Most developing and underdeveloped countries are looking at viable partnerships to ensure that their citizens get access to the necessary infrastructure and basic services. These partnerships are either public with other government institutions or with private individuals or with Companies. China recently invaded Africa by its massive infrastructural developments and production by starting up industries in the African countries. Most of these projects are fully funded by China as a loan through contract, but the beneficiaries are expected to pay back the loans within a specified period. The mystery about these loan agreements between China and the beneficiaries is their secretive nature and that nobody is aware of its terms except the Chinese government and the people who negotiate the loan on behalf of the beneficiary. In the past many beneficiary states lost some of their very rich and strategic sources of income like ports and airports to China. This article, thus, aims to explore the construction contracts, loan terms, and dispute resolution mechanisms in case the beneficiary fails to meet their obligation of repaying the loans, by using the example of developmental projects in Kenya.
Keywords: ‘Chinese loan agreements’, ‘developing and underdeveloped countries’, ‘beneficiaries’
Kenya’s development projects are heavily funded by a loan. Currently, the debt burden is estimated to be at about USD 96 Billion. These loans are secured through loan agreements, the basic components expected to be cleared in the agreement include the parties, the loan amount, and the collateral. While the other two components may be clear in Chinese loan agreements concerning Kenya, it’s still unknown what the collateral for these ever-increasing loans is.
Grant T. Harris, advisor to former President Barack Obama said, “the uniqueness of Chinese loans is in the secrecy of their terms”. Kenya, amongst other loans, benefitted majorly from theUSD 3.2 Billion loan for her standard gauge railway that connects the capital city to the coastal city of Mombasa, launched in 2017. The loan servicing has been poor since the project has not been generating revenue as it was expected. This has spurred fears as to whether Kenya would lose some of its rich sources of revenue like the port of Mombasa to China. This is not a new occurrence as Sri Lanka already lost her Hambantota Port in 2017 as did Zambia losing Kenneth Kaunda International Airport to China in 2018.
While this may sound myopic, Kenya is a sovereign state with the citizens enjoying absolute sovereignty and the three arms operating on a delegated sovereignty. For this simple reason, there is a need for the leaders to be accountable as to how they raise revenues for development as well as how the same is used to prevent the management of the country’s most rich sources of revenue and employment from being taken over by lenders upon default.
Nature of Construction Contracts
Construction contracts by natureencompass the sale of goods and labor invested in putting up structures for instance the railway or roads or buildings. In these contracts, critical decisions may be made from time to time on vital issues as to varying the orders, extending the completion time, and provision for expenditures.
The freedom of contract however allows parties at the point of negotiation to decide the form they may want their contract to take. Construction Contracts may take different forms based on the financier. Some of the most common forms are FIDIC Forms of Contracts which are widely used. For the projects funded by the World Bank, they always apply the World Bank form of Contract. The European Union also has the European Union form of contract for the Union’s financed projects. There are also Joint Building Council Forms which are for building projects and finally the Japan International Cooperation Agency forms of contracts for the projects funded by Japan. Recently, parties in the construction contracts have relied so much on the standard form of contract to which the employer/beneficiary always has a little say but the contractor who in most cases is the fancier.
Advantages of the standard form contracts- There is sharing of foreseeable risks since the standard forms are usually negotiated by the different bodies involved. The use of standard form contracts saves the time the parties would have spent negotiating how every clause of the contract should be framed.
Disadvantages of the standard form contracts- Most of these forms are complex and difficult to understand. Parties have very little say on some very critical clauses of the contract since there is little room for changing the clauses.
The various forms of contracts FIDIC have are different models for different work types. The choice of model is based on the following factors:
- The level of control each party has to the work or output.
- The allocation of risk as to who bears the risk of construction and equity risks
- The size of the project in terms of the cost
- The nature of the works to be involved
The various models available for the FIDIC Forms of Contracts are:
1. FIDIC Conditions of Contract for Construction, (New Red Book)
This is mostly used when the design of the work is by the employer. Although the Red Book may allow the contractor to design out some elements of the work, it is more suitable for projects where the employer designs the work.
2. FIDIC Conditions of Contract for Plant and Design/Build (the new Yellow book)
Initially, the focus was on Electrical and Mechanical Engineering works and it applied mostly in such works however, with the focus on procurement method, it was revised to focus and apply in projects where the contractor designs and builds.
