CONSTRUCTION LAW SUMMER SCHOOL 2014 International contracting · CONSTRUCTION LAW SUMMER SCHOOL 2014 International contracting ... • Prohibition against penalties (as opposed to

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CONSTRUCTION LAW SUMMER SCHOOL 2014International contracting

Jane Davies Evans and Marc Frilet1 September 2014

INTERNATIONAL CONTRACTINGCONTENTS

• PART 1: Jane Davies Evans• Local practice and international norms• Significant developments in international contracting

• PART 2: Marc Frilet• The World Bank contract conditions for construction works in civil law countries• Practical consequences of the duty to advise the employer and decennial liability in

Napoleonic civil law countries

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CONSTRUCTION LAW SUMMER SCHOOL 2014International contracting: PART 1

LOCAL PRACTICEMandatory laws

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INTERNATIONAL CONTRACTINGLOCAL PRACTICE

• What are mandatory laws?

• Laws that you cannot contract out of

• Laws that apply by virtue of the location in which the international Contractor is working• Law that apply by virtue of your choice of applicable law • Laws that apply by virtue of where the international Contractor comes from

INTERNATIONAL CONTRACTINGLOCAL PRACTICE Example mandatory laws that apply by virtue of the location in which the international Contractor is working

• Building regulations• Technical regulations (pressure vessels, structures, concrete, welds, I&C, E&M, highway

pavements, etc etc)• Health & safety regulations• Planning and environmental requirements• Local employment laws (including minimum wage requirements and visas)• Local taxation / customs and excise requirements• Import / export requirements (including currency transfers)• Corporate/branch registration requirements• Registration with the local industry professional body for the particular type of work• Public procurement regulations for contracts with a public sector Employer• Anti bribery and corruption regimes• Investor protections

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Example mandatory laws that apply by virtue of your choice of applicable law • Restrictions on contractual arrangements → contract provisions (or entire contract) or

a resulting arbitration award) may be unenforceable under the applicable / local lawExamples:• Exclusion of liability for gross negligence prohibited• ‘Pay when paid’ clauses prohibited• Certain disputes may not be referred to arbitration• Prohibition against penalties (as opposed to liquidated damages that are a ‘genuine pre-

estimate of loss’)• Prohibition against liquidated damages

• Implied terms / compulsory provisions Examples:• Adjudication of disputes• Obligation to pay interest on unpaid sums• Right to suspend performance for non payment• Release from obligation to perform due to force majeure


Example mandatory laws that apply by virtue of where the international Contractor comes from (extra territorial mandatory laws)

• Anti bribery and corruption regimes• Investor protections• International sanctions / trade embargoes

Note: certain jurisdictions may treat mandatory law provisions in ‘their’ law as a matter of ‘public policy’ for the purposes of the New York Convention on of the Recognition and Enforcement of Arbitral Awards, and refuse to enforce awards based on contractual provisions / arbitral procedure that would have been contrary to the local law had the local law been the applicable law of the contract

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INTERNATIONAL NORMS

INTERNATIONAL CONTRACTING

INTERNATIONAL NORMS RE: PAYMENT (1/2)

• Interim payments• Monthly

• For Measured Work contracts by reference to work done• Minimum invoice amount is common

• On completion of milestones (% of Contract Price or agreed lump sums)

• Advance payment• Most common in civil works contracts (payment to mobilize in advance of production)• Typical range? 10 / 15% of Contract Price• Secured by ‘on demand’ bank guarantee• ‘Clawed back’ against future invoices once production commences

• Retention• % of amounts otherwise payable retained by Employer to cover defects• Typically capped at 5% of Contract Price • Typically 50% returned on completion, the remainder after defects liability period• Contractor may be able to release retention early against an ‘on demand’ bank guarantee

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INTERNATIONAL NORMS RE: PAYMENT (2/2)

• Late payment of sums due to Contractor• Interest payable to Contractor• Entitlement to suspend performance on notice• Entitlement to terminate for prolonged late payment on notice

• Currency of payment• Local / international currency by agreed % split• How to address currency exchange risk?

• Security for payment?

• Price escalation?


INTERNATIONAL NORMS RE: SECURITY TO BE PROVIDED BY THE CONTRACTOR • What may be secured?

• Advance payment • Off site materials• Performance guarantee

• General performance• Failure to meet specific criteria

• Retention monies

• Forms of security• Parent company guarantees• ‘On demand’ guarantees, issued / confirmed by bank local to the Employer• Bank guarantees requiring proof of entitlement• Letters of credit

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INTERNATIONAL NORMS RE: LIABILITY

• Mutual liability between the Contractor and Employer• No liability for consequential loss• Indemnities re: insured loss/damage • Caps on liability do not apply to indemnities

• Contractor’s liability to Employer• Cap by reference to Contract Price• Cap does not apply in instances of fraud, gross negligence / wilful misconduct• Liquidated damages for delay• For supply of plant, liquidated damages for failure to achieve performance

specifications

• Employer’s liability to the Contractor?


INTERNATIONAL NORMS RE: TERMINATION

• Employer can terminate for convenience

• Either party can terminate for prolonged force majeure

• Termination by Employer due to Contractor default• Non performance (with notice and opportunity to remedy)• Without notice or opportunity to remedy for liquidation / bribery and corruption

• Termination by Contractor due to Employer default• Prolonged non payment (with notice and opportunity to remedy)

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INTERNATIONAL NORMS RE: DISPUTE RESOLUTION AND APPLICABLE LAW

• Multi tiered dispute resolution mechanisms, arbitration as the final step

• Seat, form of arbitration?

• Applicable law?

