When an Owner comes after the Contractor for liquidated delay damages (LDs) after a project is completed late, the Contractor’s only substantive defense is to argue that the delay was excused by force majeure or Owner actions (naturally there may be procedural defenses, like timeliness). However, a recent decision by the United States Court of Federal Appeals for the Federal Circuit has erected a new requirement that the Contractor must first fulfill before it can assert its substantive defense. The decision in question is M. Maropakis Carpentry, Inc. v. United States, ___ F.3d ____, No. 2009-5024 (June 17, 2010). It holds that in order to dispute the basis for an LD assessment by the U.S. Navy, the Contractor first had to submit a certified claim for a time extension. No time extension claim = no defense to LDs.

After finishing the project 467 days late, Maropakis had sent letters asking for a time extension but failed to turn them into a formal, certified claim. Maropakis then brought a claim against the Navy for the unpaid contract balance, which the Navy had withheld as partial payment for claimed LDs. The Navy counterclaimed for the full 467 days of LDs. The court granted summary judgment on the Navy’s counterclaim, on the basis that since Maropakis had never formally sought (in the form of a certified claim) a time extension, the court had no jurisdiction to consider such a claim in defense of the LD assessment. The trial court agreed, as did the Federal Circuit on appeal.

The Federal Circuit’s ruling on appeal was as follows: “we hold that a contractor . . . must meet the jurisdictional requirements and procedural prerequisites of the CDA [Contract Disputes Act-the U.S. law that requires claims to be certified before they can be litigated], whether asserting the claim against the government as an affirmative claim or as a defense to a government action.” The Court saw no reason to distinguish between affirmative claims and matters of defense to government claims in applying the requirement for a certified claim prior to litigation, at least when the defense would involve an adjustment to the contract terms, as in the case of a time extension.

The dissenting opinion argued in vain that there is a clear distinction between presenting an affirmative claim for relief, where claim certification is required, and simply defending against a government claim, where no affirmative relief is sought.

The simple lesson of Maropakis is that whenever completing a U.S. government contract late, it is vital to submit a formal claim for a time extension so as to preserve your right to dispute a possible LD assessment (which may not come for several years). There are also two broader concerns. First, this is another brick in the wall of recent decisions by the Federal Circuit hostile to the position of Contractors. Contractors should be learning that they are not dealing with a tribunal at all inclined to give them the benefit of the doubt. Second, developments in the law relating to U.S. government contracts frequently spread to the U.S. private sector. Where private contracts require some sort of formalities associated with asserting a claim, the Owner may raise similar arguments, seeking to bar any ability to dispute its later assessment of LDs when the claim formalities were not followed to seek a time extension.

Andrew Ness
Christian Henel

Introduction

With the loss of capability of investment by the public sector, there was a global tendency in 80’s and 90’s to diminish the role of the State, with the privatization and concession of public services to the private sector. In Brazil, The Brazilian Privatization Program – PND, was instituted under the Law No. 8,031, of 04/12/1990, when the concept of privatization became an integral part of the economic reforms initiated by the Federal Government. At that time, all effort was concentrated on the sale of productive state owned companies, tied to strategic sectors, which allowed the inclusion of steel manufacturers, petrochemical and fertilizer companies in the PND.

Between 1990 and 1994, the Federal Government privatized 33 companies, 18 of which were controlled companies and 15 minority shareholder participations of Petroquisa and Petrofertil. Other eight auctions of minority shareholdings were held under Decree No. 1,068. Through these operations the Government obtained receipts of US$ 8.6 billion that, along with the US$ 3.3 billion in debt transferred to the private sector, brought the total to US$ 11.9 billion.

Due to the large amount of funds needed for the viability of infrastructure projects, private companies were incapable of compromising their budgets during the long course of maturation of such projects. The transfer of part of the infrastructure to private initiative, demanding substantial investments in its planning, development and operation, began to be financed by other agents and other sources, due to the integration of the partners in the respective projects.