3. FIDIC Conditions of Contract for EPC Turnkey Projects the (Silver Book)
This is used mostly where the contractor carries out every work until the point of handing it over to the employer. It thus gives the contractor more discretion in carrying out the project with little interference or supervision of the employer.
4. FIDIC Short Form of contract the (Green Book)
This is preferable for simple construction works that require a small amount of capital investment (less than USD 500,000).
The other critical element of these contracts is the selection of the PPP modalities. The choice of modality is mostly influenced by the nature of work and the source of finance and how the loan will be repaid if the financing is by way of loans. Some of the modalities are:
Operation and maintenance contract (O&M)
This is where a private company is contracted just to operate and maintain a project. This is where the project requires some special know-how the government may procure a company to do the same.
This is where a private company will finance, build, and upon completion, transfer the project to the government. There is always a certificate of completion. The government will then repay the cost based on the agreement. The private company does not bear any other risk after transfer.
Build Operate Transfer (BOT)
In this modality, the government finances the project. The project company will build and operate on a concession and upon the end of the concession transfers the project to the employer who is the government. This also applies to projects where operation and maintenance require special skills.
Build Operate Transfer (BOOT)
This is where the project is financed, built, and operated by a private company on a concession. Upon expiry of the concession, the company is to transfer the project to the government. This model is also called Develop Build Finance Operate (DBFO). Under this model, the private company assumes the construction, equity, and commercial risks. Upon handing over of cite, the project ownership passes to the private company until the final transfer.
Rehabilitate Own Operate Transfer (ROOT)
This is where a private company takes over an existing project that requires some repair to rehabilitate it, operate it on a concession, and transfer at the end of the concession.
Build own operate (BOO)
This is where a private company will operate but there is no transfer. The operation and maintenance of the project are outsourced. It’s most suitable for rehabilitated projects which have been tolled.
Most of the construction contracts financed by the contractor reduce the employer’s obligations to site handing, inspection at the time of hand-over, and repayment of the loan or the contract sum plus the applicable interests. This payment can be done either by way ofa lump sum contract where the amount due is paid once after work is completed. Secondly, the payment can also be an express contract different from a lump sum payment. Lastly, it may also be by way of a reasonable frequent sum usually called quantum meruit.
Based on the contract as to when the payment is due, the contractor will issue the employer with a certificate of payment which will specify the amount that is due. The general rule is that the contractor is not entitled to payment without the certificate. Moreover, the contractor cannot be paid more than the amount specified in the certificate even where the certificate had errors.
In a contract, the parties must be clear on payment terms as to how much to be paid and the payment plan as to timings. Where the contract does not specify when the payment is due, it would be due within a reasonable time based on all the underlying circumstances. In case of payment is due upon the occurrence of an event or issuance of a certificate, payment will be strictly due upon the same. When the employer defaults in paying this amount due, this is a breach of contract and the contractor is free to exercise his rights under the contract or law.
Defenses for Non-Payment
- Force majeure
Contracts have in the past viewed this as a factor to mostly affect the contractor stopping the works but not the employer to render them incapable of paying the amounts due. The outbreak of Covid-19 for instance brought to halt revenue-generating activities. This would thus automatically affect the employer’s ability to pay. For instance, the Kenyan standard gauge railway income has been used to partly service the loan to China that was used in its construction. This pandemic however led to the government halting most activities that would cause people to travel. The railway also connects the Port of Mombasa to the Capital which was in total lockdown for a while and that meant, nobody would travel to or from Nairobi.
The government for the year 2020/2021 struggled to raise money for its expenditure. This would automatically affect their ability to service such loans. Can this be considered a factor to increase the time for loan repayment?
This is where the contractor claims the amount due to them and the employer also claims the cost of repairing defects or cost for delays. However, for the defects, there is a time within which the employer must give notice failure to which the cost will be on them. The defect notification period is usually stated in the contract and where it is not, for turnkey projects, then it will beone year from the date of completion or the date when the taking-over certificate was issued. The defect notification period can however be extended if the facility cannot perform the work for which it was meant from the date the taking-over certificate is issued because of defects in the design of work, materials, or workmanship not being as per the contract. However, thisextension cannot go beyond two years.