INTERNATIONAL CONTRACTINGSignificant developments

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SIGNIFICANT DEVELOPMENTS FOR INTERNATIONAL CONTRACTING (1/2)

• Economic• Increased willingness of Courts to block demands for payment under bank

guarantees• In the public sector

• Increased scrutiny of performance on public works contracts / concessions• Increased focus on anti bribery and corruption• Increased focus on tax compliance

• Increased risk of actual / de facto expropriation etc. of international Contractor’s assets by ‘host’ States


SIGNIFICANT DEVELOPMENTS FOR INTERNATIONAL CONTRACTING (2/2)

• Political • International economic sanctions

• Increased regulator focus on activities of international Contractors• Prohibition on extensions of guarantees issued to targeted entities

• Investor-State protections • Increased risk that protections violated as governments favour national interests over

international investors• Increased recourse by contractors to international law remedies

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CONTACT DETAILSJane Davies [email protected]+44 7714 960096

CONSTRUCTION LAW SUMMER SCHOOL 2014


Jane Davies Evans

Barrister, FCA, FCIArb, FDBF, LLB (Sc) Hons

International Arbitration │Energy & Natural Resources │ Engineering & Construction

[email protected] +44 7714 960096

NOTES AND MATERIALS (1 September 2014)

I. INTERNATIONAL NORMS

II. SANCTIONS

III. INVESTOR-STATE ARBITRATION

I. INTERNATIONAL NORMS

Contractors or employers will often seek to justify a position in negotiations by asserting that their position is in accordance with ‘international norms’, and external finance is typically preconditioned on the project contracts being let on ‘internally accepted terms and conditions’.

But what does this mean? Is there an internationally accepted approach to the allocation of risk between employer and contractor? Does FIDIC – or other widely used forms of contract – represent the international norm? And, if there are international norms, are the applied consistently across different sectors?

In my experience, an individual’s view as to what constitutes the internationally accepted norm on a given issue is typically determined by their exposure to previous projects. On further enquiry, a deeply held opinion as to a particular norm, will often be founded on a small selection of contracts (quite possibly numbering in single figures).

In this paper, I share with you my view of what may constitute international norms for key negotiating issues, acknowledging fully that these ‘norms’ are dictated by the projects that I have been involved in – both in non-contentious and dispute situations – over my career. Although English-qualified, I studied Scots law (which has a Romano-Dutch historical context, and adopts many civil law principles) and spent much of my professional career based in Paris working on international projects governed by civil laws. My practice is almost exclusively international, based in the energy and natural resources sector and major infrastructure, and focusing on typically higher risk jurisdictions in Africa, Latin America, the Russian Federation and wider CIS, India, China, Asia and the Middle East.

INTERNATIONAL NORM? COMMENTS

PAYMENT PROVISIONS Advance payment • Typically in the range of 10 → 15% of the Contract Price.

• Paid shortly after commencement. • Provision of an ‘on demand’ bank guarantee in an agreed

form entitling the Employer to obtain repayment of the advance without proof of Contractor default, will be a precondition to payment of the advance.1

• The Employer will ‘claw back’ the advance against future invoices once interim payments fall due.

• A standard feature of civil works contracts, where advance payment will be made to fund what can be significant mobilization costs to transport plant and equipment to site. Not so prevalent in EPC contracts for the supply of process or power plants).

• Conditions of contract may require the Contractor to demonstrate how the advance was expended.

• Failure to demonstrate the advance has been used for the purposes of the project and/or general non-performance would typically justify making a demand on the securing guarantee.

• ‘Claw back’ may be deferred until interim payments have reached an agreed level (typically 10 → 15% of the Contract Price).

Interim payments • Standard feature of significant international contracts → Contractor receives Contract Price spread over several tranches.

• Interim payments are typically due monthly or upon completion of pre-agreed milestones in the project.

• Exceptionally – where the Contractor has an equity stake in the project – the Contractor may defer payment until the asset starts generating income for the Employer / sponsors.

1 See items # to # below as to bank guarantees.


Monthly:

• Contractor to submit an application for interim payment monthly setting out the work done in the previous month.

• A minimum invoice amount is common.

• Typically used when the Contractor is being paid by reference to Measured Works, ie, quantities of work done paid by reference to agreed rates.

• Also used when the Contractor is paid by reference to % work completed assessed by reference to priced work packages.

• A variation on this approach may be allow the Contractor to decide how often to submit interim payments, stipulating that the minimum interval between each application must be no less than 1 month.

On completion of milestones:

• Contractor can apply for payment of a pre-agreed % of Contract Price or agreed lump sums on completion of milestones.

• Most common in EPC / supply agreements. • Main issue for negotiations is agreeing (a) the

definition of the milestones, and (b) how completion of each milestone is to be evidenced.

• Clear milestones that can be evidenced objectively (for example, execution of identified key subcontracts / supply contracts are preferable to avoid disputes).

Retention • % of amounts otherwise payable retained by Employer to cover potential defects (does not apply to the advance payment).

• Typically capped at 5% of Contract Price. • Typically 50% of retentions sums will be returned on

completion, the remainder on expiry of the defects liability period.

• Contractor may be able to release retention early against an ‘on demand’ bank guarantee.

A normal feature of all construction contracts, irrespective of sector.

Rare in consultancy (design, supervision, project management) contracts.


Late payment of sums due to Contractor

• Interest payable to Contractor if the Employer has not paid sums due on the agreed payment date.

• Entitlement to suspend performance on notice. • Entitlement to terminate for prolonged late payment on

notice.

• In many jurisdictions, there would be a statutory right to interest even if the parties did not include a contractual right.

Currency of payment

• Local / international currency by agreed % split • How to address currency exchange risk?

Security for payment • Not common.

• In more difficult jurisdictions, payment may be secured / facilitated by letter of credit, but typically at the Contractor’s cost.

• FIDIC allows some protection under the right to request ‘reasonable evidence’ of funding, and possibility to terminate if not provided.

Price escalation • Almost unheard of if contract ≤ 1 year in duration. • If allowed, by reference to indices linked to the key costs.

• Employers may prefer to provide as ‘free issue’ materials that are particularly susceptible to inflation (steel etc).

• Some contracts / jurisdictions recognise the concept of a disruption in economic balance and may give relief to the Contractor.


LIABILITY Mutual liability between the Contractor and Employer

• No liability for consequential loss. • Indemnities re: insured loss/damage. • Caps on liability do not apply to indemnities.

• To take care in jurisdictions that do not allow exclusion of liability for gross negligence / wilful default etc, does this include exclusions of consequential loss?

• To ensure due diligence as to the mutual insurance cover taken out.

