7 August, 2018
In recent years, infrastructure investment has been a key driver of economic development for countries in Asia Pacific. Whilst some countries focus on accelerating development of their domestic infrastructure (such as Australia and the ASEAN countries), others are funding and exporting resources to facilitate such investment (such as China). The different economic policies of countries, coupled with the legal, political, cultural and social complexities in Asia Pacific, mean that different parts of the region are characterised by their own set of issues and trends in construction disputes. In this article, we take a look at some of the key issues and trends in construction disputes involving Australia, the ASEAN region and China.
The Australian construction industry is a mature and developed sector of the Australian economy. Research published by the Australian Bureau of Statistics (ABS) in 2017 recorded the construction sector as the second largest industry in the Australian economy, with an annual economic contribution of approximately A$128.7 billion.1
It is also a highly competitive sector of the Australian economy. The level of competition has continued to grow as international contractors have in recent years entered the Australian market. This has been driven by an increasingly global perspective to the EPC contractor market.
The highly competitive construction industry has resulted in Australian companies operating in this sector being well respected internationally, given the technical expertise and knowledge they have developed with respect to the delivery of large construction projects, across a variety of sub-sectors, including mining, energy, oil and gas, transport and other public infrastructure. Like the rest of the world, the scale and complexity of such projects in Australia continues to grow, while technological improvements have increasingly greater impacts on the delivery of these projects.
The Australia construction industry is subject to extensive laws and regulations. This includes various security of payment laws across the Australian states and territories which provide an expedited adjudication process for the interim resolution of payment disputes under construction contracts. The ‘West Coast’ model legislation that applies in Western Australia and the Northern Territory allows adjudication claims to be made up or down the contractual chain though in practice, the adjudication process tends to be used predominantly by contractors and subcontractors to enforce the payment of progress claims made in respect of construction work performed under a construction contract and to maintain cash flow down the contracting chain.
In Australia, both State and Federal governments have acknowledged the need to improve security of payment for EPC contractors and subcontractors. Several reviews and inquiries in recent years have identified security of payment as an issue in the Australian construction industry. The lack of consistent security of payment laws across Australia jurisdictions has been identified as an ongoing issue. Most recently, in May 2018, the Australian Federal government released a final report concerning the Review of Security of Payment Laws in Australia, undertaken by Mr John Murray AM. The report includes over 80 recommendations to improve consistency in security of payment legislation and enhance protections to ensure contractors get paid on time for work they have done, regardless of which state or territory they operate in.
Key amongst these is the recommendation to make security of payment laws nationally consistent with what is commonly known as the East Coast model, which is modelled on the New South Wales security of payment legislation. Following the release of this report, the Australian Federal government intends to consult with industry to consider the report’s recommendations and explore ways to improve the protections in the construction industry.
National courts remain a popular mechanism for the resolution of construction disputes. Nevertheless, international arbitration has become an increasingly common forum for the final resolution of large construction projects in Australia where international contractors have played a significant role in the delivery of the project. Australian developers and contractors operating outside of Australia are also increasingly turning to international arbitration as the favoured forum for construction disputes.
While Australia is a single, but federal, jurisdiction, the ASEAN region in comparison encompasses 10 independent jurisdictions: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam. Each of these have different and varied cultural, economic, political and legal landscapes. Together, ASEAN is the seventh largest trading block in the world. One constant theme across the entire region is the continuing need and appetite for infrastructure investment. That investment has vastly outstripped GDP growth across ASEAN during the last decade, and future infrastructure investment requirements are estimated by the Asia Development Bank to be in excess of US$2,759 billion.2 This reflects the increasing demand for power, transportation, water and sanitary systems in ASEAN countries.
Governments, state agencies, and international developers and contractors have been at the forefront of providing this infrastructure through traditional direct forms of procurement and, increasingly, public-private partnerships. The resulting mix of international parties, each with their own cultures and systems, operating across such a broad and varied region often gives rise to significant challenges and divergent interests. Ultimately, this gives rise to disputes.
In our experience, it is increasingly common on major projects within ASEAN that complex disputes arise which are not easily and swiftly resolved. This is particularly the case on projects where governments and state entities are involved. At the heart of many of these disputes lies a fundamental divergence between the state's desire to procure state-of-the-art infrastructure and a lack of adequate funding.
Consequently, major projects can be conceptualised and then approved without necessarily ensuring adequate certainty on the scope of the project, with poor or incomplete contractual and technical documentation, and without detailed budget development that allows for full contingencies. In practice, this leads to project participants having differing expectations as to how the project will be delivered. It is therefore common to see significant and complex arguments about variations (given scope and documentation issues) and pricing (as insufficient budget is allotted to cover the contingency).
A further issue which flows from this, is state actors' ability to exert control over project participants to delay payment, including by issuing, applying or interpreting laws or regulations in a manner which impacts cash flow. This is less of an issue in Singapore and Malaysia, due to the availability of security of payment legislation (as in Australia and the UK). However, we see problems in countries such as Indonesia and Vietnam, where public procurement regulations and contractual payment mechanics can be applied in a manner which prevents or significantly delays payment processes, thereby negatively impacting contractor cash flow. These issues are also compounded by the potential for political change and uncertainty, which can bring with it reviews, delays and potential termination of projects; again giving rise to claims and disputes.
While it is often preferable for these complex disputes to be resolved through negotiations and mediation to achieve a settlement, in our experience that is not always possible in some countries in the region. One reason for this is that some laws which aim to prevent public corruption and state losses can be applied broadly (and be perceived to apply broadly) so as to discourage representatives of states, or state owned entities, from agreeing to any deal which can be perceived as costing the state more than what was originally agreed. For example, if a fixed lump sum contract for US$100m was agreed, and a dispute arose over a variation which would cost US$15 million, even a settlement for US$10million could be perceived as causing the state to incur a loss, despite the settlement being in the state's interest to avoid the inherent litigation risk of a formal dispute. It is therefore common that disputes which one might expect to be settled, are instead escalated to formal dispute resolution.
