Infrastructure Initiatives In Southeast Asia: Construction Challenges And Opportunities.
Legal News & Analysis - Asia Pacific - ASEAN - Construction & Real Estate - Energy & Project Finance
5 November, 2019
Seoul Head of Disputes, Mike McClure, recently spoke at the 2019 Annual Conference of the International Bar Association in Seoul during a session on the initiatives that Asian countries have launched in order to build, finance and operate infrastructure in the region and in other parts of the globe.
In collaboration with Of Counsels, Dan Waldek and Mark Veitch, and Senior Associate, Murphy Mok, of the firm's Asia construction team, this article captures, in Q&A format, some of the topics addressed during the IBA session, including an overview of the construction/infrastructure market, approaches to contracting and claims, the impact of technology, and dispute resolution trends in the region.
What does the construction market look like in Asia. In particular, what sort of projects are coming to market, who is carrying them out (government /public/private sector), and where are these projects?
Each Asian country has its own nuanced cultural, legal, social and economic landscape and it is important to beware of generalisations. However, we have set out below some of the key features both in the North Asian and ASEAN regions and across the continent more generally.
The ASEAN region as a whole is united in experiencing substantial economic and population growth – a trend which is set to continue over the coming years. Against that background, the Asia Development Bank has reported the total infrastructure needs in the region will grow from US$2.8 trillion (baseline estimate) to US$3.1 trillion (climate-adjusted estimate). This works out to an annual investment need of US$184 billion to US$210 billion. This need for large scale projects involving energy, road, rail, water, and other infrastructure will continue to drive demand in the construction sector.
Indeed, various countries have plans in place to provide for future investment in infrastructure, e.g. Vietnam Socio-Economic Development Plan (US$61.5b), Indonesia National Medium-Term Development Plan (US$460b), Philippine Development Plan "Build, Build, Build" (US$71.8b), and the Thailand Transport Infrastructure Development Plan (US$76b).
Large construction projects in ASEAN often have a public interest element and can involve a government or state-owned enterprise.
Whilst some countries focus on accelerating development of their domestic infrastructure (such as the ASEAN countries), others are funding and exporting resources to facilitate such investment (such as China).
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. The US$900 billion Belt and Road Initiative comprises two main components – the land-based "Silk Road Economic Belt" and the oceangoing "Maritime Silk Road" – and spans more than 60 countries and regions, stretching from Asia to Europe via Southeast Asia, South Asia, Central Asia, West Asia and the Middle East. According to the China International Contractors Association, in 2018 alone Chinese contractors concluded 7,721 construction contracts along the Belt and Road.
There is often competition between Japan and China for construction contracts. According to BMI Research, since 2000, Japan has financed $230 billion worth of projects in the region (completed or under way), while China has spent $155 billion. China has the Asian Infrastructure Investment Bank with US$100 billion in funding, whilst Japan launched the Partnership for Quality Infrastructure scheme, which together with the Asian Development Bank, intends to offer US$110 billion in funding for infrastructure investment in Asia. Where China has the Belt and Road Initiative, Japan has the Asia Africa Growth Corridor, a maritime route that connects Indian ports to Africa. However, in spite of such competition, there is also increasing Sino-Japan collaboration on infrastructure projects. For example, China and Japan formed a committee to take part in the auction for the Thai high speed railway project that connects Thailand’s three airports.
General trends across Asia
The Asian Development Bank reported (2017) that Asia will need to invest US$26 trillion between 2016 to 2030 – equivalent to US$1.7 trillion per year – on developing its transport, power, telecommunications and water supply and sanitation sectors, to support its current predicted growth rates. If social infrastructure (mainly education and health) is also factored in, then the financing gap for infrastructure widens further.
Two of the key areas of growth are transportation and energy, e.g. the US$23 billion investment in a network of railways including the Singapore-Kunming Rail Link and the renewed deal for East Coast Rail Link, which China Communications Construction Company has renegotiated to RM 44 billion (down from an original price of RM 66 billion), with a 50-50 joint venture to operate the 640km line across Kuala Lumpur.