Contractor’s liability to Employer

• Typically capped by reference to Contract Price. • Cap does not apply in instances of fraud, gross negligence

/ wilful misconduct (by contract or operation of law). • Liquidated damages for delay. • For supply of plant, liquidated damages for failure to

achieve performance specifications

• To take care in jurisdictions with Contract Acts derived from the Indian Law of Contracts Act 1872. Liquidated damages figure may act as a cap on liability subject to proof.

• In civil law, additional ‘penalty’ provisions are common. The theory is that this is allowed (contrast common law jurisdictions that typically will not enforce penalties), but legal opinion in many jurisdictions is that unreasonable penalties will not be enforced.

Employer’s liability to Contractor

• If stipulated, capped at Contract Price. • Often not addressed save for exclusion of consequential loss etc.


TERMINATION Termination for convenience • Common feature → allows Employer to terminate on

notice (typically 14 to 28 days). • Contractor will be paid for work done to date,

compensated for supply contracts etc that cannot be terminated without cost and demobilization costs.

• Under many common law jurisdictions, Employer cannot terminate to give work to another contractor / complete itself, and will be liable to the Contractor for loss of profits on the remaining scope if it does so.

• Many civil law jurisdictions reach the same conclusion by requiring right to be exercised in good faith.

• Option can be used to cap liability / ensure termination goes smoothly even if potential to terminate for default.

Prolonged force majeure • Common feature to enable either party to terminate for prolonged force majeure.

• Period can range from 100 days to 18 months +.

Termination by Employer due to Contractor default

• Non-performance (typically with notice and opportunity to remedy).

• Without notice or opportunity to remedy for liquidation / bribery and corruption.

• Ideally (but infrequently) the contract will specify whether the contractual rights are additional to ‘common law’ right to terminate for non- performance.

• Some jurisdictions recognise the concept of futility → no need to give notice if impossible / futile to expect Contractor to remedy. Again, infrequently included expressly.

Termination by Contractor due to Employer default

• Prolonged non-payment (not rectified on notice). • In some sectors / geographical areas, material breach (on

notice).

• Ideally (but infrequently) the contract will specify whether the contractual rights are additional to ‘common law’ right to terminate for non- performance.


DISPUTE RESOLUTION AND APPLICABLE LAW Dispute resolution • Multi-tiered dispute resolution mechanisms.

• Arbitration as the final step.

• Almost all contracts for significant international engineering and construction projects include a multi tired DR mechanism, requiring claims to be addressed initially at a project level, before being determined by an independent (or quasi- independent) second tier forum.

• Almost all contracts for international contracting require that disputes are determined finally by arbitration. The preference for arbitration (rather than litigation) reflects (a) concerns by contractors working outside of their ‘home’ jurisdiction that the local court may favour a local employer, in particular, where that employer is a government entity and/or well connection politically; and (b) that – due to the wide spread application of the New York Convention – it is generally easier to enforce an arbitration award internationally, than it is to enforce a local court order and/or judgement.

• Increasingly, contracts typically exclude the ability to appeal an issue of law (or any aspect of the award) to the local courts, save where the local law allows recourse to the supervisory court.

Applicable law • No ‘norm’ per se.

• Both local law and international ‘neutral’ law (English, Swiss, New York etc) laws are common.

II. INTERNATIONAL SANCTIONS

INTRODUCTORY NOTES AND SLIDES

The international community is increasingly turning to sanctions or embargoes (referred to as sanction regimes) against entities in order to effect changes in behaviour by regimes that are considered undesirable by the broader international community.3 In so doing, and in order to limit the circumvention of sanctions by targeted entities, the international community has increasingly focused on the work of international contractors (who are compelled to comply with the sanctions) when promulgating additional sanctions.

These sanctions are not only mandatory, but carry significant penalties (both financial and potential imprisonment) for breaches, irrespective of intent. Contractors and suppliers operating in or dealing with regimes who are the subject of international sanctions must therefore take extreme care not to expose itself (as a corporate entity) and its personnel (who can be liable as individuals). At the same time, contractors must deal with its own commercial exposure to claims under the construction contract and associated contracts.

The following slides identify the key issues that contractors need to deal with at an operational level, when sanctions impact on the international business.

3 The use of sanctions to limit the operational effectiveness of terrorism organisations is outside the

scope of these notes / slides.

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CONSTRUCTION LAW SUMMER SCHOOL 2014International contracting and sanctions

Jane Davies Evans1 September 2014

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• Agenda– Introduction

• The purpose of sanctions• Primary sources of international sanctions• Current sanction regimes (UK)

– Evolution of international sanction regimes• Types of measures implemented• Measures targeted at international contractors / developers• Typical exemptions

– Who must comply with a given sanction regime?– Impact of sanctions on construction projects

INTERNATIONAL CONTRACTINGINTERNATIONAL SANCTIONS

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• To encourage a change in behaviour of a target country or regime

• To apply pressure on a target country or regime to comply with set objectives

• As an enforcement tool– Where diplomatic efforts have failed AND– International peace and security are threatened

• To prevent and suppress the financing of terrorism

www.hm-treasury.gov.uk/fin_sanctions_role.htm

Article 41, UN CharterCommon Foreign and Security Policy (EU)

INTERNATIONAL CONTRACTINGINTERNATIONAL SANCTIONS – THE PURPOSE OF SANCTIONS

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• United Nations Security Council Resolutions

• Regional– European Union Council Regulations– Arab League Declarations

• National– E.g., United Kingdom

• Act of Parliament• Statutory Instruments• Asset Freezing Unit statements

INTERNATIONAL CONTRACTINGINTERNATIONAL SANCTIONS – PRIMARY SOURCE MATERIAL

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1. Afghanistan2. Al Qaida3. Belarus4. Burma / Myanmar5. Democratic Republic of Congo6. Egypt7. Eritrea8. Federal Republic of Yugoslavia and Serbia9. Iran10. Iraq11. Ivory Coast12. Lebanon13. Liberia14. Libya15. North Korea16. Republic of Guinea17. Republic of Guinea – Bissau18. Russian Federation

http://www.hm-treasury.gov.uk/fin_sanctions_afu.htm

19. Somalia20. Sudan21. Syria22. Tunisia23. Zimbabwe

INTERNATIONAL CONTRACTINGINTERNATIONAL SANCTIONS – EXAMPLE CURRENT REGIMES (UK)

