1. Introduction
The construction industry in New Zealand has always had a heavy reliance on international expertise, whether in engineering consultancies, major construction companies or the supply of advanced technical plant and equipment. This largely follows international trends, with the major difference in our relative isolation.
This has raised a number of challenges; not least in enforcement.
Under the traditional contract structure, the client provides the site, the design and pays for the work, and the contractor carries buildability risk, including the performance of all subcontractors and suppliers.
International involvement may be introduced at all levels, whether on the client side, through funding arrangements (project finance, equity stakes or public-private-partnerships); design-side, through international associations with local engineering consultancies; international or joint venture head contractors; or more traditionally through international supplies as subcontractors. Typically, the extent and style of involvement will depend on the project. For example, a power station development will typically see the international turbine supplier take on the head contractor role, subcontracting local supplies; conversely, a process based project (water or wastewater treatment) will have a local civils contractor, with international process design consultancy and overseas supplier of specialist equipment.
The decision on the contract structure will largely depend on the project risks. Projects with high technology or process risk, where the project has value only once the project is completed and engineering completion achieved, may favour a turnkey approach, where for other projects process risk may be low, the key risks being price, quality and delivery.
For the purposes of this paper, I will concentrate on more traditional risks inherent in international involvement in large infrastructure projects. For smaller projects, there may be international input, but this will typically be provided through local agents, where those risks are of less concern.
2. Roles of the parties
In the traditional contract structure outlined above, the roles and relationships of the parties are reasonably clear. The client contracts with the head contractor under a standard form of contract (NZS3910 or similar), and the head contractor controls the supply chain. All work is carried out locally.
Complications increase with the extent of involvement of internationally based consultants and suppliers, particularly if the client’s approach is for New Zealand law to apply and for all payments to be made on delivery to the site, and incorporation in to the works, in New Zealand currency. That approach will require the head contractor to fund all supplies.
The International Chamber of Commerce has endeavoured to fill this gap with its International Commercial Terms (Incoterms 2020), outlining the transfer of risk in international trade.
At each stage in the supply chain, responsibility for payment, insurance and transfer of ownership is covered from ex-works (EXW), through free-on-board (FOB) and cost-insurance-freight (CIF), to delivered-duty-paid (DDP). Each approach covers standard terms and conditions, and a reference to the relevant Incoterms acronym will often be enough.
More complex arrangements will be required where the international involvement concerns more than supplies to the local port.
In all cases, however, concerns will primarily be quality, price and timely delivery. At each stage the approaches to risk management will differ, depending on the particular project risks, and the risks associated with the international element.
3. Risks
Project risks should be of concern to all project participants. I assume for the purposes of this paper that competence and solvency are not an issue. If there are solvency issues on the part of any party, then the entire procurement structure may require reconsideration, with payments, possession and ownership being more tightly controlled.
Similarly, a number of risks may be inherent in the domicile of the overseas participant. If the rule of law, stable government, enforceability of the contract, alternative supplies or adoption of the UNCITRAL Model Law (with support of the local courts) are in doubt, then a more radical approach may be appropriate. Cultural differences may also be an issue, with common law countries holding to the sanctity of contract, but with civil law countries adopting a more interventionist approach, and some jurisdictions having only an emergent approach to the rule of law.
Regardless of the contract form adopted, the following risks typically arise:
Political – more of a risk in one-party States (or kleptocracies), the potential for government intervention can be a real issue. The first consideration (depending on cost) is to consider if there is an applicable Investor-State-Dispute-Settlement (ISDS) treaty in place. This would enable an investor company to take enforceable arbitral proceedings against the offending State. Enforcement can be an issue. A more pragmatic approach is to ensure that political intervention is a force majeure event under the head contract, and to then deal with alternative supplies if the need arises.
Foreign Exchange – in most cases, international suppliers will contract only in US dollars or Euro, where local clients will require local currency. The issue, then, is one of who hedges for FX, and when. For the purposes of tendering, foreign exchange fluctuations will usually be tagged, with the tenderer reserving the right to adjust the price on award. The mechanism for such adjustment is typically a wholesale buy rate, quoted by the supplier’s local banker.
Technology / process risk – technology tends to move at such a rate that suppliers will often contract for what they anticipate they will be able to deliver, rather than proven technology for a particular project. For example, contracting for a power station with an output, availability and efficiency which is not yet available; offering software solutions by adapting proprietary software to new use; proposing a combination of existing technology to novel extensive uses; or process technologies new to the proposed environment.
In each case, work-in-progress may have no value until completion, and there is no realistic opportunity for an alternative supplier to step-in. This situation is exacerbated by the owner being committed to the supplier’s technology, with downstream commitment to servicing costs and future pricing.
Solutions may vary from contracting only for a pilot plant to prove the technology, with a staged roll-out; two stages of completion, with engineering completion at take-over (bringing exposure to liquidated damages to an end), followed by tests after completion for output, reliability, availability and efficiency (with performance related liquidated damages for each).
Supply chain – this probably relates more to the adopted contract structure. While there are benefits to a single point of responsibility, often there is little to be gained in imposing supply items where the head contractor has little of value to contribute.
