Sanctions and Material Adverse Change Provisions

Craig Shepherd and Arnold Hoong have recently published an article in the Global Arbitration Review’s Asia-Pacific Arbitration Review 2023 on the contractual effects of sanctions on construction projects. The article explored the effect of sanctions on contractual obligations within projects in the Asia-Pacific region as well as globally, and discusses what project owners and contractors should look out for.

The article takes another look at force majeure and frustration in light of sanctions, whilst also highlighting the benefits of material adverse change clauses (or hardship provisions) as a customisable way for parties to improve project management, predictability and stability. Below are some of the key takeaways from the discussion.

The last few years have seen an elevated level of strife around many parts of the world including the Asia-Pacific. At the time of the article, extensive sanctions regimes affect Russia, North Korea, Belarus and Myanmar, while long term sanctions impact on businesses from Cuba and Iran.

The implications of sanctions go well beyond projects located in directly sanctioned countries. In recent history, sanctions have shown that the effects on logistics and the overall viability of projects can be global.

In the authors’ view, force majeure and frustration provisions are not adequate to deal with the consequences of sanctions in the international project space, and the authors believe that the time may be right for a more widespread adoption of material adverse change protection.

Force Majeure

Force majeure operates as a defence so parties can be excused from performance of their contractual obligations if the occurrence of specified exceptional events prevents them from carrying out the performance.

Most standard form contracts provide for force majeure only as a defence for failing to perform contractual obligations, and rarely as a ground for a claim. In most instances, these force majeure provisions allow parties to be given additional time or even a possible right of termination. It is however relatively rare for force majeure to trigger a right to payment, although the costs incurred in addressing sanctions may be immense.

Such clauses also often require a party to be “prevented” from performing its obligations and, while sanctions may impose additional hurdles on the performance of a contract, performance may not be prevented, particularly where the project is not in a directly affected country and the impact of sanctions is on logistics, material supply or costs.

In the authors’ opinion, force majeure will often provide an inadequate remedy for sanctions in the international projects market.  The remedy available under the contract is unlikely to carry with it payment and may not be triggered at all if the consequence of the sanction is merely to cause difficulties, rather than to fully prevent work.

Frustration

Frustration applies where a contract has become impossible, illegal, or drastically different to perform from the original agreement. Where frustration is invoked and established, the contract will be brought to an end, and the contract will be seen as discharged.

Frustration is generally not available where the obligations simply become difficult or onerous to perform. So long as performance is possible, frustration will rarely be allowed.  In the context of sanctions, this means that unless the project or the parties are in a state directly impacted by the sanctions, frustration is unlikely to be relevant. Parties indirectly affected by sanctions may not find remedy in frustration.

Therefore, frustration is also unlikely to be an adequate response. It is difficult to establish and brings a contract to an end rather than providing an appropriate mechanism to address the consequences of sanctions.

Material Adverse Change & Hardship

Less widely incorporated than force majeure clauses, and not existing as a matter of common law like the concept of frustration; a third and far better answer can be found in material adverse change (MAC) or hardship provisions. MAC clauses are common in some forms of contracts but are not widely used in construction projects outside the common law world.

The key feature of a MAC clause is that it allows parties to pre-negotiate the contractual mechanism for adjustment of the contract in the event of material changes to the circumstances. Perhaps the most significant difference between a MAC and force majeure provision is that a MAC provision does not require performance of the contract to become impossible. Instead, it can be effective where circumstances have made the contract only onerous or impractical to perform.

For instance, if there is a material impact on the project caused by the introduction of sanctions, even though that impact falls well short of preventing performance, a MAC clause allows for adjustments to the contract and allows the parties to continue with their obligations, with the project and with the commercial deal. The risk of sanctions can be shared, and the parties are incentivised to work together, rather than incentivising the contractor to say that performance is prevented as force majeure and frustration do.

Ultimately, the authors believe that MAC clauses are likely a good thing for the parties in almost every case, and would be a smart remedy for parties hoping for certainty when faced in a world where sanctions exist.  To date, however, they are a remedy which is rarely included in construction contracts.

For the complete article, please click here.

For more information, please contact Craig Shepherd, Arnold Hoong or your usual Herbert Smith Freehills contact.

Disclaimer
Herbert Smith Freehills LLP is licensed to operate as a Qualified Foreign Law Firm in Malaysia. Where advice on Malaysian law is required, we will refer the matter to and work with licensed Malaysian law practices where necessary.

Craig Shepherd
Craig Shepherd
Partner, Kuala Lumpur
+60 3-2777 5151
Arnold Hoong
Arnold Hoong
Associate, Kuala Lumpur
+60 3-2777 5154

Getting paid: A New Bill to streamline Construction Disputes in Thailand

Construction disputes between contractors and employers in Thailand can take years to be resolved in court or arbitration. This can result in construction work being delayed and sometimes abandoned, and contractors facing financial difficulties. In response, Thailand is considering the introduction of a draft bill titled “Act on the Settlement of Disputes regarding Payment in Construction Contracts”.