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• Wide ranging trade sanctions / travel bans• Measures targeting specific individuals / entities

– Asset freeze• Senior members of the regime• Banks controlled by the regime• National oil companies• Government Ministries

– Travel bans

• Flight restrictions• Currency restrictions• Enforcement of ‘no fly’ zones• Military action

INTERNATIONAL CONTRACTINGINTERNATIONAL SANCTIONS – TYPES OF MEASURES

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• Prohibition of supply of military equipment • Prohibition of supply of equipment used for suppression of

internal population incl. observation or monitoring of the population

• Prohibition on the purchase of government bonds or bonds issued by financial institutions in the sanctioned state

• Prohibition on dealings with financial institutions, provision of insurance etc

• Prohibition of the import, purchase or transportation of crude oil or petroleum products originating from country under sanction regime

INTERNATIONAL CONTRACTINGINTERNATIONAL SANCTIONS – TYPES OF MEASURES continued

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• Prohibition of the supply of equipment, technology, technical assistance etc re: nuclear power

• Prohibition of the supply of equipment related to the extraction and processing of oil and gas

• Prohibition of the supply of equipment or technology related to the construction or installation of new-build power plants

• Prohibition on the provision of technical, brokerage and financial assistance related to prohibited actions

• Prohibition on investing in enterprises in the sanctioned state engaged in prohibited actions / industries

INTERNATIONAL CONTRACTINGINTERNATIONAL SANCTIONS – TYPES OF MEASURES continued

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• For contracts entered into prior to [date] – But person relying on exemption must register with the relevant authority

• For equipment etc to be used for certain purposes– Protection– Official observers– Media– Humanitarian purposes

• Where a general licence has been awarded

• Asset freeze may be relaxed by relevant authority– Basic needs – Legal representation– Bank account charges where the assets are frozen– Extraordinary expenses with prior notice– Diplomatic functions– Overseas students

INTERNATIONAL CONTRACTINGINTERNATIONAL SANCTIONS – TYPICAL EXEMPTIONS

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• Typical EU sanction wording

INTERNATIONAL CONTRACTINGINTERNATIONAL SANCTIONS – WHO MUST COMPLY

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International ContractorEU / State A

International BankInternational

Project CompanyTargeted State

Local Bank State B

International Partner / Consultant

National Oil Company / Government entityTargeted Entity

EPC Contract

Facility Agreements and Undertaking

Performance Bond

Counter Guarantee

INTERNATIONAL CONTRACTINGINTERNATIONAL SANCTIONS – IMPACT ON INTERNATIONAL CONTRACTORS

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• Typical sequence of events:

– International contractor incorporated in State A is executing construction project in State B for state entity

– International contractor has provided security to the Employer• Performance bond / bank guarantee issued by local bank to Employer• Counter guarantee issued to local bank by contractor’s international bank

pursuant to facility agreement– Situation in state deteriorates– Government of State A recommends no non-essential travel to State B– International insurer restricts cover for project– Personnel want to leave State A– International community impose increasingly stringent sanctions against State B and/or

the Employer– International contractor notifies Employer

• Force majeure situation• Evacuation of expatriate personnel

continued


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Typical sequence of events continued:

• Employer does not recognise force majeure

• Employer issues ‘extend or pay’ demand on the performance bond / bank guarantee issued by local bank

• Local bank makes demand on counter guarantee

• International bank asks contractor

• For permission to extend

• To transfer funds

• To provide indemnity for demand under Facility Agreements


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• Do sanctions → force majeure such that the contractor is excused performance of its obligations under the EPC Contract?

– What does the sanction say?– Is force majeure recognised by the relevant authorities?– What does the construction contract say?– What does the local law say?– Have other contractors continued to work?– Has the Employer completed the works / operated the facility?

National Oil Corporation v. Libyan Sun Oil CompanyRSM Production Corporation v. La Republique centrafricaine

INTERNATIONAL CONTRACTINGINTERNATIONAL SANCTIONS – COMMON QUESTIONS ASKED

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• Do sanctions provide a defence to claims re: failure to meet contractual obligations? (1)

• Common wording

• Council Decision (EU) No. 36 / 2012


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• Do sanctions provide a defence to claims re: failure to meet contractual obligations? (2)

Shanning International Limited vs. Lloyds Bank and others

(2001) 1 WLR 1462 (HL), (2000) Lloyd's Rep Bank 235 (CA), LTL 5/1/2000 (High Court)– Contract to supply medical equipment to Iraq– Shanning had issued counter guarantee for performance of supply contract– Supply contract could not be completed due to sanctions– HL adopted purposive approach to interpreting an equivalent provision

• Stated that any claim under the guarantee or counter guarantee would “plainly” be in connection with the underlying supply contract

• Found that the equivalent provision provided a permanent prohibition on claims – any potential liability for non performance was extinguished and would not revive upon the lifting of the sanction

• Reasoned that to find otherwise would make international contractors the innocent victims because the State could recover for non performance once the sanctions were lifted


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• How does the sanctions defence operate in arbitration?– As a defence– Not as a ground for non-arbitrability

• La Compagnie Nationale Air France v Libyan Arab Airlines et al., Quebec Court of Appeal (31 March 2003) – Contract for maintenance of aircraft by AF– UN sanctions introduced vs. Libya– AF terminated contract relying on sanctions– LAA filed arbitration for wrongful termination – Seat of arbitration in Quebec– AF raised preliminary issue: did tribunal have jurisdiction given sanctions defence?– Tribunal found they had jurisdiction– AF applied to Quebec courts for a declaration that the claim was non-arbitrable

• First instance: found for LAA• Court of Appeal:

• Tribunal had jurisdiction to decide its own jurisdiction• Sanctions protection operates as defence, not issue of arbitrability


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– Identify the contractual chain from the Employer to the Contractor• Construction contract / supply chain• Securities• Facility Agreements and indemnities

– Identify other relevant issues which may be impacted by sanctions• Insurance • Impact of sanctions on personnel

INTERNATIONAL CONTRACTINGINTERNATIONAL SANCTIONS – HOW TO ADDRESS THE SITUATION (1)

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CONSTRUCTION CONTRACTS AND SUPPLY CHAIN– Identify relevant jurisdictions and sanction regimes– Notification requirements / exemptions– Is there a contractual definition of force majeure?– Applicable law?– Local counsel advice as to impact of sanctions on obligation to perform– Ensure all relevant contractual notices given up and down supply chain– Identify outstanding payments due / claims against Employer– Consider claims against non-targeted guarantors– Settlement options: is set off prohibited?– Consider long term strategy for project / country

• Is termination a commercial option?• Commencing arbitration etc


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SECURITIES• At each stage of the chain of securities / counter indemnities– Identify relevant jurisdictions and sanction regimes

• Is payment prohibited? If so, where are the funds frozen?• Can guarantees be extended?