Quality – monitoring quality issues can be problematic, with many suppliers refusing entry. In such situations, quality control documentation may be of little value. Ultimately, there is no substitute for local observation of offshore fabrication.
Default – the separation of payment from possession of properly fabricated supply items is exacerbated by offshore supplies. There is no protection from local legislation, and other legal enforcement may also be problematic. The provision of bonds, holding retentions, control over payment certifications and comprehensive insurance and shipping arrangements will go a long way to managing such risks.
Dispute – the seat of any arbitration will be critical. Arbitrating locally may have appeal, and is certainly preferrable to doing so in a non-Model Law jurisdiction, but enforcement can be an issue. The combination of arbitrating in a jurisdiction where the overseas party has a significant place of business can be useful, provided that jurisdiction has adopted the UNCITRAL Model Law on Commercial Arbitration and has acceded to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. A court decision is generally of little benefit if enforcement is required outside of the jurisdiction of the court.
4. Contract structures
The role of the international contractor/supplier will depend on the nature of the project, and the extent of that party’s involvement.
For high technology risk projects, like power stations, the overseas party will typically take a head contractor role, subcontracting civil works and the like to local contractors.
Where there is a mix civil work and technology risk, for example major tunnelling projects, a joint venture approach is more appropriate. As between the client and the joint venture contractor, liability is joint and several – ie, the client may take action against either or both of the joint venture parties, for the full amount of its losses. As between the joint venture parties, typically there will be an agreement in place to cover tendering, tendering costs and allocations of responsibility as between them. Such arrangements will not be effective in limiting liability of each individual party to the client.
For projects with more limited overseas involvement, a subcontract arrangement will be appropriate. Two issues will typically arise – the first, the ability of the head contractor to cover head contract risks with the subcontract; and second, the owner having direct rights against the subcontractor.
For local clients contracting with a local head contractor, there can be a tendency to impose a local contract (for example, NZS3910 with significant amendments) with no consideration for overseas supplies. In most cases, international supplies are inherent in the project (lifts, significant steel supplies, complex plant), and contracting on the basis of local supplies is simply unrealistic (payment only on incorporation into the permanent works at the site).
In all such cases, a realistic structure, taking into account the commercial terms of international suppliers is essential. There is no shortage of high quality international supply contracts, developed and accepted internationally over a number of years.
5. Allocations of risk
In 1973, Irish construction lawyer Max Abrahamson developed the principle that risk should be allocated to the party best able to manage it.
For international supplies, there is often an accepted approach to allocation of risk which reflects developed principles, as shown by way of example in the Incoterms 2020. Departure from those accepted approaches will incur cost, and potential conflict, to no real benefit.
The starting point for risk must be risk inherent in the project, followed by the client’s approach to risk and rounded out by risks specific to the contractor/supply chain. Simply adopting a standard form contract, or a standard approach to risk, will rarely be effective.
Managing risk effectively requires an identification of risk, reduction of project uncertainties, development of a risk matrix (in the form of a risk register, identifying risk likelihood, severity and avoidance/reduction/management strategies). While the risk register may, regrettably, include “ownership”, this should not cut across the developed and negotiated allocation of risk in the contract.
6. Dispute Resolution
For international projects the only dispute resolution process is international arbitration.
Adjudication under the Construction Contracts Act 2002 is available, however when there is an international party, adjudication can only be undertaken with the consent of the international party (see section 25(3)).
Where an arbitration is an international arbitration, as defined in article 1 of Schedule 1 to the Arbitration Act 1996, then the provisions of Schedule 2 to the Act (covering issues like consolidation of arbitral proceedings, powers of the arbitral tribunal, appeals on questions of law and costs of arbitration), only apply if explicitly agreed (opt-in), as opposed to the default position (opt-out).
7. Remedies
In most cases, remedies should be available locally.
This will generally result in bonds for offshore payment, collateral warranties and, in extreme cases, the assignment of intellectual property rights to enable the client to procure alternative rectification of defects and the supplies of spares in the event of contractor default.
Where the international supply is under a subcontract, all remedies should be supported by direct collateral agreement between the subcontractor and the client.
8. Solutions
International supplies are increasingly common, with increased complexity and cost of infrastructure projects.
International experience, and international surveys, have established that a top-down approach to procurement, without regard to the practicalities of international involvement, is unlikely to result in successful project outcomes.
Adapting and negotiating accepted international standard forms to reflect project risk, and acceptance by clients that with the benefits of international involvement comes a greater acceptance of project risk, is effectively the only realistic approach.
9. Conclusion
International involvement in major infrastructure projects, whether at a consultancy, head contractor or subcontractor/supplier level, is a fact of life in major projects. Such involvement brings with it complications which need to be assessed on a case by case basis.
The starting point is not the imposition by the client of an accepted international form of contract, and leaving the head contractor to sort out the complex interfaces and to manage the risks inherent in the selection of an international supply chain. Further investigation into project risks, and adapting the chosen procurement model to deal with those risks is essential to successful project delivery.