The bill is inspired by security of payment legislation in Malaysia and Singapore. The common objectives are to: (i) allow faster and less expensive dispute resolution, (ii) create a specialised authority capable of dealing with the complexities of construction contracts, (iii) ensure that contractors are paid according to the contract, all with a view to easing cash-flow and minimising effects of pricing disputes on work disruption.

Features of the Bill
  • Section 8 restricts ‘pay when paid’ clauses, where payments to subcontractors and consultants are dependent on the employer paying the prime/lead contractor.
  • Section 15 is intended to allow contractors to seek immediate recourse for non-payment. After issuing a demand notice to the employer and where payments remain in arrears, the contractor may initiate adjudication proceedings.
  • Sections 9 and 39 codify the ‘pay now argue later’ principle. While parties may litigate a dispute in court or arbitrate the matter in parallel with adjudication proceedings, an adjudication award will be binding unless and until the court or an arbitrator (depending on the choice of dispute resolution mechanism in the parties’ contract) reaches a final and conclusive finding on the matter in dispute.
  • Sections 40 to 42 address enforcement of the Award.  Payments must be made 15 days after the adjudicator’s award is given or as otherwise specified by the adjudicator.  Upon the employer’s failure to make payment, the contractor may seek payment from the employer’s guarantor or enforce the adjudicator’s award against the employers’ assets as if it were an order of court.

This is a welcomed development.  If passed, the Bill will update Thai law to take account of the commercial realities of the industry and adopting tried and tested approach from other jurisdictions to improve contractor cash flow.

The bill is at the public hearings stage and is being refined to ensure that the bill is effective and practical to the construction market in Thailand.  We are monitoring the bill closely and are ready to assist clients navigate developments in the law.

For more information, please contact Craig Shepherd, Warathorn Wongsawangsiri, Daniel Waldek, Amornwit Phesprasert, Charlene Kong or your usual Herbert Smith Freehills contact.

Disclaimer
Herbert Smith Freehills LLP is licensed to operate as a Qualified Foreign Law Firm in Malaysia. Where advice on Malaysian law is required, we will refer the matter to and work with licensed Malaysian law practices where necessary.

Craig Shepherd
Craig Shepherd
Partner, Kuala Lumpur
+60 3-2777 5151
Warathorn Wongsawangsiri
Warathorn Wongsawangsiri
Partner, Bangkok
+66 2857 3828
Daniel Waldek
Daniel Waldek
Partner, Singapore
+65 6868 8068
CharleneYuiinYee Kong
CharleneYuiinYee Kong
Associate, Kuala Lumpur
+60 3-2777 5156
Amornwit Phesprasert
Amornwit Phesprasert
Associate, Bangkok
+66 2857 3814

Construction Law Masters Podcast: Asia Series – Goh Han Lee, General Counsel, Legal Engineering & Project Delivery, PETRONAS

We are pleased to share the second episode in our Construction Law Masters in Asia podcast series in which we welcome distinguished guests from the construction industry from across Asia to discuss their unique experiences and views of various aspects of construction law and practice.

In this episode series, Peter Godwin (Managing Partner, Kuala Lumpur) interviews Goh Han Lee, a highly experienced construction lawyer who is presently General Counsel – Legal Engineering & Project Delivery at PETRONAS. With over 20 years’ experience in law, Goh has been involved in some of the largest and highest profile development projects in Malaysia and the Middle East. He joins us to discuss:

  • How he came to specialise in construction law and the impact of mentorship on his career
  • Challenges and lessons learnt from Project RAPID, one of the world’s largest petrochemical projects
  • The evolving role and value of in-house legal function in Malaysian companies
  • Effective cost management in dispute resolution
  • The “dos” and “don’ts” for experts in construction disputes

This episode and the sound bites can be found on SoundCloud.

We hope that you enjoy listening to this episode.

 

Disclaimer

Herbert Smith Freehills LLP is licensed to operate as a Qualified Foreign Law Firm in Malaysia. Where advice on Malaysian law is required, we will refer the matter to and work with licensed Malaysian law practices where necessary.

Peter Godwin
Peter Godwin
Managing Partner, Kuala Lumpur
+60 3-2777 5104

Investing in Southeast Asia: Malaysia – Spotlight on: Projects

Glynn Cooper, Raja Irfan and Nicole Ong

With the outbreak of the COVID-19 pandemic, countries around the world had imposed lockdowns in one form or another, such as Malaysia’s Movement Control Order (“MCO”) (and subsequent Conditional and Recovery orders) and Singapore’s “Circuit Breaker”. Certain countries are now beginning to re-open their economies with businesses and services resuming progressively.

Even the most sophisticated contracts could not predict the uncertainty that the COVID-19 pandemic wrought on construction and infrastructure projects. These contracts even more so do not account for the “new normal” for when we emerge from the COVID-19 crisis. At the initial stage of the pandemic, the construction and infrastructure sector was rightfully focused on a party’s ability to seek relief for costs, delay and disruption caused by the pandemic and the lockdowns as parties were at risk of not only missing contractual obligations but going out of business entirely.

