Mark Roe and Gurmukh Riyat of Pinsent Masons look at the potential issues raised from construction contracts with states and state agencies and explore what steps contractors can take to protect themselves in the event that things go wrong:
"A good rule of thumb for a contractor entering into a construction contract with a state entity is 'test it backwards'. This means looking at enforcement issues first, before signing the contract and certainly before beginning to spend money on arbitration or other court proceedings."
The overwhelming majority of construction contracts for major projects are with states and state agencies. Despite this, surprisingly little attention is paid to the particular issues raised by such contracts and the steps that contractors can take to protect themselves in the event that things go wrong.
Perhaps the most significant issue is the ability of states to claim immunity in the face of court judgments and arbitral awards made against them. However, there are various steps that well-prepared contractors may be able to take to avoid falling into the trap of being drawn into a costly and lengthy arbitration, ultimately obtaining an award that cannot be enforced.
Am I contracting with a state?
On the face of it this seems like a simple question, and in many cases the answer will be obvious. A construction contract with a central government department, for example, is clearly a contract with an “entity of the state”. However, it is not difficult to come up with examples where the answer is less straightforward. For example, does an agreement with a company that is wholly or partly government-owned amount to a contract with the state?
Such cases will probably depend on whether the entity is exercising sovereign authority on behalf of the state, but in any case may well leave some room for argument. Given that the definition of “the state” may vary between jurisdictions, local legal advice is essential to establish the definitive legal position in any given location.
Why does it matter?
The reason why it is important to establish whether you are contracting with a state is because states may claim “state immunity” (sometimes called “sovereign immunity”) in the face of remedies arising from proceedings in which they are on the losing side.
Two levels of state immunity exist. First, at the jurisdictional level, state immunity means that a sovereign state cannot be compelled to submit to the jurisdiction of another state. A state entity may therefore claim immunity on the basis that it does not recognise the validity of the court in question. This is something states are perfectly entitled to do: they are not subject to the jurisdiction of other states, and immunity is the means by which this protection is conferred.
Secondly, at the enforcement level, a state entity may claim immunity in the face of a valid judgment from a domestic court or an award from an arbitral tribunal. Essentially, this amounts to a refusal to pay, or to comply with other terms of the award. Such action is generally open to states as a matter of national law, though naturally there are commercial and political pressures as well as legal factors that may influence a state’s willingness to rely on an immunity defence.
A further distinction can be observed between absolute and restrictive state immunity. States that claim absolute immunity use the doctrine to block enforcement against any assets of the state. Restrictive immunity, now widely recognised and in various cases codified in national legislation (including by the State Immunity Act 1978 in the UK), prevents enforcement against only those assets which are held for the purpose of being a state, such as embassies. State-owned assets that are held for commercial reasons (airlines being a good example) are less likely to be protected under the restrictive interpretation of sovereign immunity.
Look for assets elsewhere?
One way in which a contractor may circumvent the reluctance of a state entity to comply with a court or tribunal decision is to look for any assets that the entity holds in other jurisdictions. For example, property owned by a Polish state entity in London may be a more fruitful asset to pursue than property owned in Warsaw. In this case, it would be up to the claimant contractor to apply to the English courts to enforce the award, and the court would come to its own view as to the persuasiveness of any immunity defence raised.
Courts and legislators have, however, shown considerable respect for the doctrine of state immunity. Section 13 of the State Immunity Act 1978 provides that a certificate from the head of a state’s diplomatic mission is sufficient to establish that specific property is not being used for commercial purposes.
A lack of assets held outside the state in question can turn a major award into a worthless one, if the state entity is likely to claim absolute immunity. A case comes to mind in which a contractor obtained a $5 million arbitral award against the Rural Regeneration Agency of Uzbekistan. On the basis that the agency held no assets outside the jurisdiction, not only was the award worthless, but the client had spent a further approximately $1 million in tribunal costs and legal fees to obtain the award.
Bilateral investment treaties, which are discussed below, are a particularly useful means of enforcing awards in alternative jurisdictions where the employer may have assets.
One of the most prudent steps a contractor can take when contracting with a state entity is to seek a waiver of state immunity. If drafted properly, this will remove the state’s right to raise a defence of immunity.
The issue of state immunity at the jurisdictional level can be addressed by using an arbitration clause in the contract. By agreeing to submit any disputes to arbitration, the state is effectively waiving its right to object to an award made by a tribunal on jurisdictional grounds. However, an agreement to arbitrate alone will not constitute a waiver of the state’s right to claim immunity at the enforcement level.
Waiving a right to claim state immunity against enforcement of awards must be done expressly in the terms of the contract. This therefore depends on the state giving up this right willingly, and although there is no harm in a contractor seeking this concession, in many cases a waiver may be beyond the scope of what can be agreed in contract negotiations.
It is worth noting that article 24 of the ICC Rules (now article 34(6) under the 2012 rules) was held to constitute a waiver of state immunity by the French Court of Cassation in the case of Creighton v Qatar. Article 34(6) states:
Every award shall be binding on the parties. By submitting the dispute to arbitration under the Rules, the parties undertake to carry out any award without delay and shall be deemed to have waived their right to any form of recourse insofar as such waiver can validly be made.
