Contractors and risk in infrastructure
The Finance Lawyer
Contractors and risk in infrastructure
Wirot Poonsuwan
Risk allocation in a civil engineering contract for a Thai infrastructure project might not match the norm of international construction contracts, even though the projects often involve international financing.
Some international aspects of risk sharing are adopted, others are Thailand-specific. Yet many large Thai projects have been completed with unusual contractor risks - the financial strength of the government employer and a string of successful precedents in project completion certainly play a sweeping role. Both the contractor and the financier need to envision and identify these risks before a project is launched.
Physical loss vs economic loss: The risks that involve physical damage to the work or to the property of a third party or bodily injury more or less follow the international practice. During construction, the risks are allocated to the contractor and after the completion of construction to the employer. Force majeure such as a force of nature and special risks such as coups and riots are the employer’s risks, provided that the contractor provides insurance.
Risk management is carried out by the contractor required to take out insurance covering all its risks plus force majeure and special risks at its own expense in joint names with the government employer featuring insurances on the work itself and on third-party liability.
The requirements for the contractor to insure special risks are not common, perhaps even unorthodox, in an international project but can be expected in a Thai project. Economic losses are not insurable and the Thai government employer is very adept and wise when it comes to how to share those risks. The government has managed to shift quite a few of the risks to the contractors, who typically believe they can absorb the risks, but international contractors shy away from such chances.
Risks of increased costs: This is a typical economic risk. Fuel costs soar with no end in sight, and prices of construction materials and equipment are volatile and unstable. Under an international construction contract, the employer will have to bear the risk of the prices of the materials and equipment rising and the contractor will be able to adjust its contract price as their costs move up. This economic risk is not acceptable to the Thai government employer, who is used to working with a construction contract that is silent on increased costs, implying the risk belongs to the contractor.
Thai construction contracts state clearly that it is a fixed lump-sum contract entitling the contractor to no extra payment, except for some variations when the amount of work increases due to the actual measurement of the bill of quantities. Rates and prices agreed upon can never change.
When the entire construction industry faces financial difficulties, the Thai cabinet could offer a bailout plan that allows adjustments in contract prices for government projects across the board. But a cabinet resolution doesn’t normally apply to large infrastructure projects. The contractor will need to plan and have a good financier to manage this risk on their own.
Foreign-exchange risks: Another type of economic loss the government employer is reluctant to take on is foreign-exchange risk. For an international infrastructure project, materials and equipment imported and used in construction work are normally paid for in a foreign currency by the employer as part of the contract price. The fluctuation of foreign against local currencies will not affect the value of money paid to the contractor and the employer will bear the fluctuation risk.
A Thai project, on the other hand, will involve the contractor saddled with the forex risk. The contractor is commonly an unincorporated joint venture comprising a local contractor, foreign contractor or manufacturer acting jointly as the “contractor”. The currency of payment is strictly Thai baht. Rarely does the Thai government permit a portion of the contract price to be paid in a foreign currency - some mechanical and electrical contracts maybe, but not the civil engineering contract.
Global financial turmoil means one had better expect to face a situation at some point where the baht depreciates and the contractor needs more baht than usual to buy Japanese yen to pay foreign suppliers, incurring exchange losses equal to the extra baht amount it paid. To manage this probable risk, the contractor has no choice except to talk to its bankers to find good hedging products and factor the expenses into its pricing.
Wirot Poonsuwan is a former chairman and managing partner of Clifford Chance Wirot as well as a former partner of Baker & McKenzie in Bangkok. He now has his own firm, Poon & Poon, Attorneys at Law. He can be reached at wirotp@poonandpoon.com
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Tags: Bodily Injury, Construction Contracts, Economic Loss, Economic Losses, Economic Risk, Engineering Contract, Financial Strength, Force Majeure, Force Of Nature, Government Employer, Infrastructure Project, Insurance Risk Management, International Aspects, International Construction, International Contractors, International Financing, Project Completion, Risk Allocation, Thai government, Thai Project, Third Party Liability