– Notification requirements / exemptions – Identify directions from relevant central banks – Local counsel advice as to impact of sanctions on securities– Local counsel advice as to possibility of obtaining injunctions to protect securities

• Chances of success• Procedure• Legal test / required evidence• Cost• Consequences of a successful application

– Insurance


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FACILITY AGREEMENTS AND DIRECT INDEMNITIES• At each stage of the chain of securities / counter indemnities– Identify relevant jurisdictions and sanction regimes

• Is payment prohibited? If so, where are the funds frozen?• Can guarantees / indemnities be extended?• Are fresh indemnities / payments into escrow permitted?

– Notification requirements / exemptions – Identify directions from relevant central banks – Local counsel advice as to impact of sanctions on Facility Agreements / indemnities– Identify all potential defaults / cross defaults under Facility Agreements and take

appropriate action– [Local counsel advice as to possibility of obtaining injunctions / declarations against

banks]



Jane Davies Evans 1 September 2014

III. INVESTOR STATE ARBITRATION

LECTURE NOTES AND SLIDES

A contractor who participates in a construction project outside its ‘home’ jurisdiction exposes itself to additional risks above and beyond those experienced when carrying out work domestically. The contractor’s anticipated return on the construction project may be eroded through changes to the tax regime in the foreign jurisdiction where the international contractor is working (the so-called ‘host’ state), restrictions on the movement of currency outside of the host state, difficulties in registering as a foreign entity in the country, delays (or worse) in obtaining permits or licences required to execute the work, or other actions of the host government which have – intentionally or innocently - forms of intervention and interference by the host government.

Traditionally, a contractor faced with such difficulties will attempt to bring claims against the employer under the construction contract, relying on the contractual allocation of risk for change in law, licensing and permitting and/or force majeure or similar. In certain situations, in addition to these ‘traditional’ remedies, international contractors working outside their ‘home’ jurisdictions may be able to benefit from protections available to foreign investors, seeking remedies by way of investor-state arbitration against the government of the host state if these protections are violated.

While traditional ‘commercial’ construction arbitrations typically proceed under the agreement to arbitrate found in the construction contract,4 investor-state arbitrations are generally founded on the host state’s unilateral agreement to have certain disputes determined in international arbitration. A qualifying investor relies on the host state’s unilateral agreement to arbitrate and make a claim in international arbitration against the host state.

While a few contractors have been using investor-state arbitrations to seek recompense for some time, the industry as a whole was initially slow to embrace the concept. But there is a definite change in approach, with many of the investor-state arbitrations registered in recent years relating to construction projects. The reason for this change is multifaceted:

• Firstly, there is simply better awareness of this potential route to compensation.

4 For example, Clause 20.5 of the FIDIC 1999 suite of contracts.


• Secondly, the global economic and political turbulence of recent years has forced host states to face difficult decisions balancing the obligation to fulfil international obligations to foreign investors and the need to meet the expectations of their electorate.

• Thirdly, the increased use of long term project structures such as Build-Own-Operate, PFI concessions etc, has resulted in a greater number of situations in which investor protections may be violated.

• Finally, the sheer scale of international projects, the increased use of lump sum EPC contracting, and limited contractual rights to additional payment, has left many international contractors with significant losses and no prospect of recovery through traditional contract claims. Combined with a reduced number of projects in the pipeline – which may reduce a contractor’s inclination to initiate protracted legal proceedings, contractors have become more willing to try something different in order to make good their losses.

The attached slides and notes below provide an introduction to this issue.

THE BASIC REQUIREMENTS FOR AN INVESTOR-STATE ARBITRATION

The basic requirements for investor-state arbitration are as follows:

• An investor protection regime • A qualifying investor. • A qualifying investment. • A violation of the protections afforded by the regime.

Identifying the relevant investment promotion law or treaty

Investor protection regimes are typically found in local investment promotion laws or international treaty, with the latter being the most common arrangement.

Investment promotion laws operate unilaterally. A host state seeks to encourage foreign investors to invest within its national boundaries, and introduces an investment promotion law into the local statute book, promising certain protections to qualifying investors if they invest in qualifying investments in the host state and consenting to the determination in international arbitration of disputes in relation to violation of the protections.

Investment treaties operate bilaterally (when entered into by two states, in which case the treaty is referred to as a bilateral investment treaty or BIT), or multilaterally (when


entered into by three or more states, in which case the treaty is referred to as a multilateral investment treaty or MIT). The basic premise of both arrangements is that (a) the contracting states agree to provide investors from the other contracting states with certain protections on a reciprocal basis, and (b) investors from the other contracting states to the BIT or MIT may claim recompense from the host state if these protections are violated.

It is not always straightforward to identify what investment promotion laws and investment treaties are in force at any given time. Many states publish domestic legislation on government websites, but these are not always freely accessible, or may not be up to date. The situation is more complicated for international treaties. In many jurisdictions, the mere signing of the investment treaty is insufficient to give the treaty legal force in the host state. The treaty must be ratified by the host state in accordance with local law before it becomes legally binding. Finally, it is possible for states to amend or repeal domestic legislation, or to withdraw from an investment treaty. While certain institutions publish lists of investment treaties thought to be in force at any given time,5 the most reliable method to confirm what laws are in force is to contact the office of the Attorney General of the host state, the treaty section of the relevant Ministry of Foreign Affairs and/or the host state embassy.