Commercial banks, multilateral agencies, export credit institutions, pension funds, insurance companies and participants in international capital markets became important financiers of infrastructure projects in Brazil through Project Finance. As a financial model which adapts itself to the need of funds for projects developed by the private sector, Project Finance represents an important instrument to make investments in infrastructure viable in developing countries viable.

The Practical Use and Importance of Project Finance

Project Finance is usually defined as the financing of long-term infrastructure, industrial projects and public services based upon a non-recourse or limited recourse financial structure where project debt and equity used to finance the project are paid back from the cash flow generated by the project. In this context, it represents a financing technique which generally allows a company to raise funds to set up a project based on the feasibility of such a project and its ability to generate revenues at a level sufficient to cover construction and operational costs, as well as debt service and a return for the investor (cf. FINNERTY, John D. Project Financing: Asset-Based Financial Engineering. London: John Wiley and Sons, 2007, p. 4).

Projects like power plants, toll roads or airports share a number of characteristics that make their financing particularly challenging. Large-scale projects might be too big for any single company to finance on its own. On the other hand, widely fragmented equity or debt financing in the capital markets would help to diversify risks among a larger investors’ base, but might make it difficult to control managerial discretion in the allocation of free cash flows, avoiding wasteful expenditures. Project Finance is than used to strike a balance between the need for sharing the risk of sizeable investments among multiple investors and, at the same time, the importance of effectively monitoring managerial actions and ensuring a coordinated effort by all project-related parties.

Project Finance transactions require joint efforts from lenders, investors, suppliers, off takers and sponsors of the project in order to make feasible the implementation of a project, dealing with special challenges, such as:

(1) They require large indivisible investments in a single-purpose asset: Project Finance than deals have contemplated the creation of a special purpose vehicle with bankruptcy remoteness features, as a ring fencing technique, which usually results in credit enhancement for financiers and cost reductions for sponsors, although the creation of a project company is not necessarily a rule inherent to project finance;

(2) Projects usually undergo two main phases (construction and operation) characterised by quite different risks and cash flow patterns: Construction primarily involves technological and environmental risks, whereas operation is exposed to market risk (fluctuations in the prices of inputs or outputs) and political risk, among other factors. Most of the capital expenditures are concentrated in the initial construction phase, with revenues instead starting to accrue only after the project has begun operation; and

(3) The success of large projects depends on the joint effort of several related parties so that coordination failures, conflicts of interest and free-riding of any project participant can have significant costs: From the construction company to the input supplier, from the host government to the off-taker, all parties have substantial discretion in allocating the usually large free cash flows generated by the project operation, which can potentially lead to opportunistic behaviour and inefficient investments.

Trends of Project Finance Structures in Brazil

A. Detailed Financial Structure

In project finance, several long-term contracts such as construction, supply, off-take and concession agreements, along with a variety of joint-ownership structures, are used to align incentives and deter opportunistic behaviour by any party involved in the project. The definition of the advantages and limits of a Project Finance structure requires a detailed analysis of the various aspects must be made by those interested, involving, amongst others:

(1) A study of the structure that comprises Project Finance, detailing the advantages, the disadvantages and limits of each model;

(2) The criteria of evaluation and requirements established by the agents in charge of classification of credit and the respective impact on the composition of the interest rate of the financing;

(3) Identification, allocation and development and implementation of the criteria and methods to manage the risks involved;

(4) Formulation of an accurate economic-finance model to obtain the resources on the international market;

(5) Techniques and implications of the necessary due diligence; and

(6) Monitoring the project during its building and operational phases and respective management of financial documents, also contemplating the securitization of the receivables.

In Project Finance equity is held by a small number of sponsors and debt is usually provided by a syndicate of a limited number of banks. Concentrated debt and equity ownership enhances project monitoring by capital providers and makes it easier to enforce project specific governance rules for the purpose of avoiding conflicts of interest or suboptimal investments. The use of non-recourse debt in project finance further contributes to limiting managerial discretion by tying project revenues to large debt repayments, which reduces the amount of free cash flows. Moreover, non-recourse debt and separate incorporation of the project company make it possible to achieve much higher leverage ratios than sponsors could otherwise sustain on their own balance sheets.

