ARTICLE
January 26, 2018

Construction Arbitration Two Ways

- By: Erin Miller Rankin, Nicholas Lingard,
Sarah-Jane Fick and Monika Hlavkova

Editorial Note

This article is a continuation from a presentation, Construction Arbitration Two Ways: Practical and Strategic Consideration for Managing Construction-related Contract and Treaty Arbitration which was held 20^th February 2017.

Introduction

In this article, we take a look at construction disputes and the different ways arbitration can help protect contractors’ rights. We offer some basic tips on how to minimise the chances of a dispute arising during the life of a project, how to run a successful construction case, and what to think about when investing in construction projects abroad.

Arbitration is well suited to the resolution of construction disputes. The combination of high-stakes projects, complex technical issues and specialised construction law concepts drives a need for flexibility, confidentiality and input from individuals with industry-specific expertise when resolving construction disputes.

The Kuala Lumpur Regional Centre for Arbitration (KLRCA) recently reported that 61% of its 2016 case load pertained to construction industry disputes.[1] As South East Asian projects commenced before the global financial crisis now approach completion, it is inevitable that the strength of the construction disputes market in Malaysia and the broader region will continue to grow.

Common reasons that disputes arise in construction projects 

Contentious issues arising throughout the life of a project easily can escalate into formal dispute proceedings (including arbitration). Some common issues, together with tips on how to address them, are discussed below:

• Failing to follow the contract. Many employers use versions of standard form contracts that have been amended to reflect previous project requirements. Taking the time to train site staff in the specific nuances of the governing agreement before mobilising to site will save significant headaches when site relationships become stressed.
• Over-optimistic schedules and unrealistically low profit margins at the outset. Squeezing a contractor to assume excess risk at bid stage may be a short term win for the project owner, but may result in receipt of an incomplete or defective project and years of expensive arbitration proceedings. Contractors should present realistic bids, and take a pragmatic approach to negotiating at tender-stage. Equally, owners need to be realistic in their expectations having regard to their priorities in terms of time, cost and quality.
• Failing to submit the requisite notice. In many jurisdictions, provisions relating to notice are considered prerequisites to asserting claims. To avoid missing contractual deadlines that could defeat claims, ensure commercial teams are well informed about issues arising on-site and diarise potential expiry dates for notification.
• Asserting poorly substantiated, inflated claims. Unmeritorious claims weaken relationships, damage credibility and are unlikely to be persuasive. Continuing to pursue claims that have been rejected by a project owner or engineer on objectively reasonable grounds is not only likely to damage the parties’ commercial relationship, but may also be viewed dimly by an arbitral tribunal.
• Implementing variations before time and costs are agreed. Standard form construction contracts contain sophisticated mechanisms for instructing, completing and claiming payment for variations to the original contract scope. These provisions should be strictly complied with, and contractors should avoid prioritising completion of the project (including variations), over compliance with the contract should they wish to prevail in claiming either time or money.
• Failing to mitigate delays and disruption. Making genuine efforts to mitigate delays and disruption on site must be balanced against competing obligations to subcontractors and suppliers (eg, payment obligations to subcontractors and suppliers must be complied with if the different agreements do not contain ‘pay when paid’ provisions). An open channel of communication with a head contractor’s supply chain is crucial to spotting issues early and holding frank negotiations to fairly and effectively resolve commercial problems. 

Precisely because it is difficult to predict how and when a dispute will arise, ensuring that project records are maintained (including site diaries and internal notes of phone calls and conversations on site) is a matter of best practice. Issues of legal advice privilege should also be considered where in-house and external counsel are providing advice on sensitive issues relating to a project facing a potential dispute. Accurate and comprehensive documentary records are key to providing a tribunal with relevant evidence necessary to ensure a party has met its burden of proof. As a matter of arbitral practice and/or a function of institutional rules,[2] a party bears the burden of establishing its factual allegations. 

Two ways to arbitrate

Arbitration is a consensual process, and a tribunal’s jurisdiction to hear and determine a dispute flows from the parties’ agreement to arbitrate.

Such an agreement typically is incorporated into the parties’ commercial contract (for instance, Clause 20.6 of the 1999 edition FIDIC Red Book) although in some cases it can also be the subject of an ad hoc agreement between the parties to submit a dispute to arbitration.