Across the region, 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. Some jurisdictions are looking at PPPs for delivering all sorts of infrastructure projects, from social housing through to major industrial parks. Power projects are also a central focus in Indonesia, Vietnam, Myanmar and the Mekong with significant focus on IPP's to drive through those governments' hydro and conventional power generation programs.
The region is also seeing significant growth in oil & gas infrastructure projects with several national oil companies and private developers across South East Asia evaluating or in the early engineering phases of major hydrocarbons production facilities. This is consistent with the global trend of growth in this sector.
Is the approach to contracts drawn from the common law or civil law? Are standard form contracts - FIDIC or others commonly used? Risk allocation or other key themes when negotiating contracts.
The approach (i.e. common law or civil law) varies from state to state in Asia.
In terms of negotiating construction and infrastructure contracts, it is important to note that states, their agencies and potentially state-owned enterprises may claim to be immune from being sued or having any judgment enforced against their assets as a result of a concept known as sovereign immunity. This is a complex area of international law. However, this risk can be avoided by insisting on including a 'waiver of sovereign immunity' provision in any commercial contract so that claims can be brought against the state or a state-owned enterprise.
A further complexity of dealing with state parties in the region may arise from changes in government, government policy and law. Given that many complex projects can take many years to execute from original project planning, through design, construction, testing and completion, an important feature for private parties executing projects in the region is stability. While not all changes of government and law are problematic, many can have a significant adverse economic impact. This is particularly the case where new governments decide to cancel projects or introduce new laws or regulations, or impose new taxes which make executing a project more time-consuming and expensive. For this reason, where contracting in countries that may be more likely to have changes in government, policy and law, foreign parties should seek to include in their project agreements entitlement to relief (including both time and money) arising from such changes – these are commonly referred to as 'stabilisation' provisions.
Taking security is standard practice for project owners engaging with contractors, particularly in the ASEAN region. Historically, many project owners in the region were conservative and only looked to invoke on-demand bonds in the most severe cases of contractor default. However, in recent years we have seen project owners increasingly looking to invoke their security, obtain cash up front and argue about the consequences later.
Conversely, we have seen that contractors are increasingly prepared to try to restrain payment under on-demand bonds and guarantees, via court or arbitration proceedings.
FIDIC is still the dominant form of contract across Asia. Whilst purchasers, sponsors and governments are still strongly focused on hard pass-down of risks with the FIDIC forms being modified accordingly, we are also seeing some major infrastructure projects being delivered through risk-sharing schemes. This is leading to enquiries from clients into complex modifications to the FIDIC books and advice on alternative pricing structures that move away from rigid lump-sum or remeasurable pricing structures. Government projects are tending to retain hard pass-down of risk with contractors in some jurisdictions still struggling to get paid for change orders given rigid government budgeting. For this reason, we are seeing high numbers of otherwise straightforward variation claims proceeding to arbitration.
Importance of culture
What is the approach to contracting and claims? Does the presence of foreign contractors have an impact?
An international infrastructure project will involve interfacing with the local legal and regulatory framework. The laws and cultures of each country may be unfamiliar and will create new risks and issues for foreign parties. There may be different construction regulations, foreign direct investment and ownership laws, health and safety laws, environmental laws, currency controls, local labour laws and tax laws. Successfully managing these risks becomes increasingly complex when different cultural norms and languages are involved.
For example, in respect of the Belt and Road Initiative, Chinese parties investing in foreign countries cannot avoid or ignore the local legal landscape. It is important that local laws are complied with because non-compliance with laws can expose the company and its personnel to criminal investigations and even prosecution. It is also important to appreciate the reputational harm that could occur as a result of such non-compliance.
Some of this risk can be mitigated by agreeing to use the laws of a neutral country to govern the contractual relationship between owner and contractor (or contractor and subcontractor). In our experience, English or Singapore law is commonly adopted for these types of complex construction contracts across the ASEAN region, for example. While this does not remove the parties entirely from the local legal framework, it helps provide neutrality and certainty to understanding the parties' rights.
