Belt and Road Initiative

Managing disputes risk when working with States and SOEs in infrastructure and construction projects

Publication May 2019


Introduction

The Belt and Road Initiative (BRI) has encouraged investment in construction and infrastructure projects across Central and Southeast Asia, even stretching as far as Eastern Europe and East Africa and most recently Italy. As a Chinese initiative, these massive-scale projects have involved many Chinese state-owned enterprises (SOEs) in China contracting with other states, SOEs, contractors and investors to build railroads, highways, dams and critical infrastructure projects. This article covers the disputes risks that typically arise in BRI infrastructure projects, particularly with states or SOEs, and offers ways to mitigate those risks.

Disputes risks associated with BRI construction and infrastructure projects

BRI construction and infrastructure projects contain a myriad of elements that could lead to disputes arising, particularly for the reason that there is no one definition of what constitutes a “BRI project.” These colossal projects often use regional or local parties who may not be prepared for the pace or size of development. Further, importing foreign workers and the application of local labour laws often cause local tension. The procurement of materials and design development are other areas of major challenges. Materials may not be available or of the appropriate quality and fundamental changes to designs may introduce delays.

Political risk is another aspect that investors and contractors should consider, given how many states have renegotiated or cancelled their BRI construction projects. Some land-intensive projects like dams or generators may have significant environmental effects or displace rural populations in unanticipated ways. Rural regions may face terrorist threats targeting BRI investments, as seen recently the Balochistan region of Pakistan. This upheaval – and the substantial price tag for these projects – has caused some governments to reconsider the BRI’s benefits.

Disputes risks associated with BRI participants

Unlike other trade or investment treaties, the BRI is an informal network of states agreeing under non-binding Memorandums of Understanding (MOUs) to participate in development initiatives that are largely funded by China and carried out by Chinese SOEs and firms. While China may have previous bilateral investment treaties (BITs) with some BRI participants, there are no BRI-specific investment treaty rights and few BITs between BRI participants, which could limit recovery through investment arbitration.

Adding to the complexity of the BRI, many state participants are lowerincome or developing economies where there is a less robust rule of law. Investors will also see significant risks in operating in jurisdictions where bribery and corruption are part of doing business. Forms of security like liens may be unavailable or difficult to execute in foreign jurisdictions. Litigation in some states raises questions about the impartiality of the court and whether the resulting judgment will be enforceable abroad. International commercial arbitration can help parties with crossborder disputes to avoid an unfamiliar court system and the uncertain enforceability of the resulting judgment.

Anticipating the broad potential for commercial infrastructure disputes, numerous arbitral institutions have drafted and promoted BRI-specific rules and courts. The International Chamber of Commerce launched a BRI commission in March 2018; the Hong Kong International Arbitration Centre followed suit in creating an advisory committee for BRI project parties. China has also created two Chinese International Commercial Courts in Xi’an and Shenzhen to specifically handle BRI disputes. The China International Economic and Trade Arbitration Commission (CIETAC) promulgated the first-ever set of investment arbitration rules in China to handle investor-state disputes, with the breakaway Shenzhen Court of International Arbitration also offering both ICC and ICSID facilities.

One of the biggest challenges in cross-border investment and development is to ensure that an arbitral award, once rendered, will be recognized and enforced against assets in a foreign state. China has reciprocity and commercial reservations to the New York Convention, meaning that it will only recognise Convention awards from Convention states that recognise Chinese awards, and that it will not enforce Convention awards that are not considered commercial under Chinese law. Some BRI participants (like East Timor, the Maldives, Iraq, Turkmenistan and Yemen) are not parties to the Convention, meaning that awards granted in those states will not be recognized or enforced in China. Further, if the investment itself is tainted by bribery and corruption, a Chinese domestic court may find that enforcing a related award is contrary to its public policy under Article V of the New York Convention.