Who is a qualifying investor?

Almost without exception, the criteria which determine who is a qualifying investor are the nationality or citizenship of the investor. Investors can be natural persons or legal entities (corporations and the like).

Investment promotion laws will typically frame the definition in the negative, requiring that the qualifying investor is not associated with the host state. In contrast, investment treaties will typically frame the definition positively, requiring that the investor must be associated with the other contracting state or states in order to qualify for protection.

For natural persons, the investment treaty will typically require that the investor has the nationality or is a citizen of one of the other contracting parties to the treaty. Natural persons who hold joint citizenship of both the host state and one or more of the other contracting parties to the treaty will often be excluded. In addition, some investment treaties require the investor to be resident in the other contracting state.

5 For example, the International Centre for the Settlement of Investment Disputes or ICSID, within

the World Bank in Washington DC.


Whether a natural person is a national, citizen or resident of a particular state will usually be determined, in the first instance, by reference to that law of that state.

For legal persons, relevant factors in determining nationality include:

• the place where the investor is constituted or incorporated, • the place from where the entity is controlled, • the place where the seat of the management of the entity is located.

In addition, and in response to investors planning the structure of investments so as to benefit from protections that would not otherwise have been available to them, investment treaties may require that the entity has a further connection to the other contracting state. For example, the investment treaty may require that the entity carries out “business activities” or “substantial economic activities” in the territory of the other contracting state, or that the management of the investor is seated in that territory.

It is common practice for international contractors to set up a locally incorporated special purpose vehicle or similar to undertake construction works in the host state. This may be a requirement of the local laws of the host state, or allow for the recovery of locally charged value added tax and similar costs by the international contractor. Many investment treaties recognise the validity of this business structure and include such entities in the definition of qualifying foreign investors, provided that the locally incorporated entity is controlled directly or indirectly by nationals of another contracting state.

What is a qualifying investment?

The ICSID Convention did not define an investment, preferring to leave this to the consent of the parties, expressed by means of contract, national legislation or treaty. Most BITs define the term broadly. Assessing whether or not an international contractor’s interest in a particular international project meets the qualifying investment criteria will therefore involve a careful analysis of previously decided investor-state arbitrations in light of the specific wording of the relevant law or treaty.


The following indicators are often referred to by Tribunals seeking to determine whether the investment that is the subject of the investor-state arbitration is a qualifying investment:6

• the investment should continue over an appropriate duration;7 • the investment should be capable of generating a profit or other return

for the investor; • the investor should assume an element of risk; • the investment should involve a substantial commitment on the part of

the investor;8 and/or • the investment should contribute to the economic development of the

host state.

A further issue which can be of relevance to international contractors is the requirement that the investment must comply with the laws of the host state, for example, that the construction contract was procured in accordance with the mandatory public procurement regime. A failure to comply with the mandatory regime, or evidence of corruption and the like may result in the Tribunal declining jurisdiction.

There was an initial debate as to whether construction contracts were capable of being qualifying investments, but the view that construction contracts can be qualifying investments appears to be the preferred view (subject of course to the particular situation).

For example, the following investments have been found to be qualifying investments:

6 This has been referred to as the “Salini test”, by reference to the award in Salini Costruttori

S.P.A.& Italstrade S.P.A. v. Kingdom of Morocco (Jurisdiction) ICSID Case No ARB/00/4 (ICSID, 2001, Briner P, Cremades & Fadlallah). See also ICSID Case No ARB/07/21 (ICSID, 2009, Paulsson).

7 A dredging contract lasting twenty three months was deemed to be of sufficient duration in Jan de Nul NV & Dredging International NV v Arab Republic of Egypt (Jurisdiction) ICSID Case No ARB/04/13 (ICSID, 2006, Kaufmann-Kohler P, Mayer & Stern). The tribunal also accepted the Claimant’s submission that investment in the construction industry commenced when the contractor started expending monies on the pre-qualification process.

8 For construction projects, the importing of skilled personnel, plant and machinery in order to perform the construction works may evidence that this indicator has been met. See for example, Toto Costruzioni Generali S.P.A. v The Republic of Lebanon (Jurisdiction) ICSID Case No ARB/07112 (ICSID, 2009, van Houtte P, Feliciani & Moghaizel, op. cit.).


- the construction and operation of a hotel,9 - a concession for the mining of metals and minerals,10 - the renovation, construction and operation of airport terminals,11 - a real estate development including construction of residential accommodation

social and commercial infrastructure12 - the development of a tourist resort,13 - dredging operations,14 - the development of a hazardous waste landfill facility,15 - the design and construction of public roads.16

THE PROTECTIONS AVAILABLE TO A QUALIFYING INVESTOR

Potential violations relevant to construction contracts include:

- the host state passing legislation nullifying or modifying the underlying construction or concession contract,

- the host state interfering with the performance of the contract, for example, by occupying part of the construction site or failing to assist the contractor in removing unlawful occupiers from the site,

- the host state – as Employer under the construction contract – failing to perform its obligations under the contract,

- expropriation of the contractor’s plant, equipment and/or materials, or the entire project.

9 Amco Asia Corporation & others v Republic of Indonesia (Jurisdiction) ICSID Case No ARB/81/1

(ICSID, 1983, Goldman P, Foighel & Rubin). 10 Vanessa Ventures Ltd v Bolivarian Republic of Venezuela ICSID Case No ARB(AF)/04/6 (ICSID,

2013, Lowe P, Brower & Stern). 11 ADC Affiliate Limited and ADC & ADMC Management Limited v Republic of Hungary ICSID

Case No ARB/03/16 (ICSID, 2006, Kaplan P, Brower & Van Den Berg). 12 MTD Equity Sdn Bhd & anor v Republic of Chile ICSID Case No ARB/01/7 (ICSID, 2004, Sureda

P, Lalonde & Oreamuno Blanco). 13 Waguih Elie George Siag and Clorinda Vecchi v Arab Republic of Egypt (Jurisdiction) ICSID

Case No ARB/05/15 (ICSID, 2009, Williams P, Orrego Vicuna & Pryles). 14 Jan de Nul NVop.cit. 15 Metalclad Corporation v United Mexican States op. cit. 16 Salini Costruttori S.P.A.& Italstrade S.P.A. v. Kingdom of Morocco op.cit; Bayindir Insaat Turizm

Ticaret Ve Sanayi AS v Islamic Republic of Pakistan (Jurisdiction) ICSID Case No ARB/03/29 (ICSID, 2005, Kaufmann-Kohler P, Berman & Böckstiegel); Pantechniki S.A. Contractors & Engineers (Greece) v The Republic of Albania.