In addition, many States, including Malaysia, have entered into bilateral and multilateral treaties that contain the Contracting States’ agreement to arbitrate disputes with investors from the other Contracting State(s) who allege that State conduct has breached the investment protection standards set out in the relevant treaty. In the words of one leading arbitrator, such agreements constitute “arbitration without privity”.[3] In other words, the Contracting States have made an offer to arbitrate disputes in the relevant treaty and that offer is then accepted and an agreement to arbitrate perfected by a qualifying investor initiating a dispute in accordance with the terms of the dispute resolution provision in the treaty.

Contract and treaty arbitrations are not necessarily mutually exclusive—a contractor may be able to pursue both in parallel. However, the contractor should always consider how provisions of the treaty (such as “fork-in-the-road clauses”), the underlying contract, and other rules of international law affect the choice of forum. In some cases, bringing a domestic court claim or pursuing a contract-based arbitration could foreclose the road to investment arbitration under a treaty, and vice versa.

Commercial Arbitration

As noted above, an arbitration agreement usually is included in the dispute resolution provision of the parties’ overarching construction contract, although the parties are free to agree in writing to arbitrate a dispute at any time. Of course, reaching an agreement to arbitrate after a dispute has arisen can lead to very difficult negotiations. 

Under most national laws, including the Malaysian Arbitration Act 2005,[4] an arbitration agreement is a binding contract between the parties in its own right. Should the overarching construction contract be terminated or declared void, the arbitration clause contained within it will survive, and the parties would still be entitled to pursue arbitral  proceedings. As a result of this doctrine of severability, many disputes arise surrounding the validity and meaning of arbitration agreements.

Succeeding in construction arbitrations

Strategic use of fact witnesses, experts and technology can make or break a claim.

Fact witness evidence is introduced by a witness with personal knowledge who typically submits a written statement that stands as their primary evidence and then, if called, testifies at an arbitral hearing. Fact witnesses should have first-hand knowledge of the issues they speak to, and should limit their evidence to statements of fact, not opinions, arguments or personal assessments. To bolster credibility, the testimony of a fact witness is most effective when corroborated by relevant project documents. In addition to existing employees who could act as witnesses, consider ex-employees of your client or your client’s counterparty in the proceedings or employees of subcontractors who were involved in the issues in dispute at the relevant time.

Expert evidence is presented in the form of a report in which the expert offers his or her opinion on issues falling within the expert’s area of expertise. In construction arbitration, it is common to see expert reports on delay (including, for instance, critical path analyses), quantum (i.e., assessments of the quantification of claims) or specific technical engineering issues. Such witnesses are appointed as independent experts in a particular area; and they have a duty to the arbitral tribunal, not the party that appointed them. An expert’s report should offer unbiased views, usually underpinned by detailed analyses and examples. In some cases, tribunals may order opposing experts addressing the same issue to present joint statements in proceedings or to provide oral evidence concurrently (colloquially known as ‘hot tubbing’).

As a result, it is critical to select an expert with genuine expertise in the subject-matter of his or her report, and who presents as objective and reasonable. Once a professional with the relevant expertise has been identified, detailed vetting of past appointments, published opinions and LinkedIn profiles can uncover hidden skeletons that could damage credibility in an arbitration. Personal attributes such as good communication skills, confidence and calmness under pressure are also beneficial. An expert with entrenched views who is easily irritated and unable to explain the basis for their opinions when challenged is unlikely to fare well under cross-examination.

Finding ways to present complex information simply is also key. Digitally simulating the knock-on effects of a delay event across site can be a powerful tool to breathe life into a conceptually difficult issue in dispute. Claims consultants are increasingly offering 3D modelling software for contentious engagements. As tribunals become more accustomed to the use of digital simulations in proceedings, we expect to see more clients embracing new technology where this can be used to strengthen a claim. 

Investment Treaty Arbitration

As we have mentioned above, in addition to the protections afforded by its contract, a contractor may also benefit from protection under a bilateral investment treaty (BIT) entered into between its State of nationality (State A) and the State where its construction project is located (State B), or multilateral treaties such as the 2009 ASEAN Comprehensive Investment Agreement. These treaties typically protect qualifying foreign investors against expropriation (subject to certain conditions), unfair and inequitable treatment, and other adverse conduct by a foreign State, and allow investors to bring claims in arbitration directly against that State for breaches of the treaty protections. Malaysia, for instance, is party to 50 active BITs and several free-trade agreements and multilateral treaties that contain investment protections.[5]

If a BIT exists between State A and State B, the contractor generally has two initial hurdles to pass: under the terms of the BIT, does the contractor qualify as an “investor”, and does it have an “investment”?