However, in many cases, it will not be possible to agree this and the parties may end up contracting using the law of the country in which the project is being built. Unfamiliarity with those laws can often lead to problems. For example, most construction contracts provide that liquidated damages will be payable where the contractor is delayed in achieving completion. The purpose of this is to have a fixed pre-determined sum to compensate the owner for delay rather than the owner having to undertake a complex task of proving its actual losses caused by the delay. There is often an expectation by project owners that the parties' bargain will be upheld and the right to payment of liquidated damages enforced. That is true in many systems of law (including English and Singapore law). In contrast, some systems of law (such as Thailand) adopt a different approach and effectively treat the amount of liquidated damages agreed by the parties as a cap on liability, and provide a judge or arbitrator with discretion to decrease the amount payable by the contractor.
This can come as an unexpected surprise when a project owner tries to enforce what it had previously understood to be a clear right to a fixed payment of liquidated damages. As the entitlement to recover liquidated damages is usually an important consideration for project owners, care should therefore be taken to ensure that these types of provisions are enforceable under the parties' choice of law for their contract.
A similar issue may arise where a foreign contactor is not familiar with local labour regulations which may restrict overtime for its employees. If the foreign party is not familiar with these when it formulates a bid for a contract, it may find itself exposed to significantly higher personnel costs once the contract is awarded. In turn, this could have a dramatic impact on the contractor's economics for the project.
In both cases, these risks can be mitigated by undertaking thorough due diligence in advance of any project to become informed of the local law risks as soon as possible so that strategies can be taken to navigate them. Steps can also be taken to adopt a neutral system of law for relevant project agreements, and agreeing to arbitrate any disputes in a neutral international forum.
Impact of technology
What new technologies are being used and how? Are there any government initiatives around promoting technology, such as to promote the use of digitisation, BIM, drones, or apps in contract administration?
Despite the general focus on technology across Asia, there appears to be a slow uptake of smart construction technologies, particularly in ASEAN nations.
For example, the Singapore Building and Construction Agency (BCA) published a report last year stating that by 2025 residents may see various changes, including Integrated Digital Delivery (IDD) focusing on the greater use of digital technologies and Building Information Modelling (BIM) throughout all four stages of the project lifecycle (i.e. design, manufacturing and fabrication, construction and facilities management). This will be facilitated by pioneering 40 to 60 IDD projects, with funding for teams to adopt IDD. Furthermore, in addition to strengthening efforts on achieving the nation’s target of greening 80% of Singapore’s buildings by 2030, BCA is focusing on ensuring that these green buildings perform optimally when in operation. In order to implement these changes, the intention is to have about 80,000 personnel trained in DfMA, IDD and Green Buildings by 2025, up from about 33,000 in 2018.
In China, however, knowledge and understanding of BIM are increasing rapidly. Although, notably the construction market in China is fragmented and, as such, enthusiasm and capacity to implement BIM processes is varied. The Ministry of Housing and Urban- Rural Development (MOHURD) is the key government agency driving BIM adoption. In 2011, it produced its twelfth Five-Year Plan which included BIM standards and adoption. However, because the BIM policy was not mandatory, the level of take-up in the early stages was minimal. MOHURD has since delivered its thirteenth Five-Year Plan (which runs from 2016-20) and the Chinese BIM policy now includes provisions for the adoption of BIM to be driven by government.
However, there is no consolidated approach through government towards developing standards.
It is a commonly held view in China that British standards in respect of smart construction methods should be considered "best practice" and replicated in China. This may, in part, arise from the fact that Hong Kong was under British rule before reverting to Chinese sovereignty in July 1997. Therefore, whilst mainland China is now focusing more on BIM, the most significant adoption has been in the Hong Kong region. For example, the Hong Kong Special Administrative Region requested that training be focused on UK BIM Level 2 standards.