InHanak v. Green, Morris LJ stated that set-off is a substantive defense that can reduce the claim or extinguish it completely. The courts have also usedthis defense for two contracts that are closely related contracts where the parties are claiming against one another to constitute equitable set-off.
This is where the employer claims the contract sum from the contractor for having done a defect. The difference with set-off is for abatement the employer is only claiming the contract sum and not damages for breach. InMultiplex Constructions (UK) Ltd v. Cleveland Bridge UK Ltd., Jackson J in determining the extent to which a contractor could use the defense of abatement to refuse to make payment for a subcontractor stated that; “in a contract for labor and supply of materials, where the performance is defective, the employer is entitled to exercise the defense.”
Remedies for Contractors in case of default in Repayment
In case of delayed payments, the contractor may be entitled to a finance charge which is a fee for late payments on loans. The financing charge is valued at an annual rate of 3% above the average short-term bank lending rate to borrowers at the place of payment.
Suspension of Work
A contractor who is still carrying on with work has a right to suspend the work if the employer defaults paying or delays in making such payments as when due.
Sri Lanka’s Case Study
The former President of Sri Lanka Mahinda Rajapaksa contracted China Harbor Engineering Company for the Hambantota Port Development Project. In 2015, after HE. Rajapaksa was voted out, the new government struggled to service the loans. After unsuccessful negotiations, the pressure saw the government hand over the Hambantota Port and 15000 acres of land around it for 99 years to China in December 2017.The surrender of the Port to China has been viewed not only as a remedy for default by Sri Lanka but a cunning move by China to have control of the territory based on its strategic location along the commercial and military waterway.
Dispute Resolution upon Default
Construction contracts like any other will specify the dispute resolution mechanism preferred by the parties. This can either be negotiation, arbitration, or litigation. Most of the Chinese projects have an arbitration clause with the seat of arbitration being in China which also raises questions as to fairness. Most construction contracts have a Dispute Avoidance/Adjudication Board which is appointed by the parties as a preliminary procedure. This board helps the parties avoid any possible dispute or it may also adjudicateany dispute and give binding interim awards before parties can resort to arbitration or litigation. The purpose of the Adjudication Board is to allowquick enforceable orders pending final determination by arbitration or litigation. It should however be noted that a claim for payment of a loan that is due is not a dispute per se but a rightful claim that parties should always negotiate first before declaring dispute. InFastrack Construction Ltd v. Morrison Construction Ltd, it was stated that a dispute only arose after a party had given a notification of a difference which was rejected.
Kenya just like most African Countries has over-relied on Chinese-funded projects to develop its infrastructure. These projects though may be beneficial for the country’s economic progress, if there is a well-structured assessment and repayment plan, it may plunge the nation into unreasonable debts and default leading to loss of some of the country’s economic hubs to the Chinese on attachment and take over due to the following reasons-
- With poor financial affordability, the public sector may not be able to service the loans as when due. The government does not only need money to pay for the PPP projects but also finance its recurrent expenditure. Inadequate affordability will thus occasion problems such as default.
- The government not carrying out public participation to take into account the thoughts and wishes of the Citizens end up procuring projects that remain moot and stale as the citizens feel they are not of quality standards. The unwillingness of the Citizens to use these projects or to pay for them may plunge the government into default for lack of finances to service the loans
The consequence of losing these economic hubs like the ports, is they are strategic points to the countries’ commercial and military activities. For this reason, the concept of the country’s sovereignty will be more absurd than a reality.
Proper pre-contractual analysis to be able to assess the viability of the project, the ability of the country to service the loan based on the economic performance. Proper negotiation of the loan agreement, both parties should have favorable terms in the contract unlike the lopsided loan agreements that China has signed with Countries they advance funds to.
About the Author
Mr. Ogada Obila is a Legal Assistant at ALP East Africa.
Managing Editor: Naman Anand
Editors-in-Chief: Jhalak Srivastav and Akanksha Goel
Senior Editor: Gaurang Mandavkar
Associate Editor: Abhinandita Biswas
Junior Editor: Parishti Kaushik
Preferred Method of Citation
Ogada Obila, “Lopsided Chinese Loan Agreements in Developing Countries: A Case Study of Developmental Projects in Kenya” (IJPIEL, 11 March 2022)