In our experience, most complex projects in the region require disputes to be finally resolved by arbitration, preferably in a neutral seat (although, as explained below, some countries require construction disputes to be resolved by domestic arbitration). In addition to arbitration, it is increasingly common to find that parties are able to use statutory or contractual processes to solve problems early on in projects. For example, both Singapore and Malaysia have security of payment legislation which provides for payment claims to be adjudicated swiftly during the course of a project. In other countries, such as Indonesia and Vietnam, FIDIC forms of contract have been used for some major projects allowing parties to use dispute avoidance boards (DABs) to resolve problems on a timely basis (although, in practice, DABs are not widely used in the ASEAN region). While the statutory security of payment regimes have largely been effective, it remains to be seen how effective DABs have been in practice. This is due to issues of practical enforceability, which ultimately require the commencement of arbitration. On the whole, therefore, it is common that disputes on major projects in ASEAN eventually end up in arbitration.
In parallel with the infrastructure development in the ASEAN region and Australia, China's construction industry has undergone significant transformation in recent years. Since the announcement of the Belt and Road Initiative in 2013, Chinese contractors have undertaken and invested in a vast number of infrastructure projects overseas. According to the China International Contractors Association, in 2017 alone Chinese contractors concluded 7,217 construction contracts along the Belt and Road and 13,267 construction contracts globally. The nature, size and geographical coverage of these projects, coupled with the broader implications of the Belt and Road Initiative, present Chinese contractors with a unique set of legal challenges.
Whilst many of the issues that Chinese contractors encounter are those commonly encountered in construction and infrastructure projects (such as changes to work scope, delay to completion or defects in works), Chinese contractors also experience – perhaps more often than their counterparts in developed countries – problems during project execution that are not strictly related to the construction works, but are the product of the political, legal or economic environment of the host country.
Many countries in which Chinese contractors operate can be characterised by relatively high political risks, weak rule of law and/or poor governance. As a consequence, projects in these places are more likely than those in developed jurisdictions to be affected by events such as change to host government (whether through election or political coup), discriminatory or arbitrary acts of local authorities, civil unrest or armed conflicts. This can cause the contractor to incur substantial costs and losses and bring even the largest projects to a standstill.
Whilst it is possible for contractors to mitigate these risks at the outset through contractual risk allocation and/or political risk insurances, not all costs and losses can be anticipated and covered. In those circumstances, it will be necessary for contractors to recover their losses under the contract. For instance, we have advised on claims flowing from prolonged suspension or termination of a project due to the impact of decisions by national and regional governments, as well as insurgency in the host state.
In practice, assessing the contractual implications of a claim event may not always be at the forefront of a contractor's mind. It is easy for contractors to focus on minimising the time and cost impact of an event to the project, only to realise later that their claims are time barred or otherwise prejudiced. To address this problem, it is advisable for contractors to involve experienced counsel as soon as they become aware of a potential claim event, to assist in identifying, substantiating and managing potential claims and, where appropriate, in commencing legal proceedings to protect and pursue these claims.
In line with our experience in the ASEAN region, there is a general trend amongst Chinese contractors to resolve disputes arising out of complex projects by way of arbitration outside the host state. Here, Chinese contractors generally prefer to have a right to commence arbitration if a dispute cannot be amicably settled or mediated, rather than going through a multi-tiered dispute resolution mechanism (such as those provided in FIDIC standard forms of contract) that requires the dispute to be referred to a dispute adjudication board before the parties can commence arbitration.
Whilst contracting parties are generally free to choose how they wish to resolve disputes under the contract, this is not possible where local laws and regulations require disputes to be resolved by arbitration in the host state. For instance, Indonesian law requires all contracts with subcontractors that provide services to holders of Production Sharing Contracts to provide for domestic arbitration.
Meanwhile, Philippines law confers upon the Construction Industry Arbitration Commission original and exclusive jurisdiction over all domestic construction disputes.
Domestic arbitration may not be in the best interest of foreign contractors. In less sophisticated jurisdictions (where many Chinese contractors operate), there is a risk that local proceedings could involve procedural delays, lack of procedural fairness, inexperienced arbitral tribunals and/or potential for influence by the employer (particularly if it is a state-owned entity). In this regard, there is value in contractors engaging international counsel to work with, or manage, local counsel. International counsel can help minimise litigation risks and assess the prospects of challenging the jurisdiction of any domestic arbitral tribunal, to secure a more suitable (and neutral) forum in which to resolve the dispute.
As infrastructure investment in Asia Pacific continues to grow, complex construction disputes will be inevitable. Many of the risks in construction projects can be managed through proper project due diligence, appropriate structuring (for example, to ensure protection through available investment treaties) and negotiating contractual protections where possible (such as stabilisation or change-in-law provisions).
Above all, parties should try to agree to arbitrate disputes in a neutral seat and under the auspices of an internationally recognised arbitration institution (such as SIAC, HKIAC or ICC) in order to provide themselves with the best framework for resolving cross-border, international construction disputes on a balanced legal, linguistic, technical and cultural playing field for all stakeholders.
1. ABS (2017), Australian National Accounts: National Income, Expenditure and Product, December Quarter 2017, ABS Cat. No. 5206.0, Table 37
2. Meeting Asia’s Infrastructure Needs, ADB, 2017
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For further information, please contact:
Murphy Mok, Herbert Smith Freehills