INTRODUCTION
For an international construction contract, the large sums of money typically involved mean that financial risks for project participants and stakeholders are great and as such receive much attention. Although the responsibility for risk management largely falls to the project manager, legal solutions – best provided at the time of project development and subsequent contract formation are essential. Following is a highlight of some legal solutions to the key financial risks.
Payment
In any construction contract, cash flow is critically important to the solvency of a contractor who is constantly paying for materials, equipment and workers, as well as for the principal who is sourcing the funds from its business operations or, as is often the case, from a project financing agreement. To mitigate the risks associated with not being paid (for the contractor) or having illegitimate payment claims made (for the principal), it is essential to have robust legal terms which dictate the process to be followed.
In many common law jurisdictions, ‘security of payment’ legislation which assists in regulating payment claims by contractors via a statutory adjudication scheme for payment disputes is becoming more and more prevalent. These schemes have been successful in facilitating cash flow and have also reduced the likelihood of a payment matter ending in dispute which is costly for both parties.
For international projects outside of these jurisdictions, payment matters are left to the agreed terms of the construction contract. For standard form contracts commonly used on international projects such as those of FIDIC, the payment process clauses are fairly robust and straightforward. Such an example is found in the FIDIC Conditions of Contract for EPC/Turnkey Projects (Silver Book), in Clauses 14.1-14.15. If a bespoke contract is to be used, both parties would benefit from ensuring the payment terms are well thought through for the particular project.
Taxation
For construction principals and contractors operating internationally, taxation matters often demand dedicated project accountants to be employed to mitigate the risk of falling foul of the law. Changes in taxation law during a project and special taxation legislative treatment for large projects to attract investment are not uncommon. Particular taxation applied as a domestic industry protection mechanism is also common and needs to be carefully considered in deciding where to procure goods, services and equipment. Such mechanisms can lead to the splitting of a project into ‘onshore’ and ‘offshore’ contracts. Both principal and contractor need to consider this.
Various national and international reporting standards will need to be adhered to which are usually outlined in the laws of the project location in addition to those in which each company is registered. The accounting rules most commonly used for this are either the International Financial Reporting Standards (IFRS) or the US Generally Accepted Accounting Principles (US GAAP).
Insurance
Insurance is essential for any construction project but during the implementation of an international project, political risk insurance is something often considered – particularly in the developing and less democratic countries of the world. The types of risks covered include; politically motivated violence or war, expropriation of assets, repudiation of contracts, and business interruption. All project participants have an interest in purchasing appropriate political risk insurance to cover their particular loss as it would be difficult and unlikely to be recoverable via legal avenues under such scenarios.
Insolvency
Insolvency of parties on international construction projects (known as cross-border insolvency) presents creditors with significant obstacles to recover what they are owed, primarily due to the spread of assets and creditors across jurisdictions. With each country having its own local insolvency laws, proceedings for recovery are time consuming and costly. Fortunately, since 1997 there is a growing body framework of law in the form of the UNCITRAL Model Law on Cross-Border Insolvency, which provides a basis to encourage cooperation and coordination between jurisdictions. 23 jurisdictions have adopted the Model Law in some form. In the European Union, a similar framework has been in place since 2002 in the EC Regulation on Insolvency Proceedings 2000.
To best mitigate insolvency risk, parties would be best to have an understanding of the developing field of cross-border insolvency law, ensure that the transfer point of asset ownership is clear in contracts and where applicable, registered according to local laws such as the Personal Property Security Act 2009 (Cth) in Australia.
By: Kevin Pascoe
This article is based on my exam response in the Melbourne Law Masters in Construction Law subject ‘International Construction Law’ in August 2015.