Developing and negotiating a contract for an international project can be a daunting task. Not only does it require tackling the usual complexities of, for example, an engineering consulting or engineer/procure/construct type contract, but you also face extremely difficult cultural, logistical, and even political issues that do not factor into a contract for a domestic project. This article discusses some of these challenges and identifies possible strategies for managing the associated risks.
Managing contract challenges and risks in international projects
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| A local agent or partner that is a part of the culture can be a valuable asset for an expatriate company. |
In the classic contract development and negotiation process, the parties have equitable status and usually have a reasonable understanding of the position of their counterparts on the other side of the table. Ideally, both parties strive to reach an agreement that can be labeled as a "win-win" scenario. This objective is normally reached as compromises are made by both parties and a reasonable middle ground is achieved.
However, as anyone who has been through the process knows, the classic case sometimes bears little resemblance to reality. Often one party arrives at the negotiating table in an inferior position—work is needed to keep the home office busy, the project financier is demanding that the project work be performed by a certain firm, or the project sponsor is behind schedule and needs to make some progress. If this is the case, the party in the superior position can extract more concessions from the other party and the theoretical middle ground ends up resembling a battleground strewn with casualties.
But even in these situations the process will be based more on known than unknown factors, and each party will leave the negotiating table with a reasonable understanding of their commitments. Industry standard documents such as the Engineers Joint Contract Documents Committee (EJCDC) contracts, the American Institute of Architects (AIA) contracts, or others by the Design Build Institute of America (DBIA) or the Construction Management Association of America (CMAA) facilitate this process. These documents have been developed over time and address many of the issues that are part of most domestic projects.
Consider then the added dimensions of developing and negotiating a contract for an international project. Even if you are familiar with the culture of the country where the project is located, many issues still exist that will complicate the contract and blur the roles and responsibilities of each party.
One of the first topics of discussion is what type of contract will be used. Since the project is not located in the United States, the foreign party may be reluctant to use an industry standard, U.S.-type contract such as those listed above. Internationally, the International Federation of Consulting Engineers (FIDIC) family of contracts is widely used and bears little resemblance to the EJCDC, AIA, DBIA, or CMAA documents. This type of contract is commonly used by the World Bank and other multi-lateral institutions.
FIDIC’s contracts have two parts. Part 1 is a standard, unchangeable template and Part 2 consists of the "Conditions of Particular Application" or COPA where the specifics of the project are listed along with the strikeouts, addenda, and other edits to Part 1. Familiarization with this form of contract requires some study for U.S.-based engineers.
FIDIC contracts include a standard cost escalation clause that will be a new feature for engineers that have worked primarily in North America. This clause recognizes the potential for cost changes throughout a project’s duration because of inflation or local currency fluctuation. The contract includes a framework for incorporating published local price indices in a formulaic method, providing a tracking process for raw material and labor prices. Depending on the project country and the method of payment—whether in local currency or U.S. dollars—this feature of the contract can reduce risk substantially.
Negotiation of the specifics of this clause may be extremely important to the success of the project. Research will be needed to determine the overall inflation history of the country where the project is located, as well as the volatility of the local currency. Finding appropriate cost indices to include in the contract may be challenging because published consumer price index data may have little relevance to an engineering or EPC contract raw material or labor inputs.
The use of multiple currencies in international contracts is not uncommon. For example, a contract may contain clauses that stipulate that certain portions of the work are to be paid in local currency. This type of arrangement is sometimes preferable for foreign clients when paying for certain items with their own cash while other items are bought with euros, dollars, or other "hard currencies" obtained through an international loan or grant. Fluctuations in the exchange rate of the local currency could have a significant effect on the project finances. For this reason, international contracts may include a clause that adjusts the value of the local currency portion of the contract according to the exchange rate.
If such a clause is not included and the local currency percentage of the contract is significant, some other means of mitigating the exchange risk must be found. Many times, the party subject to currency exchange risk will purchase a "hedge" or insurance policy to limit the risk to manageable levels. During contract development, it is important to plan for the type and percentage of contract income being received in each currency, as well as the use of each currency in paying project expenses and repatriation of profits.
