International arbitration in 2021
Continuing economic woes for the construction and infrastructure sectors
Is international arbitration in these sectors on the rise?
The COVID-19 pandemic hit the construction and infrastructure sectors at a time when, in several markets, they were already economically strained. While many projects progressed successfully over 2020 (no doubt due to the commendable collaborative efforts adopted and the willingness of parties to negotiate and compromise), the effects of the ongoing pandemic will further challenge these sectors into 2021. Reduced consumer demand, lower revenue and an uncertain long-term outlook mean that the financial forecasts on which many projects were based now look optimistic at best. That is coupled with the additional difficulties – and hence cost – associated with execution of projects brought about by legislative changes (eg borders being closed), health implications (eg staff contracting COVID-19) and social distancing expectations (which materially impacts logistics). As we continue to see the longer-term economic realities of the COVID-19 pandemic crystallise in 2021, the true extent of the economic woes facing these sectors is starting to be understood.
We consider here three key issues that we predict will shape the international arbitration landscape in these sectors over the coming year.
Less finance available for international projects
Reduced market liquidity coupled with suppression in investor risk appetite means there will be less finance available. We expect this will affect investors across the spectrum, from private equity to institutional investors as well as major asset owners and operators. This will make it increasingly difficult for many much-needed infrastructure projects to proceed. We expect that many previously approved projects will stall, leading to the instigation of arbitration by those reliant on the financial closing of those projects.
Moreover, while many States have announced plans to increase investment in infrastructure to drive forward economic recovery, these efforts may focus on domestic investments, with emerging economies losing out on critical foreign investment. For example, even prior to the pandemic, China had cut its overseas lending through its Belt and Road Initiative by almost 95 per cent, from $75bn in 2016 to $4bn in 2019. At the same time, it has announced a new ‘dual-circulation’ economic strategy that prioritises domestic demand and technological innovation over closer integration with the outside world. This trend will continue into 2021 and, depending on how such policies are implemented, could cause an increase in arbitration if it leads to a reneging on commitments or nationalisation of sectors and critical assets.
Perhaps a silver lining is the acceleration in the change of both public and corporate opinion towards sustainable and lower-carbon infrastructure, transport and energy. Many States have announced that low-carbon investment will be at the core of economic stimulus packages, creating opportunities for both investors and the market more broadly.
Financial distress of big market players
2020 saw ongoing financial distress throughout the construction and infrastructure sectors, with associated supply chains being particularly affected as cash reserves were depleted and future projects put in doubt. There are reports that in December 2020 alone 20 construction entities in the UK collapsed.
Moreover, last year saw a marked change in the willingness of States to prop up long-established and State-owned/backed companies. Major contractors (such as Arabtec in the UAE) have been casualties of the global downturn. Chinese State-owned enterprises have defaulted on their bonds, resulting in local government finance vehicles (collectively, the State’s biggest spender on construction projects) struggling to raise capital and causing some to question the long-held assumption that the Chinese authorities would always bail out State-owned enterprises.
Looking forward over 2021, we anticipate an increased number of arbitrations in these sectors as cash-poor project participants struggle to meet their payment obligations on time and the acceptance of future payment promises becomes untenable.
Increased focus on project securities
Given prevalent financial distress in these sectors that strains long-established relationships and erodes trust, we are seeing an increasing number of calls on project securities, such as performance or retention bonds and parent company guarantees (both up and down the supply chain). We anticipate this will continue into 2021. That will lead to an increase in contractors commencing emergency arbitration to prevent the enforcement of project securities or, where this procedure is not available, court action for interim relief prior to the constitution of the tribunal (eg as occurred in the Sharjah Federal Court of Appeal Case No. 1015/2020 in the UAE). In addition, we expect issuers to apply greater scrutiny in response to calls on performance securities, which may, in turn, lead to formal dispute proceedings (eg the 2020 Hong Kong case of West Kowloon Cultural District Authority v AIG where the issuer refused to pay out on an on-demand bond). Consequently, instruments that were once considered ‘as good as cash’ are, in some jurisdictions, no longer as secure.
As economic woes continue to bite, we set out below some practical actions that project participants can take to protect their position and attempt to resolve disputes quickly and amicably:
- ensure that contract governance/stewardship is properly followed and documented, including following the change of control procedures, and that calls on project securities are followed to the letter;
- undertake regular due diligence to understand the pressures and financial standing of counterparties;
- seek an early merits assessment of claims to allow for clarity on the strength of claims and to encourage commercial reality in setting strategy and understanding likely accounting on projects;
- consider third-party funding to pursue legitimate claims in arbitration to reduce the strain on resources and balance sheets; and
- consider making full use of alternative dispute resolution mechanisms, whether provided under the contract or otherwise, to narrow issues in dispute before commencing.
These trends have been identified by global projects disputes specialists from across our network, who have been advising on these issues and closely monitoring trends in these sectors for decades.