Nonrecourse debt can generally be deconsolidated, and therefore does not increase the sponsors’ on-balance sheet leverage or cost of funding. From the perspective of the sponsors, non-recourse debt can also reduce the potential for risk contamination. In fact, even if the project were to fail, this would not jeopardise the financial integrity of the sponsors’ core businesses. One drawback of non-recourse debt, however, is that it exposes lenders to project-specific risks that are difficult to diversify. In order to cope with the asset specificity of credit risk in project finance, lenders are making increasing use of innovative risk-sharing structures, alternative sources of credit protection and new capital market instruments to broaden the investors’ base.

Hybrid structures between project and corporate finance are being developed, where lenders do not have recourse to the sponsors, but the idiosyncratic risks specific to individual projects are diversified away by financing a portfolio of assets as opposed to single ventures. Public-private partnerships are becoming more and more common as hybrid structures, with private financiers taking on construction and operating risks while host governments cover market risks.

There is also increasing interest in various forms of credit protection. These include explicit or implicit political risk guarantees, credit derivatives and new insurance products against macroeconomic risks such as currency devaluations. Likewise, the use of real options in project finance has been growing across various industries. Examples include: refineries changing the mix of outputs among heating oil, diesel, unleaded gasoline and petrochemicals depending on their individual sale prices; real estate developers focusing on multipurpose buildings that can be easily reconfigured to benefit from changes in real estate prices.

Finally, in order to share the risk of project financing among a larger pool of participants, banks have recently started to securitize project loans, thereby creating a new asset class for institutional investors. Collateralised debt obligations as well as open-ended funds have been launched to attract higher liquidity to project finance.

B. Partnering Construction Contractual Structure

Within time and the more use of Project Finance structures, parties have evolved to the use of Engineering Procurement Construction (EPC) – the favourite contract model for the lenders – and Engineering Procurement Construction Management (EPCM). Nevertheless, because the EPC contract approach shifts all the risk of project completion cost and performance onto the contractor’s shoulders, it tends to trigger an adversarial project team relationship, potentially leading to a breeding ground for conflict, contractual disputes and major claims that undermine the project’s financials and its ultimate successful outcome. Therefore, the challenge in Project Finance has been the adoption of the Alliance contracting as a viable, proven alternative to adversarial business-as-usual contracts.

Alliance contracting offers a unique system of project delivery whereby risks are shared between owner and contractor. They are incentive-based relationship contracts in which the parties agree to work together as one integrated team in a relationship that is based on the principles of equity trust, respect, openness, no dispute and no blame. Alliance contracting can relieve the pressure of the short-term demands on the industry and set the foundation for longer term structural improvement in the way the industry works. Also, significantly reduces, the risk of claims and disputation between the parties through the use of inclusive and collaborative legal and commercial arrangements. These arrangements enable the parties to work together in an open and generative manner and to strive to achieve the business goals of everyone in the relationship and can provide a bankable project delivery method even for project financing.

C. Submission to the Equator Principles

Project Finance transactions may encounter social and environmental issues that are both complex and challenging, particularly with respect to projects in the emerging markets. Large industrial and infrastructure projects, such as for power generation, are becoming increasingly conditioned to social and environmental risk assessments in order to be approved. In this context, Brazil is following the international trend to adopt the Equator Principles for Project Finance transactions.

Equator Principles represent a set of socioenvironmental guidelines adopted by 61 banks worldwide for financing projects amounting to US$10 million or more and are intended to serve as a common baseline and framework for the implementation by each lender of its own internal social and environmental policies, procedures and standards related to its project financing activities.

Today, 7 banks are signatories of the Equator Principles in Brazil. They work to ensure that the projects they finance are developed in a manner that is socially responsible and reflect sound environmental management practices. By doing so, negative impact on project-affected eco-systems and communities should be avoided where possible, and if this impact is unavoidable, it should be reduced, mitigated or compensated for, or both, appropriately.