Project expectations
Before the negotiation process begins, it is critical to understand as much as possible about the motivation of the party across the table, as well as the business culture relevant to the project. In some ways, the motivation factor may be the easiest to understand. However, assumptions that would normally apply in North America may be far off the mark in other parts of the world. For example, the other party may have wildly inflated expectations about the contributions your firm will bring to a project. Immediate and dramatic results may be anticipated.
My company was involved in an international joint venture in which the other party assumed that our participation as a U.S. firm would guarantee huge and almost immediate increases in project awards from a U.S.-based project sponsor. These expectations were never discussed with us and were apparently based on a complete misunderstanding of how the competitive awards were made. In this party’s culture, projects were "given" to companies based on relationships and "understandings" with the project sponsor. When the anticipated gains did not materialize after a short time period, the joint-venture relationship deteriorated and was eventually dissolved. Because of the completely unrealistic nature of these expectations, it had never occurred to us that it was the basis of the other party’s motivation for pursuing the joint-venture contract. Had we understood this fact before the negotiation process, we could have avoided a very costly and unproductive endeavor.
Negotiations in which the other party continues to revisit contract issues that were previously agreed upon can be extremely difficult. Sometimes this occurs because of the party’s inexperience and insecurity, but in other cases it is a tactical maneuver designed to extract concessions. Demands to reopen issues—even after the signing of a contract—are not uncommon and can almost be anticipated in some parts of the world. Obviously, these situations can become intolerable and result in a firm having to walk away.
The use of a local agent or partner that is a part of the culture can be a valuable asset for an expatriate company. The right individual in this role can understand many of the subtleties and underlying motives of the other party and can bridge the cultural gap between the parties. It is important that this agent have the same type of financial interest as the expatriate firm, which usually involves a partnership or some type of success fee.
Resolving disputes
While no one goes into a contractual relationship planning for failure, providing for an exit strategy when things go wrong can significantly minimize the cost of a failed venture. This strategy should at least include a method of dispute resolution, agreeable to both parties from the outset. The FIDIC documents provide for binding arbitration under the guidelines of the International Chamber of Commerce. Other details of the arbitration such as the venue and the procedure for the appointment of the arbitrator or the arbitration panel can also be specified. A method of terminating the contract for convenience and for cause should also be included. Termination provisions should feature safeguards so each party is protected from undue damage in the event of a termination that is not created by that party’s default or non-performance under the contract.
While not discounting the importance of dispute resolution and exit strategies, the method of contract enforcement is a potentially more important factor to consider. In many developing countries, the judicial system may be weak, inefficient, corrupt, or practically nonexistent, and enforcing a contract or even an arbitration judgment may be impossible. These conditions, along with the inherent bias against a foreign entity, usually rule out any attempts to access the legal system in the country where the project is located. Attempting to force adjudication according to U.S. law is also problematic since the other party must agree to this stipulation in the contract and then may have little or no incentive to follow through with this commitment once a dispute arises.
In many instances, the contract is only as good as the commitment and reputations of the parties involved. For that reason it is critical to know the other party as well as possible. How have they performed on other contracts? What do other companies that have worked with them have to say about their performance? What is their overall reputation? When performing this due diligence on a company’s background, the tendencies of the local culture should be considered. In some parts of the world, it is common to minimize bad news or to neglect it entirely, and it may be difficult to obtain a true picture of a company, especially from other companies that belong to the same culture. Government officials also may be reluctant to share bad reports for various reasons. The best sources for unvarnished information could be other expatriate companies and international funding agencies.
While many problems can develop, it is important to understand that international projects can be significant profit centers for U.S. companies if the associated risks are managed properly. Knowing as much as possible about the project, the local culture, and the other party to the contract is a critical step toward achieving success.
David M. Roebuck, P.E., CCM, LEED AP, is president of Armentrout Roebuck Matheny Consulting Group, PC, of Athens, Ga. He has worked on engineering projects in South America, Africa, Eastern Europe, Central Asia, and the Caribbean. He can be contacted at droebuck@armentrout-roebuck.com.