Whilst there is a slow uptake in technologies such as drones (which have inherent problems around highly flammable substances) and BIM, Southeast Asia and the Mekong countries in particular are currently developing a large number of smart city projects and we are also hearing of clients using technology to monitor asset health.
What is happening in dispute resolution?
What trends are you seeing with the use of Alternative Dispute Resolution?
Many Asian cultures prefer less confrontational methods of resolving disagreements. Consequently, there is an increased focus on mediation in the region. This is particularly true in the context of Belt and Road disputes, where China is advocating for mediation as a preferred dispute resolution option.
Mediation is also gaining popularity for domestic disputes in Mainland China, whereas in Hong Kong it is often mandatory for parties to mediate public infrastructure disputes before commencing arbitration.
Further south, Singapore has been championing mediation. Notably, in August 2019, 46 countries signed the UN Convention on International Settlement Agreements Resulting from Mediation (Singapore Convention), making it the highest record of first-day signatories for a UN trade convention. The Singapore Convention is an important milestone as it could see cross-border mediated settlement agreements being enforced internationally. This would address the common criticism that an international settlement agreement is only binding contractually and therefore not enforceable in domestic courts. Singapore has also established the Singapore International Mediation Centre (SIMC) and the Singapore International Mediation Institute. The SIMC in particular has been campaigning for arbitration-mediation-arbitration clauses, which will allow the institutions to govern the process. In particular, the Singapore International Arbitration Centre refers the matter to mediation after the exchange of the Notice of Arbitration and Answer.
Progress in respect of mediation has not only been made in Singapore. For example, in 2015, Vietnam revised its Civil Procedure Code to allow out-of-court settlement agreements to be enforced. However, it should be noted that this does not recognise agreements reached in foreign proceedings and Vietnam is not party to the Singapore Convention. Meanwhile, the Vietnam International Arbitration Centre launched the Vietnam Mediation Centre in May 2018, and published new Mediation Rules which came into effect on 1 July 2018.
Despite the push for mediation, arbitration remains the most popular option for resolving construction disputes in Asia. There is a general trend across the region to arbitrate disputes outside the host state, with Singapore and Hong Kong being the preferred seats.
We are seeing that contractors, particularly Chinese and those from certain Southeast Asian countries, 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.
Statutory adjudication is also available for some types of claims in some countries. 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 April 2016, the Development Bureau of the Hong Kong Special Administrative Region Government published a report on the public consultation on proposed security of payment legislation, but as yet no draft legislation has been considered by the legislative counsel.
Other methods of dispute resolution
In 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 (referred to above) 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.
Issues of enforcement
Parties need to consider the local jurisdiction in respect of enforcement and recognition of contractual rights and allocation of risk. For example, the general position in Malaysia under Section 75 of the Contracts Act 1950 was that where there is a breach of contract, an innocent party cannot recover simpliciter the sum fixed in a damages clause regardless of whether it is stipulated as a penalty or liquidated damages. The innocent party must prove the actual damage he has suffered. This made it difficult to claim liquidated damages in large construction contracts in Malaysia. Whereas in Thailand, although the court recognises the liquidated damages clause, the court has discretion to adjust the amount of compensation downwards if it considers the amount of liquidated damages to be excessive or unreasonable.
Region specific causes of 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 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).
An issue that we have seen arise when dealing with some ASEAN state parties is that individuals are not empowered (or believe they are not empowered) to agree a settlement of any claim that could later be argued to have not been in the state's interests. The issue arises because some countries have laws which are designed to protect against corruption but which are broadly applied to prevent any loss to the state and individuals involved in projects fear that by agreeing to a commercial settlement of a claim they may not be fully protecting the state's interests. As a result, they believe that it is better to spend the time and money of pursuing a formal dispute resolution process to have a third party (i.e. a judge or arbitrator) conclude that they are wrong rather than agreeing a commercial settlement that would result in a better financial outcome for the state.
For further information, please contact:
Mike McClure, Partner, Herbert Smith Freehills