The court effectively held that, by submitting to the jurisdiction of the ICC, the Qatari state had agreed to waive its right to cite immunity in the face of an ICC award.
The case generated a mixed response and, in general, variations persist across jurisdictions as to how state immunity claims are treated. In Creighton, the Court of Cassation took a narrow view of immunity and consented to enforcement. Although this appears to be a contractor-friendly result, two previous decisions of the French courts in this case were decided in favour of state immunity before being overturned, suggesting that even in this jurisdiction there is still a high threshold to overcome. It is not entirely clear whether the English courts would reach the same conclusion.
While some countries are fortunate to have domestic courts that are reliable, consistent and impartial, many others are home to local courts which are anything but. Often, bringing a claim against the state in these jurisdictions can be a fruitless exercise, and the likelihood of any liability being found on the part of the state can be negligible. In such cases, international arbitration provides an attractive alternative forum in which to resolve disputes.
The modern framework for international arbitration was established by the New York Convention 1958 (fully titled the Convention on the Recognition and Enforcement of Foreign Arbitral Awards). The Convention requires that courts of contracting states give effect to arbitration agreements and enforce arbitral awards made in other contracting states, thereby giving parties a means of resolving disputes that is removed from the vagaries of local courts.
Before entering into an agreement, it is essential for a contractor to check whether the state it is contracting with is a signatory to the Convention. If the state in question is not a signatory to the Convention, an arbitral award against it is likely to be worthless in the event that enforcement is attempted in that state as the award will simply not be recognised.
If the state is a signatory, this should provide a route to enforcement. However, signatory status does not always guarantee that an award will be enforced. Some jurisdictions will still ignore an award in spite of the Convention, while in other cases conditions on the ground may simply be too volatile to make enforcement proceedings a realistic prospect.
These considerations point back to the issues discussed above on the location of the state’s assets, and the need to think strategically about how this may inform any decisions taken about where to commence enforcement proceedings.
A further consideration for any contractor commencing arbitration proceedings against a state is the relative speed of the enforcement process across jurisdictions. Timescales can vary considerably: what takes six months in the Netherlands may take four years in Turkey. Careful planning should therefore take place to check that the most appropriate and convenient location is chosen, given the distribution of assets owned by the state entity.
Bilateral investment treaties
Bilateral investment treaties (BITs) are treaties between two states that are designed to encourage investment by agreeing various protections for investors domiciled in either signatory country. The number of BITs varies from country to country; Germany has concluded agreements with 147 countries, whereas many states have agreed far fewer, or none at all.
A BIT is not a substitute for a contract, but will usually provide guarantees of fair and equitable treatment and protection from the expropriation of assets. Construction contractors working abroad have been held to be “investors” for the purposes of BIT protection.
When contracting with a state, it is prudent for a contractor to check whether the state in question has agreed a BIT with its home country, which it may be able to rely on should the need arise. Even if there is no BIT in place, the contractor can gain the protection of any BIT that exists between the contracting state and a third country by establishing a subsidiary in that territory. With some clever structuring it is therefore possible to get the benefit of BIT protection with most states.
Further protection is provided by the International Convention on the Settlement of Investment Disputes (ICSID). This agreement enables disputes with states that are ICSID signatories to be resolved by specially appointed ICSID tribunals rather than local courts. To date 158 countries have signed up to the Convention, of which 150 have also ratified.
ICSID will apply where a BIT is in place between the contracting state and the domicile of the contractor. In addition, it will apply in situations where ICSID has been incorporated into domestic legislation. So, for example, Sierra Leone has passed the Investment Protection Act 2004, which provides that:
Where any dispute between an investor and the Government in respect of a business enterprise is not settled amicably, it may be submitted at the option of the aggrieved party to arbitration...within the framework of any bilateral or multilateral agreement on investment protection to which the Government and the country of which the investor is a national are parties.
This means that, for example, even though Italy does not have a BIT with Sierra Leone, an Italian contractor could refer a dispute with the Sierra Leone state to ICSID arbitration because both countries are signatories to the Convention.
A good rule of thumb for a contractor entering into a construction contract with a state entity is “test it backwards”. This means looking at enforcement issues first, before signing the contract and certainly before beginning to spend money on arbitration or other court proceedings.
Contractors should always try to seek a waiver of state immunity at the point at which the contract is being negotiated, and should remember that an arbitration clause alone will not constitute a waiver. Given that the contract is likely to name an arbitration centre, it is worth noting that the ICC rules offer a measure of protection with regard to a deemed waiver of immunity, though this should not be treated as a substitute for an express waiver.
A prudent contractor should also investigate what assets the state entity holds, and whether these are located within the jurisdiction or elsewhere (and if so, where).
Finally, it is likely to be worthwhile for the contractor to structure its affairs to receive the protection of any BITs that the contracting state has in place.