Introduction to International Construction Contracting Part II

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1 Introduction to International Construction Contracting Part II by John B. Tieder, Jr., Senior Partner Watt Tieder Newsletter, Spring 2009 More and more U.S. contractors are becoming active in projects outside the United States by way of merger and acquisition to recognition that international markets offer new opportunities for the U.S. contractor. In Part I of this article, the subjects were treaties and their application to the U.S. contractor abroad. In this Part II, the article turns to the Foreign Corrupt Practices Act, and other aspects of contracting to construct outside the United States. Foreign Corrupt Practices Act (FCPA) 15 U.S.C. 78dd-1, et seq. and Similar Conventions The United States Foreign Corrupt Practices Act (FCPA) 15 U.S.C. 78dd-1, et seq. prohibits United States companies from bribing foreign officials to obtain a contract or other commercial advantage. It also requires certain accounting and reporting standards. It allows qui tam actions, i.e., a person who believes there has been a violation of the FCPA can initiate an action regardless of whether the United States Department of Justice is interested in pursuing the matter. For some period the United States was the only country which seriously enforced its antibribery laws. In the last decade, however, there have been several anti-corruption initiatives such as, The United Nations Convention Against Corruption, Organization for Economic Cooperation and Development (OECD) Corruption Initiative, and the International Chamber of Commerce (ICC) Anti-Corruption Initiative. These conventions and initiatives are in various stages of implementation. At this stage, a United States contractor s primary concern is still the FCPA. The prohibitions of the FCPA are quite instinctive and compliance is not difficult. A possible area of confusion is grease payments. There are payments for the performance of nondiscretionary administrative actions, e.g., releasing shipments from customs, and are not prohibited. If faced with this circumstance, it is best to obtain specific legal advice. Agents In order to work in a new country, a contractor must have a local representative someone who is responsible for assuring that there is compliance with all local laws and regulations. This is typically an agent. An agent is often paid a percentage of the contract value, e.g., 5%-10%. 1

2 The process of paying an agent often seems inappropriate, and perhaps worse, to a contractor. There is, however, nothing inherently improper with the use of an agent; indeed they are necessary. The agent s duties should be set forth in an agreement and specifically provide that the agent will comply with all applicable national and international laws, and the FCPA, see paragraph 3 above, in particular Civil Law System The United States, with the partial exception of the State of Louisiana, is a common law country. The significance is that in common law jurisdictions precedent, i.e., prior court decisions, establish binding law in particular situations. This provides some comfort in contract preparation. Worldwide, the common law system is in the minority. Other than the United States., the major common law countries are Canada, except the province of Quebec, England, Wales and Northern Ireland (not Scotland), Republic of Ireland, Australia, New Zealand, Malaysia, and significantly, India. The majority of the rest of the world follows the civil law system. In summary, civil law provides general principles which are applied in each case without the benefit of precedent. In almost all civil law countries, there are particular provisions dealing with construction (works) contracts; in some countries, the general principles are supplemented by detailed regulations and required contract terms. See for example the article in this edition of, Building Solutions, entitled, Introduction to German Construction Law. The lack of precedent, however, is a shock to those who are used to common law principles. One provision of virtually every civil law country is the decennial (10 year) structural warranty. It is absolute and cannot be waived or reduced. It is, in effect, strict liability for structural defects for 10 years. Choice-of-Law Provision As with domestic contracts, the parties can select the substantive law applicable to the contract. If the parties do not select the applicable law, the decision will be made in accordance with conflicts-of-law principles. This can be a time-consuming and expensive process with a result that may not be satisfactory to either party; thus it is important to set forth the choice-of-law in the contract. When dealing with a private foreign entity, the parties have a great deal of flexibility in choosing the applicable law. When, however, one of the parties is a public entity, the public entity may be restricted to its own domestic law. In either situation, if there is a mandatory provision of local law, it cannot be superseded by the party s choice-of-law on the particular mandatory point. This seldom happens on construction contracts. 2

3 It is recommended that the law chosen be a well understood system. The most popular choices are the laws of England, New York State of the United States or Switzerland. A growing trend is to have the applicable law be, general principles of international contract law, such as is set forth in the, UNIDROIT Principles of International Commercial Contracts. This is, however, too uncertain for the first time international contractor. Forms of Contract There is a well established set of contract documents designed specifically for international construction. These are the Fédération Internationale Des Ingénieurs- Conseils (FIDIC) documents. The first edition was drafted in There is now an entire family of such documents. The current editions are as follows: Conditions of Contract for Works of Civil Engineering Construction, 4 th edition (FIDIC) Conditions of Subcontract for Works of Civil Engineering Construction (FIDIC) Conditions of Contract for Electrical and Mechanical Works (FIDIC) Conditions of Contract for Electrical and Mechanical Works 3 rd Ed Supplement (FIDIC) Client/Consultant Model Services Agreement, 4 th Edition (FIDIC) Conditions of Contract for Design-Build and Turnkey 9FIRIDIC) Conditions of Contract for EPC Turnkey Projects (FIDIC) Conditions of Contract for Plant and Design-Build for Electrical & Mechanical Plant (FIDIC) Conditions of Contract for Design Build and Operate Projects (FIDIC) Form of Contract for Dredging and Reclamation Works (FIDIC) Short Form of Contract (FIDIC) Joint Venture (Consortium) Agreement (FIDIC) Sub-consultancy Agreement (FIDIC) These forms deal with issues which are not typical in domestic construction, e.g., currency fluctuations, allocation of risks not normally encountered in domestic construction such as war and revolution, changes in laws and legislation, and repatriation of the contract proceeds. They also have the benefit of wide use and are thus known to the industry and to arbitrators who may be called upon to decide disputes. Copies may be obtained from the FIDIC website: 3

