Belt and road deals conjure up legal risks for China’s lenders

Some emerging market nations along the route of Beijing’s trade initiative may not be used to abiding by contractual terms, analysts say

PUBLISHED : Saturday, 13 May, 2017, 2:01pm
UPDATED : Saturday, 13 May, 2017, 2:01pm

Increasing infrastructure construction in emerging markets along the route of Beijing’s Belt and Road Initiative will lead to heightened legal risks in project financing and execution, according to a dispute resolution expert.

Some emerging market nations and their state-related entities may not be used to abiding by contractual terms in their commercial dealings, and may see a claim of “sovereign immunity” as justifiable when faced with legal proceedings.

“For some of these governments and their related entities, it may be the first time that they are entering into significant foreign-funded project,” said Paul Teo, a partner and head of arbitration for Greater China at international law firm Baker McKenzie.

“They may be unfamiliar with the structure and operation of the contractual terms, and they may not be comfortable dealing in such a contractual setting,” said Teo, who also advises companies on the avoidance and resolution of cross-border disputes.

They may be unfamiliar with the structure and operation of the contractual terms and they may not be comfortable dealing in such a contractual setting
Paul Teo, Baker McKenzie

China could invest US$313 billion to US$502 billion in the 62 nations in Central and South Asia, Africa and the Middle East – along the Silk Road Economic Belt and the 21st Century Maritime Silk Road – in the next five years, according to a Credit Suisse research report.

Most of the investment may go to infrastructure projects in India, Russia, Indonesia, Iran, Egypt, the Philippines and Pakistan.

As much of the funding will be provided by Chinese commercial and policy banks, including the China-led Asia Infrastructure Investment Bank , risks of project failure and how the lenders can protect themselves are increasing concerns.

Belt and Road projects offer huge opportunities, but also present sources of risk for Chinese banks

The report conceded that it would take time for China and the recipient countries to iron out details of how contracts should be structured to protect all parties’ interests.

But as geopolitics is at the core of the initiative, Teo pointed out that the Chinese parties may be persuaded to partially give in to the demands of the emerging nations.

“Based on the current mood and practice, a lot of the large multilateral banks, even some of the private banks, may give deal facilitation more weight than strict insistence on the full suite of contractual rights and remedies to address scenarios of default,” he said.

Increasingly, it is common for the parties to stipulate in contracts that certain pre-agreed and specific categories of assets belonging to the borrowing nations will be subject to “enforcement”, should the dispute go to arbitration or court against the nation borrower and their state-related entities.

Cash crunch on China’s new Silk Road

Teo said that given the popularity of international arbitration, many dispute parties end up agreeing to arbitration over litigation.

“This is where many problems can arise. If you do not word the dispute resolution clause properly in the contract, the whole provision could be found to be uncertain and unenforceable,” he cautioned.

“Without a clear jurisdiction clause, the process will be open-ended and risky. You could potentially find yourself having to answer a case before a local court in a developing jurisdiction where you cannot be sure if the proceedings will be transparent and fair,” Teo said.

When it comes to project execution, Teo said good project management and contract administration were key.

“They will help ensure that the project is completed on time, within budget and to satisfactory quality, while at the same time allowing legal claims and disputes to be resolved expeditiously.”

A scenario in which potential disputes can arise is when the project owner’s design is not spelled out in sufficient detail in the contract, resulting in delays and claims.

Cases of losses incurred by Chinese contractors due to project design alteration include the light-rail project in Mecca, on which China Railway Construction Corporation booked a 1.39 billion yuan loss in 2010 as costs ballooned 30 per cent after the Saudi Arabia government substantially increased its demands on the project.

Another is a pipeline-laying project by Sinopec Oilfield Service, which last year incurred a 3 billion yuan loss due to an “unexpected” change in design by the Saudi Arabian project owner. In March, Sinopec officials lamented that the process of seeking compensation was tougher than they had expected.