Contract Risk in International Infrastructure Projects 1

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Monday, March 31st, 2014
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Project risks and risk allocation on infrastructure projects can vary significantly between countries, across different industries and particularly in developing jurisdictions where risk profiles have not been settled and new participants often have disproportionate bargaining power.

Nonetheless, there are some common themes and issues on international infrastructure projects which contracting parties should be prepared to consider.

EPC Contracts

Engineer, procure and construct (EPC) contracts are a common form of contract on major infrastructure projects internationally, particularly where the project involves the procurement of operational plants.

An EPC contract is essentially a design and construct (D&C) contract, where a single contractor takes responsibility for all elements of design, engineering, procurement and construction. The key difference between a standard D&C contract and an EPC contract is the commissioning and performance element.

EPC contracts typically include a complex commissioning and testing regime designed to ensure that the plant being procured operates in the manner required and to the specified performance levels.

In most instances, there will be various tests which must be passed at different stages and a number of performance guarantees which the plant must meet, with performance liquidated damages payable by the EPC contractor where the various performance guarantees are not met. This mechanism can extend some way into the operational lifetime of the installation.

The EPC contract essentially provides a “turnkey solution”, with a single contractor bearing the completion and performance risk for the entire project. This is not only ideal from a principal’s perspective, but also means that the EPC model usually results in a “bankable” model which satisfies the lenders.

Split EPCs

Where the project works involve a significant cross-border element, the EPC contract may be split into an onshore and offshore component.

This is done primarily for tax purposes. Generally speaking, by splitting the works into onshore and offshore packages, the offshore contract is not subject to local tax regimes in the project country. This reduces the tax liability in the project country and therefore also reduces the cost to the principal of the overall EPC works.

Other reasons for split EPC contracts include:

  • Local registration / licencing requirements – i.e. local laws may require that a principal engage a locally based contractor that is licenced to perform works in the project country. A principal can then split the EPC across those works which must be performed by a local, registered contractor and those which can be performed by a contractor based overseas; and
  • Currency protection – some jurisdictions stipulate that payment must be made in the local currency and in countries where the currency is subject to high inflation or is unstable, volatile or wildly fluctuating, this can become a costly exercise for a principal. Under a split EPC contract structure, the principal can divide the works so that a component is payable offshore in a more reliable, predictable or readily available currency.

Because this split EPC model means that a principal is engaging two different contractors to perform separate scopes of work, a “wrap agreement” is usually also entered into under which each of the onshore and offshore contractors (or a parent company) “wrap” the risk together and therefore provide the principal with a single point of responsibility.

Governing Law

Where a principal and contractor are from different countries (from each other and/or from the country in which the project is located), the parties will need to consider which law should govern the contract – the law of the project country, the law of a party’s country or the law of an independent country.

In making this determination, some of the issues which need to be considered include:

  •  Whether the chosen law will impact on enforcement of any judgment;
  •  Whether there are gaps in or concerns with the local law of the project country;
  • Whether there any country specific requirements (for example, some jurisdictions mandate that the domestic law must govern the contract); and
  •  The law of other related financing documents.

It may well be that parties end up in a situation where there are different laws governing:

  • The contract;
  • The arbitration;
  • The arbitration agreement; and
  • The subject matter of the contract (i.e. local laws that will apply to the works irrespective of the law governing the contract, such as health and safety laws).

Dispute resolution

Parties involved in an international infrastructure project will also need to consider what dispute resolution mechanism should be included in the construction contract.

The ability to enforce a judgment is the key consideration here.

Generally, arbitration is preferred over litigation, with 148 countries being signatories to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. By contrast, only a limited number of foreign jurisdictions provide for the enforcement of judgments made in Australia and similarly the judgments of only a limited number of foreign jurisdictions can be enforceable in Australia.

In regions where adversarial processes can be counterproductive from a cultural perspective, it may be worth considering other alternative dispute resolution mechanisms. Dispute Resolution Boards are a good example of a more relationship-based dispute resolution method which has seen success in Asia.

By: Rob Buchanan and Simone Alphonse
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  1. PRAKASH

    Dear Mr. Rob Buchanan,
    A very good & Informative article on Contract Risks. I have a presentation on "Risk Mitigation in EPC Project in Oil & Gas Surface Development Facilities. You have really covered all statutory contract risks Internationally. If you require, I will mail you my presentation.
    With warm regards
    Prakash Nagarik