Chinese Infrastructure Investment Goes Abroad

By Lucio Blanco Pitlo III

August 06, 2015

http://thediplomat.com/2015/08/chinese-infrastructure-investment-goes-abroad/

As Chinese companies expand their operations abroad, especially in the construction and infrastructure sector, they will need to learn and adapt to new legal jurisdictions. This includes restrictions on foreign equity participation in certain sectors or on foreign entity operation of public utilities, national security laws, local content policy, as well as local labor and environmental legislation. Familiarity with this legal landscape and ensuring that they are in full compliance will raise the chances that Chinese infrastructure projects abroad will be successful.

For several decades after adopting market-oriented reforms and opening up, China was much better known for absorbing foreign investment, as multinationals moved in to capitalize on the country’s low production costs. Over the years, however, China has increased its overseas investment, and now ranks as the world’s third largest outbound investor. Indeed, there is much excitement about the country becoming a net capital exporter very soon – by 2017 according to forecasts. One overseas sector that is primed for Chinese attention is construction and infrastructure. However, a surge in Chinese investment in this sector would have serious implications, not only for the Chinese government, its state-owned enterprises, and its privately owned companies, but also for host states, as well as foreign and local companies with which PRC companies may partner in consortia or joint ventures as it enters new markets.

China has been a major driver in the growth of regional and global merger and acquisition (M&A) activity. From energy and natural resources to infrastructure and now technology-intensive sectors, Chinese companies are making great strides in establishing a global footprint and building Brand China. This “Go Out/Go Global” policy is supported by the PRC government, with state-owned enterprises (SOEs) were among the most active players. Of particular interest are Chinese firms involved in transportation infrastructure and construction, as they stand to receive a tremendous boost from recent China-backed initiatives, notably One Belt, One Road and the Asian Infrastructure Investment Bank. Since these initiatives promote, among other things, regional transportation connectivity, they could help China export its surplus capital as well as the capacity for infrastructure that it has developed over the years.

From the standpoint of commercial law, increased Chinese outward investment means that Chinese companies will have to navigate new legal jurisdictions and regulatory regimes. Investing overseas offers many potential benefits, but it also comes with risks that Chinese companies should be prepared to handle and mitigate. Unfamiliarity with foreign laws and regulations and variances in legal culture and thinking may breed differences between Chinese firms and their foreign counterparts in a joint venture or consortium or between the Chinese entity and the foreign government regulatory body if a Chinese firm is the sole designated contractor or operator of a public works project.

In many projects it undertakes, especially in non-democratic developing and underdeveloped countries, Chinese investments came after the conclusion of state-to-state agreements and thus enjoy considerable sovereign backing and protection from both the investor and host states. In many other jurisdictions, however, the field is leveled and all players compete to win contracts with no special privileges or preferential treatment accorded. Also, companies involved in purely commercial contracts, such as infrastructure projects, are generally not immune from litigation even if they are SOEs. Moreover, such contracts are also not usually considered to be executive agreements that can confer immunity on contracting entities.

The political relations of China with the host state may also have implications for investments made by Chinese companies. In recent years, for example, China suffered setbacks in its infrastructure investments in developing countries such as the Philippines (for instance, the National Broadband Network and Northrail projects), Myanmar (the Myitsone Dam project) and Sri Lanka (Colombo Port City and Hambantota Port projects). As new governments came to power in these countries, contracts signed by earlier administrations with China were placed under review, and some were found to be in violation of domestic laws, and so were subsequently suspended or cancelled. Chinese companies need to take steps to protect themselves from these risks and uncertainties. While one could make the case that reneging on a previous contract is a political question beyond the ken of a company, it would still be prudent for Chinese firms to ensure that they were not caught in violation of local laws, that they did not bribe their way into the contract, and that they did not compromise on agreed project standards or specifications without just cause and the prior consent of the contracting party. This will help give them the high ground should the dispute be referred for commercial arbitration.

The dispute settlement mechanism clause in contractual agreements may provide Chinese companies with a means to resolve disputes. Internationally, most states have already passed their own national arbitration laws, recognizing that arbitration constitutes an affordable, fast and amicable method of resolving business disputes. Some of these national laws also comply or adhere with the United Nations Commission on International Commercial Arbitration (UNCITRAL) Model Law, which was adopted to promote a harmonization of arbitration laws across different jurisdictions. Knowledge of these legal frameworks and allocating legal resources for same are, thus, important for outgoing Chinese companies.

Contractual agreements between companies are typically confidential in nature and not readily disclosed to third parties. That makes it difficult to survey the choice of law and venue for dispute resolution as reflected in the dispute settlement clause of contracts Chinese companies sign for overseas projects. Often, the details of the contract only come to public attention when the project becomes the subject of host government scrutiny or is investigated for alleged misconduct or violations. This was, for instance, the case for the Northrail Project between Chinese SOE China National Machinery and Equipment Corporation (CNMEG, later renamed Sinomach) and Philippine SOE North Luzon Railways Corporation (Northrail). The project aimed to develop a railway service to link the Philippine capital Manila with nearby provinces to the north (on Luzon Island). The infrastructure project was later suspended and then ultimately cancelled due to alleged corruption and a failure to comply with competitive bidding as required by the government procurement process. In the contract’s supplementary agreement, UNCITRAL arbitration rules was the choice of law and the Hong Kong International Arbitration Centre (HKIAC) was the choice of venue. This could signal general acceptance of UNCITRAL rules and recognition of HKIAC as a neutral and able venue for resolving contractual disputes.

As Chinese companies gradually expand their international reach, it has become increasingly imperative for them to invest time and resources into acquiring the knowledge to navigate new foreign jurisdictions. Aside from obtaining cutting-edge technology to improve product quality and enhancing efficiency to win client confidence, equipping themselves with the appropriate legal resources ensures that they can remain in compliance with the rules that prevail in the markets where they operate.

Lucio Blanco Pitlo III is a member of the Philippine Association for China Studies (PACS) and has a Master of Laws from Peking University. He is a former research assistant at the University of the Philippines Asian Center and a former technical assistant at the Philippine National Coast Watch Council Secretariat.