The protections typically available to a qualifying investor are set out below.

The right to receive ‘fair and equitable treatment’ from the host state

One of the primary protections afforded to qualifying investors is the entitlement to receive ‘fair and equitable’ treatment from the host state. The host state need not be the Employer under the construction contract in order for the contractor to invoke this protection. For example, a contractor who is thwarted in enforcing its contractual rights in the host state’s courts through a so-called ‘denial of justice’ may be able to invoke this protection. Likewise, a contractor who is denied essential building permits for arbitrary reasons or in a manner inconsistent with the contractor’s legitimate expectations based on assurances and/or prior experience, may be able to claim that it was not receiving ‘fair and equitable treatment’.

The case of MTD v Chile concerned an investment by Malaysian investors to develop real estate in Chile.17 The Chilean Foreign Investment Commission (FIC) approved the investment, despite it being against the Chilean government’s urban policy. After expending considerable sums buying land and developing the proposal, the investors were refused the necessary permit to begin construction. The Tribunal found that FIC’s approval of an investment against government policy constituted unfair treatment under the relevant treaty.

In Metalclad v Mexico, a US investor was denied a municipal construction permit to develop and operate a hazardous waste transfer station and landfill in Mexico after it had received assurances from federal officials that its existing federal and state permits allowed for the construction. In addition, the local government issued an Ecological Decree creating an ecological reserve over the site barring the operations permanently.18 The Tribunal found that the lack of transparency regarding the relevant legal requirements and the municipality’s failure to arrive at its decision to deny the permit in an orderly and timely manner constituted unfair treatment.

Protection from expropriation of the investment

Qualifying investors will normally receive protection from expropriation of the investment or measures tantamount to expropriation, except under specified conditions and with payment of prompt, adequate and effective compensation by the host state. The expropriation may be partial (for example, expropriation of the 17 MTD Equity Sdn Bhd & anor v Republic of Chile op.cit. 18 Op.cit.


contractor’s equipment, plant and/or materials) or the entire investment may be expropriated. The expropriation may also be direct (for example, by way of nationalisation) or indirect (for example, by cancelling a licence and thus depriving the investor of the use and enjoyment of its investment).

Metalclad v Mexico is also an example of expropriation with the tribunal finding that issuing the Ecological Decree barring the development permanently constituted expropriation.19

Another example is ADC v Hungary.20 ADC had been awarded contracts to renovate, construct and operate terminals at Budapest airport. Several years into the project, the government legislated to change the legal and regulatory regime applicable to the airport, and ADC’s contracts were voided. The Tribunal held this to be an unlawful expropriation as it was neither in the public interest nor accompanied by adequate compensation.

The right to receive full protection and security for the investment

Many investment laws and treaties provide that the qualifying investor is entitled to have their investment protected from physical damage. The host state may be liable if the investment is damaged through the actions of the host state, or by the host state’s failure to take appropriate measures to prevent damage being caused by others.

Tribunals are generally slow to impose a strict liability on the host state, or to be overly prescriptive as to the level of protection required to be provided by the host state. Further, a claimant in an investor-state arbitration is under the same duty to mitigate loss as a claimant in a traditional commercial arbitration. As such, an international contractor should maintain their own security for the construction site, and not assume that the host state’s obligation to provide ‘full protection and security’ requires the host state to provide site security for the works.

In AAPL v Sri Lanka a Hong Kong company had invested in a shrimp farm in Sri Lanka.21 The farm was subsequently destroyed and a number of employees were killed by Sri Lankan security forces operating against rebel forces. The Tribunal

19 Ibid. 20 ADC Affiliate Limited and ADC & ADMC Management Limited v Republic of Hungary op.cit. 21 Asian Agricultural Products Ltd (AAPL) v Republic of Sri Lanka ICSID Case No ARB/87/3

(ICSID, 1990, El-Kosheri P. Asante & Goldman)


found that Sri Lanka had failed to provide the required protection to the investor and its employees.

The investor in AMT v Zaire, a US company, suffered losses as a result of looting and destruction of industrial and commercial complexes by Zairian soldiers.22 The Tribunal found that the government had failed to provide full protection and security to the investment.

Protection from discrimination

This protection typically has two elements.

• Firstly, the right to receive the same treatment as domestic investors of the host state (the concept of ‘national treatment’).

• Second, the right to receive the same treatment as foreign investors from other states, notwithstanding that the host state may have agreed more favourable protections for investors from that other state (the ‘most favoured nation’ or MFN treatment).

Returning to MTD v Chile, in that case the Malaysian investor was able to invoke the MFN provision in the Chile – Malaysia BIT and rely on more favourable provisions in Danish and Croatian BITs.23

Free transfer of investments and returns

A further protection commonly available to qualifying investors is the ability freely to transfer investments to others and to repatriate returns generated by investment to the investors’ ‘home’ jurisdiction. These protections have become of increased interest to contractors in the current economic climate, with a number of countries introducing or threatening to introduce currency controls and/or unable to pay international contractors in foreign currency given the global economic crisis.24

22 American Manufacturing and Trading Inc v Republic of Zaire ICSID Case No ARB/93/1 (ICSID,

1997, Sucharitkul P, Golsong & Mbaye). 23 MTD Equity Sdn Bhd & anor v Republic of Chile op. cit. 24 However, some regimes exempt measures taken in response to economic crisis.