Under most BITs, the first question is relatively straightforward—as long as the contractor is a national of State A, it is likely to be able to bring a claim. For instance, the 1995 Malaysia-India BIT defines investor as “any national or company of a Contracting Party”.  

In construction disputes, the second question, on the other hand, can raise difficult legal and factual issues. BITs typically define the term “investment” broadly, to include “any kind of asset” owned or controlled by the contractor in State B, followed by a non-exhaustive list of tangible and intangible assets.[6] From a construction perspective, this type of wording is likely to cover real estate, plant and machinery, shares in a company (including shares held indirectly through subsidiaries), or a long-term contract. However, in some fora, in particular in arbitrations conducted under the Rules of the International Centre for Settlement of Investment Disputes (ICSID), certain additional “objective” criteria have to be met: a qualifying “investment” requires a contribution by the contractor, a certain duration, and an assumption of investment risk.[7]Accordingly, one-off transactions and simple sale and purchase agreements would not qualify under the ICSID test. Long-term constructions projects, such as Build-Operate-Transfer type arrangements, can, in principle, constitute an investment. Whether they do in each case is fact-specific, and will depend on the terms of the applicable BIT. 

Another common threshold question in investment disputes arising out of construction projects is that of attribution. That question is governed by international law, and in particular the International Law Commission’s Articles on Responsibility of States for Internationally Wrongful Acts. If a contractor fails to show that the relevant conduct is attributable to the State, its BIT claim will fail. Often, a contractor enters into a construction contract not with the Government directly, but with a State-owned company. For instance, in a December 2016 award, the Tribunal in Garanti Koza v Turkmenistan had to consider whether breaches by a State-owned highway operator of a contract for the planning and construction of 28 highway bridges in Turkmenistan, were attributable to Turkmenistan.[8] On the facts, it concluded that they were.  

The merits of an investment treaty claim are underpinned by the substantive protections granted in the BIT or the multilateral treaty. Such protection typically include: (a) a prohibition on expropriation without payment of compensation, which often covers both overt expropriations and also measures that have the effect of an expropriation; (b) a guarantee to afford investments fair and equitable treatment; (c) a guarantee of full protection and security that requires a host State to exercise due diligence to take reasonable measures to protect the investor’s investment, including from harm caused by third parties; (d) a guarantee that an investor is entitled freely to transfer funds into and out of the host State, including the returns on its investment; and (e) relative standards of protection against treatment that is less favourable than the treatment afforded to the host State’s own nationals or the investors of a third State who are in similar circumstances to the investor.

One protection which is particularly relevant in construction disputes is an observance of obligations or so-called “umbrella clause”. If a BIT contains an umbrella clause, an investor arguably is able to bring a claim under that BIT for breaches of a contract entered into with the State (e.g., a construction contract). Although such clauses are controversial and different tribunals have adopted different approaches to determining their proper scope and the requirements that must be met before a treaty claim can be brought, an umbrella clause, in essence, elevates a claim for breach of contract into an international law claim for breach of the relevant treaty. This can have several advantages, such as if the investor prefers international arbitration over bringing a contract claim in domestic courts.

Contractors that commit capital and technical expertise to construction projects abroad face an additional level of political risk, not normally associated with contracts between private parties investing within a single jurisdiction. In those circumstances, BITs and multilateral investment treaties provide valuable protection and a means for the contractor to bring a claim directly against a foreign State for adversely interfering with its investment. Contractors that are planning to invest abroad should therefore always consider the scope of the treaty protection available to them and, if appropriate, structure their investment so that they obtain the desired level of treaty coverage. For instance, a number of investors have chosen in the past to invest in Venezuela through a Dutch subsidiary in order to obtain the protection of the Netherlands-Venezuela BIT, which they considered provided a favourable level of investor protection.

Conclusion

There are a variety of steps, at many different stages of a project, that can minimize the likelihood of an expensive construction dispute. These range from the structuring of foreign investments in major projects, to carefully managing relationships on-site. Regardless, an understanding of the relative commercial and/or political interests invested in a project can be the key to unlocking the effective resolution of a brewing dispute.