In states that have a less robust rule of law, Investor-State Dispute Settlement (ISDS) is an important mechanism for pursuing states or SOEs in default, especially when the state considers an SOE as a state entity. Each state has its own immunity laws and practices: states like China claim absolute immunity from suit and from execution of commercial awards, which often extends to SOEs. By reason of its absolute immunity position, China will generally not recognise and enforce awards rendered elsewhere against state assets in China, except in certain limited situations. China also maintains reservations to the ICSID Convention limiting suits to expropriation and nationalization. However, there may be latitude under certain BITs to bring investment disputes, as was the case under the South Korea-China BIT in Ansung Housing Co, Ltd v People’s Republic of China, ICSID Case No. ARB/14/25.

It is important to note that sovereign immunity from suit can be waived in an arbitration clause, which prevents a state from arguing that a suit should be stayed, set aside or annulled. Immunity from execution, however, presents more of a challenge as the rule in many jurisdictions is such that a waiver of immunity from execution would only be recognized if the waiver is made by the state before the court at the time when execution proceedings are brought. As such, even if China is bound by an enforceable agreement to arbitrate, a contractor or investor succeeding in an arbitration against China or a Chinese SOE may still be unable to have the award recognized and enforced in China. The award creditor will have to identify assets in other jurisdictions for recourse.

China has recently indicated that it will not extend absolute immunity to its own SOEs except in situations where the SOE is conducting activities on behalf of the state and with appropriate authorisation. However, Chinese courts may interpret a foreign state’s SOEs as having absolute immunity on less stringent grounds, and therefore prevent execution of an award against the state’s assets in China. An investor may therefore have more luck enforcing awards against other BRI participant SOEs or states in courts beyond China, despite the proliferation of BRI-ready arbitration options. For example, in Svenska Petroleum Exploration AB v Lithuania & Anor [2005] EWHC 2437 (Comm), the UK court held Lithuania responsible for its SOE’s defaults despite Lithuania arguing that the SOE in question was not a state entity because the default did not relate to a state or administrative act. Assuming the SOE was properly found to be a Lithuanian state entity, Chinese courts would have come to the opposite conclusion and resisted the award’s enforcement. Investors therefore should carefully consider the target state’s immunity position as part of their BRI strategy.

Mitigate disputes before they start

Below are some suggestions on how one might mitigate and handle State or SOE arbitration risk in large-scale investment projects.

  • Every lawyer knows: the best cure for a bad commercial lawsuit is a good contract. BRI project disputes can be properly reduced and managed from the outset by choosing arbitration clauses that accurately reflect the parties’ wishes.
  • Introducing disputes lawyers and litigation team members as early on as possible, and especially during the bidding and procurement processes, can help ensure that arbitration provisions are adequately considered and vetted and will not lead to surprises. This includes drafting comprehensive waivers of state immunity in the relevant jurisdictions.
  • For BRI participants, performing thorough due diligence reduces surprises. Human Rights due diligence, political stability assessments, “Know Your Client” and other background research on SOEs, contractors and sub-parties are critical to ensuring a project’s success, particularly in regions where bribery, corruption or other business ethics issues are a concern.
  • When dealing with parties across cultural and national boundaries, it may be appropriate to include alternative dispute resolution mechanisms like negotiation or mediation in the contract. This is especially applicable to China and Chinese SOEs where culturally hybrid processes such as med-arb or arbmed- arb are more prevalent and acceptable.
  • Be mindful that some BRI participants are not parties to the New York Convention or ICSID Convention. There may be unexpected domestic barriers to recognition and enforcement of awards, particularly against States, so select an arbitral body and seat wisely.
  • China’s Arbitration Act requires parties’ arbitration clauses to choose an arbitral institution and seat or the same will otherwise be found invalid; ad hoc arbitration is not an option in China. As to the choice of institution for arbitration in China, there are uncertainties as to whether foreign arbitration institutions are allowed to operate in China. Separately, even if an arbitration agreement incorporating a foreign institution is considered to be valid, there are uncertainties as to whether an award so rendered will be considered as a domestic award or a foreign award thereby affecting the regime for enforcement. The safest options for China-registered parties therefore remain with arbitral institutions in China.

The BRI has opened many new regions to investment and development opportunities, but not without some risks. Well considered and carefully drafted dispute resolution clauses can help mitigate the effects of these risks and guide large infrastructure projects to success.


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