Now with the possibility of projects being restarted, parties are beginning to look beyond the immediate effects of the pandemic. Project and infrastructure development can be expected to rebound as priorities would shift from crisis management to economic stimulus with regional governments being able to use infrastructure spending to quickly bolster their economies.

Ongoing Projects in Malaysia

Construction works within Malaysia were generally suspended under the MCO, but with Malaysia’s recent “flattening the curve” on the rate of infections and reduction of transmissions, this has allowed the resumption of construction works subject to the adherence of standard operating procedures.

During this recovery period, the Malaysian government had announced the PENJANA Short-term Economic Recovery Plan on 5 June 2020 detailing a short to medium term economic plan based on subsidies and incentives for attracting investments for businesses in general. The Malaysian government is also expected to release its Economic Recovery Plan in October 2020 detailing the medium to long term economic plan against the pandemic focusing on more capital heavy projects and incentives.

However, in view of the recent change in government in Malaysia, the enormous expenses spent to deal with the pandemic and the fall in oil prices affecting much of the Malaysian government’s revenue, it would be fair to not expect any announcement of new mega projects, particularly as the Prime Minister of Malaysia has publicly stated that only mega projects which have been decided and which will not require additional funding may proceed.

Instead, the Economic Recovery Plan would more probably be focused on having an immediate emphasis on financing and delivering ongoing projects such as:

  1. East Coast Rail Link (ECRL) being the 640-kilometre rail connection for the east coast of Peninsular Malaysia with an estimated budget of RM44 billion. The Malaysian government has pledged to continue with the ECRL and construction has resumed with only an approximate 0.02% delay in its implementation schedule with a scheduled completion date of December 2026.
  2. Johor Bahru-Singapore Rapid Transit System (RTS) being the rail connection between the Malaysian state of Johor with neighbouring Singapore via a light rail transit system with a reported budget of RM3.56 billion and a scheduled to be completed in 2026.
  3. Mass Rapid Transit 2 (MRT2) which is the second of three planned MRT lines in the Klang Valley region of Malaysia with an alignment of 52.2 kilometres with a reported budget of RM30.5 billion and scheduled full operation to be in 2023.
  4. National Fiberisation Connectivity Plan (NFCP) which is to be administered by the Malaysian Communications and Multimedia Commission covering the expansion of coverage and improvements in the quality of both fixed and mobile broadband, whilst laying the foundation for new fifth generation (5G) networks. The Malaysian government had announced an allocation of RM3 billion to roll out six projects this year.
  5. Pan-Borneo Highway being the major road network on the Borneo island connecting the Malaysian states of Sabah and Sarawak with Brunei Darussalam and Kalimantan, Indonesia being approximately 5,324 kilometres.
  6. Kuala Lumpur to Singapore High Speed Rail (KL-SG HSR) being the proposed train connection between the capital of Malaysia with Singapore with an estimated budget of RM110 billion. While initially having an expected operational date in 2031, the Malaysian and Singapore government have agreed to a deferment with a decision on its continuation to be made by end of 2020.
  7. Bandar Malaysia, the urban re-development project of Bandar Malaysia, the 196.7ha development which is tied to the development of the KL-SG HSR as it is the intended site for the terminal station of the KL-SG HSR as well as connections with other commuter railways.
Large-Scale Solar 4 (LSS 4)

Malaysia has also looked to renewable energy as a post COVID-19 economic stimulus with the release of tenders for the fourth round of its large-scale solar scheme (LSS). The LSS4 programme is proposed to offer 1GWac worth of tender contracts for the construction and operation of LSS plants with scheduled completion dates in December 2023 and a term of 21 years for each LSS plant.

Conclusion

Projects are now facing unforeseen market conditions with various challenges beyond the typical cash-flow shortages with issues ranging from potential insolvencies, supply-chain bottlenecks and to multiple and interrelated claims of force majeure.

While uncertainty surrounding the pandemic will persist, optimistically, one can hope that project and infrastructure development to be on the uptake in 2021 and with it a more positive outlook for the construction and infrastructure sector in Malaysia.

However, in preparing for the path forward, besides addressing the immediate issue of the spread of COVID-19, parties will need to consider how to emerge from the crisis better positioned and more resilient.

Disclaimer

Herbert Smith Freehills LLP is licensed to operate as a Qualified Foreign Law Firm in Malaysia. Where advice on Malaysian law is required, we will refer the matter to and work with licensed Malaysian law practices where necessary.

Glynn Cooper
Glynn Cooper
Partner, Kuala Lumpur
+60 3-2777 5102
Mark Veitch
Mark Veitch
Of Counsel, Singapore
+65 6868 8034
Raja Irfan Badrol
Raja Irfan Badrol
Associate, Kuala Lumpur
+60 3 2777 5133