTHRAIL has not entertained SES-JV’s demands for payment of work related to PMST and for its activities as the consultant of the DOTC Task Force on the “Due Diligence Review of the NORTHRAIL Project.” All letters of SES-JV are now being referred to OGCC for appropriate legal action, it being the Corporate Counsel of NORTHRAIL. NORTHRAIL Managers As mentioned in the audit report, the consultancy contract is a condition precedent to the loan facility being offered by the consultant, thus, the contract was signed prior to the finalization of the loan agreement.

Considering that the winning bidder was not able to meet the requirement under the Invitation to Bid, the NORTHRAIL is practically not obligated to enter into contract with the winning bidder.


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The Notice to Proceed issued is pursuant to Section 4 of the Contract Agreement which covers only advance works of the consultant. This was done in relation to the COA audit observation and recommendation to immediately engage the services of a project consultant due to the development on the accomplishments of the contractor which requires expertise of the consultant and also, the consultant evaluation/review of the Contractor’s progress billings is crucial prior to payment of the billings.

Nonetheless, NORTHRAIL’s actions are expected to be undertaken in strict observance of existing laws, rules and regulations.

FMIC refused to accept the guarantee proposed by TIDCORP because the guarantee being issued by TIDCORP is not akin to a sovereign guarantee which is contrary to the provisions of the terms of reference/bid documents in the procurement of the consultant.

In such case, then, and considering that source of funding is one of the requirements stated in the bid documents, NORTHRAIL should have instructed SES-JV to look for alternative funding source.

NORTHRAIL Management at that time pursued the contract with SES-JV in view of OGCC Opinion No. 143 series of 2007, dated July 16, 2007, affirming the legality of accepting the alternative proposal of the DBP to finance the consultancy contract.

This Opinion was, however, issued long after the NORTHRAIL had entered into contract with SES-JV and after several payments have been made.