4 There are several other contract forms designed for international use, e.g., New Engineering Contract (NEC), The Engineering Advancement Association of Japan (ENAA), and the English Joint Contracts Tribunal (JCT). The FIDIC forms are, however, the predominant ones. It is not necessary to use the FIDIC or any other form of international contract. The parties are free to use their regular domestic forms of contract with the necessary modifications to account for international usage. It is recommended, however, that the FIDIC forms be reviewed and used as a check list to assure that all key points have been addressed. Payment Terms/Currency of Payment As with domestic contracts, a contractor wants to assure that its periodic progress payments stay ahead of its costs. It is particularly important on international contracts where ready access to a viable legal system may not be available and mechanics liens are unknown. In this regard, significant advance payments secured by an advance payment bond are in common usage. The contractor should try to obtain as significant an advance payment as possible, although 10% of the contract price is probably the maximum obtainable at this time. On the other hand, payment of the last 10% of the contract value has always been notoriously slow and some contractors plan their contracts assuming this amount will never be received. A related concern is the currency of payment. A contractor must determine the currency(ies) in which its costs will be incurred and provide for at least some payment in that currency(ies). A rapid change in the exchange rate such as occurred in the summer of 2008 between the United States Dollar and the Euro can be financially devastating. It is also recommended and fairly typical to purchase a hedge contract providing a fixed exchange rate. Finally, all payments which are not used in the country where the project is located should be payable outside the country. Some countries rather abruptly enact legislation restricting the expatriation of funds. Liquidated Damages/Penalties United States contractors are very familiar with the concept of liquidated damages. They are common in all types of construction contracts for delayed performance and in many power and process contracts for shortfalls in performance. In summary, a liquidated damages amount is an estimate of the loss that the other party to the contract, usually the owner, may incur if the project is delayed or, in the case of power and process contracts, 4

5 if there is a performance shortfall. Its legal underpinning is that it is a bona fide estimate made at the time of contracting of the loss that will be incurred. A liquidated damages provision cannot be a, penalty, to enforce performance. Most civil law systems, as well as Shari (Islamic law) recognize the concept of a penalty for non-performance. Thus penalty provisions are typically included in civil law construction contracts. The difference between liquidated damages and penalties from a practical view is that a penalty cannot be challenged because it was not a genuine estimate of the loss excepted at the time of contracting. It is possible, however, for a civil law judge, or arbitrator, applying civil law, to reduce the amount of the penalty if it is determined that the actual loss incurred is significantly less than the penalty amount. On the other hand, if the actual loss is significantly greater and there is some element of intent or bad faith in the contractor s actions, the penalty amount can be increased. This would not happen with liquidated damages. Intellectual Property As set forth in paragraph 2 above, there are a number of treaties governing international projects, including several dealing with the protection of Intellectual Property (IP), i.e., patents, trademarks, copyrights and trade secrets. Thus, a contractor or perhaps more significantly, engineering concerns or suppliers with a process or a product on which they hold a patent, should first determine if the country to which they are delivering that process or product is a signatory to a treaty which will honor their IP rights. Even if there is such protection, the contract should include a provision making the other contracting party financially responsible for the use of the contractor s IP beyond that specified in the Contract. Letters-of-Credit as Performance Security Performance bonds are rarely used on foreign projects. International performance security is typically in the forum of an unconditional letter of credit equal to 10% of the contract value. Unconditional means that the Employer (Owner) can call it without providing any reasons or justification. Most contractors attempt to change the unconditional Letter of Credit to a conditional one, i.e., only make it callable if specific events have occurred such as an unexcused passing of the contract completion date. These attempts, however, are rarely successful and the contractor must live with the reality of an unconditional letter of credit outstanding until at least final acceptance of the project and often expiration of the warranty/defects liability period. 5

6 Disputes Resolution On international projects, the primary means of disputes resolution is arbitration, preferably in a neutral country and not the country where the project is located. Many contracts provide for structured negotiations, mediation and disputes review boards (DRB s). All these approaches are useful and occasionally lead to resolution; however, a contractor needs the assurance that the ultimate resolution of its disputes will be by a neutral arbitrator or panel of arbitrators which can carry out is procedures free from local court interference. The only method of disputes resolution that provides impartiality without local court interference is international arbitration in a neutral (i.e., neither of the contracting parties residence) country. It is recommended that an experienced administrative body such as the International Chamber of Commerce (ICC) or London Court of International Arbitration (LCIA) administer the arbitration. They have experience in vetting and appointing arbitrators, reviewing awards to maximize their potential for enforcement, and assisting in the enforcement process. Investment Insurance Many countries provide their exporters with Government-funded insurance in cases of non-payment, expropriation, and other events which are generally not commercially insurable. In the United States, it is the Overseas Private Investment Corporation (OPIC). OPIC provides a variety of services which are described in the, OPIC Handbook and its website, The most significant is its insurance program for currency inconvertibility, expropriation, and political violence. There is also stand-alone terrorism insurance. OPIC provides coverage for commercial risks such as the improper calling of irrevocable letters of credit or guarantees and the non-payment of arbitration awards. In order to qualify for OPIC insurance, an investor must register its interest with OPIC before it commits to a particular project. There is no charge for such registration. Conclusion The above, of course, is just the basics of international contracting. Each project and country has its unique aspects, especially its local laws, but the above covers the major areas of difference from contracting for construction in the United States. 6

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