COMMENCING AN INVESTOR-STATE ARBITRATION

The applicable treaty will set out the procedure an investor needs to follow to bring a claim. Typical provisions include:

• Cooling-off period

Many investment treaties specify a period (usually 3-12 months) during which claims cannot be brought pending settlement attempts. The investor typically starts the negotiation period by sending a ‘trigger letter’ to the central authorities of the host state, summarising the dispute and requesting negotiation. Upon expiry of the period without settlement, the investor is free to commence arbitration.25

• Exhaustion of local remedies

Some treaties require the investor to have presented its claim to the courts of the host state before proceeding to arbitration. The investor is entitled to commence arbitration only if the domestic court does not issue a decision within a specified period of time.

• ‘Fork in the road’ provisions

Investment treaties often present the investor with a series of options for pursuing its claim after the cooling-off period has expired. These most commonly include ICSID arbitration, ad hoc arbitration, references to the ICC and sometimes the domestic courts of the host state. ‘Fork in the road’ provisions stipulate that once an investor chooses a particular procedure, he is prevented from electing any of the others potentially available.

THE ROLE OF ICSID IN INVESTOR-STATE ARBITRATION

The Convention on the Settlement of Investment Disputes between States and Nationals of Other States (the ICSID Convention) provides a neutral forum for the

25 Non-compliance with a cooling-off period will not necessarily preclude a tribunal from hearing a

claim, for example, in circumstances where negotiation is obviously futile. See for example Biwater Gauff (Tanzania) Limited v United Republic of Tanzania ICSID Case No. ARB/05/22 (ICSID, 2008, Hanotiau P, Born & Landau).


resolution of investor-state arbitrations pursuant to the Arbitration Rules of the International Centre for Settlement of Investment Disputes (ICSID).26

Parties may consent to ICSID arbitration in their contract, or the host state may have specified ICSID arbitration in the investment promotion law and/or investment treaties.

As of writing more than 250 disputes referred to ICSID have been determined, with a further 160+ disputes pending. The majority of decisions (both preliminary and final) from ICSID arbitrations are published by ICSID on the internet. 27

26 While other forums are available, ICSID remains the most commonly used forum for resolution of

investor-state arbitrations. For example, the Energy Charter Treaty provides for investors to choose between ICSID, the Stockholm Chamber of Commerce or arbitration pursuant to the UNCITRAL Arbitration Rules.

27 http:icsid.worldbank.org

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CONSTRUCTION LAW SUMMER SCHOOL 2014Investment treaty protections – the basics

Jane Davies Evans1 September 2014

INTERNATIONAL CONTRACTINGINVESTOR PROTECTIONS – THE BASICS

• Basic scenario• Contractor from State A decides to undertake work in State B • What rights does the Contractor have against State B (the ‘host’ state) if it loses money on this venture?

• If purely a contractual loss → unlikely to have a remedy unless State B is the Employer• But in some instances the loss will be protected under an investor protection regime → Contractor may have a route

to recovery under public international law

• The basic requirements for enforceable investor protections 1. An investor protection regime 2. A qualifying investor3. A qualifying investment4. A violation of the protections afforded by the regime

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The basic requirements for investor protection (1) – an investor protection regime

• Local investor protection law

• International treaties (most common)• Bilateral treaty = BIT• Multilateral treaty = MIT• Approx. 2600 BITs / MITs in force currently

• How to find if there is an investor protection regime?• Website of the ‘host’ state Ministry of Foreign Affairs (or equivalent)• Check the World Bank / ICSID (International Centre for the Settlement of Investment Disputes) websites• Check with the Ministry of Foreign Affairs (or equivalent) of the ‘home’ state• Unless strategically inadvisable, check with the Ministry of Foreign Affairs, AG Chambers and/or embassy

(treaty department) of the ‘host’ state in the ‘home’ state


• Two or more States enter into international treaty to encourage investment

• Each State promises to give investors from the other State certain protections if they invest in their country

• Treaty provides for investor to claim against the Host State in arbitration if these protections are violated

State A State BTREATY

Investor from State A State B

‘Host State’ARBITRATION

Investor from State A

State B ‘Host State’

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The basic requirements for investor protection (2) – a qualifying investor • Key criteria – Nationality and Citizenship

• Natural persons• Typically required to have nationality or be a citizen of one of the contracting States• Joint nationals/citizens are often excluded• May be required to be resident in the contracting State• Whether or not a national/citizen/resident normally determined (in first instance at least) by the

‘home’ State law

• Legal persons – relevant criteria• Where the investor is constituted or incorporated• Where the entity is controlled• Where the seat of the management of the entity is located• May require ‘business activities’ or ‘substantial economic activities’ in the ‘home’ State• Most treaties recognise the need for a Contractor to operate via an entity incorporated in the ‘host’ State

and will not exclude remedies on this basis alone


The basic requirements for investor protection (3) – a qualifying investment

• Often broadly defined (no definition in ICSID Convention)

• Cases rely heavily on case law

• Widely accepted indicators of investment• The investment should continue over an appropriate duration• The investment should be capable of generating a profit or other return for the investor• The investor should assume an element of risk• The investment should involve a substantial commitment on the part of the investor• The investment should contribute to the economic development of the host state

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The basic requirements for investor protection (3) – a qualifying investment

• Examples• The construction and operation of a hotel• A concession for the mining of metals and minerals• The renovation, construction and operation of airport terminals• A real estate development including construction of residential accommodation social and

commercial infrastructure• The development of a tourist resort• Dredging operations• The development of a hazardous waste landfill facility• The design and construction of public roads


The basic requirements for investor protection (4) – typical protections and violations

Typical protections• No expropriation without full compensation• “Fair and equitable” treatment (legislative stability)• Full protection and security• No discrimination (most favored nation (MFN) and/or national treatment)

Typical violations• Host State government interferes with performance of the contract• Host State breaches its contract with you• Host State expropriates investment in its entirety• Host State adopts taxes or regulations (including currency control) that significantly affect

your investment or undermine your legitimate expectations as an investor

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Investment structuring

Structuring investments to take advantage of protections that would not otherwise be available to you

State A State BTREATYInvestor from State X

Structures investment via State A subsidiary

Benefits from protections in treaty between State A and State B


Documents

CONSTRUCTION LAW SUMMER SCHOOL 2014 International contracting · CONSTRUCTION LAW SUMMER SCHOOL 2014 International contracting ... • Prohibition against penalties (as opposed to