Conclusion

The success in the financing of an infrastructure project, by means of Project Finance, depends on all the parties involved satisfactorily complying with their various contractual obligations under the Project Finance Documentation. Lenders, as well as the other participants, in accordance with the level of risk being assumed and in proportion to the benefits received from the implementation of the project, will undertake the due diligence needed to adequately measure the risks involved.

The viability of the Project Finance model, in short, is based on the consistency and efficiency of its network of agreements. Such documents must be structured and negotiated in a consistent manner with the respective legislation applicable in the jurisdictions involved, and be constructed in such a way as to allow full implementation of their respective terms and conditions, notwithstanding the natural complexity of the same, in a form which will satisfactorily identify, mitigate, allocate and allow the adequate management of the various risks involved in the Project Finance.

The Brazilian bullet train project

On July 13th 2010 Brazilian Federal Government launched bidding documents regarding the concession regime and procedures for implementation and operation of the High-Speed Rail (TAV – Trem de Alta Velocidade) that will connect the cities of Rio de Janeiro, São Paulo and Campinas. The project, the most ambitious infrastructure project under the country’s Program to Accelerate Growth (PAC – Programa de Aceleração do Crescimento), specifies that the construction, operation, and maintenance will be granted to the consortium that provides the lowest fare for service.

The concession contract establishes the limit of six years to complete the entire stretch Campinas – São Paulo Rio de Janeiro. The final schedule calls for the railway to be completed by 2017, although the Brazilian Federal Government anticipates the line will be partially open before the 2016 Summer Olympics in Rio de Janeiro.

TAV is worth US 20 billion. The Brazilian Federal Government will invest, through a new state-run entity, US$ 1.5 billion in the project and extend loans worth 60% of the total cost by the Brazilian Development Bank (BNDES – Banco Nacional de Desenvolvimento Econômico e Social).

Potential customers in the parcels market can be classified into two main groups:

- existing logistics companies, interested in moving consolidated loads, using rail as part of the chain – principal players in this field are the Brazilian National Post Office (Correios – Empresa Brasileira de Correios e Telégrafos) and Courier Companies; and

- end users, such as businesses, or individuals.

The construction of TAV will create a very large site, which will directly require numerous professional skills and directly or indirectly generate employment upline and downline The commissioning of the railway and, in particular, the development of land traffic and associated commercial zones served by the railway will create jobs in a progressive manner during the first 10 years’ of operation.

It is estimated that the railway will generate around 30,000 jobs throughout the area affected within about 10 years after commissioning. In addition a further 30,000 jobs could be generated by around 2050 in response to more fundamental shifts in the regional economy.

The choice of consortia contractor by the end of 2010

The Brazilian Federal Government will pick the contractor for the TAV in December 2010. Competitors must submit their proposals before November 29 and the winner will be announced on December 16 at the headquarters of Sao Paulo Stock Exchange (BOVESPA – Bolsa de Valores de São Paulo). Term of the concession is 40 years.

The line will be built and run on a concession basis and the government will rank bids based on the lowest fare, with a maximum permitted price of US$ 0.28 per kilometre. That would translate into economy class ticket fares up to US$ 115.00 for the 430 kilometres (270 miles) stretch between Rio and Sao Paulo.

International interest

The bidding is open to both Brazilian and foreign firms. News report that several countries and international companies have expressed interest in participating of the project:

- Austria;

- China (China Railway Materials);

- France (Alstom);

- Germany (Siemens);

- Italy (Ansaldobreda);

- Japan (Hitachi, Kawasaki, Mitsui & Co, Mitsubishi and Toshiba);

- Spain;

- South Korea (Hyundai and Samsung); and

- United Kingdom.

A new company called ETAV

Federal Government also proposed the creation of the Company of High Speed Rail (ETAV – Empresa de Transporte Ferroviário de Alta Velocidade), With the objective of planning and promoting the development of other high-speed rail lines in the country.

ETAV will be linked to the National Agency of Terrestrial Transports (ANTT – Agência Nacional de Transportes Terrestres) and will be also responsible for managing the technology used by the contractor that wins the High Speed Rail bidding process, in addition to monitoring the project’s deadlines.

Speed, locations and planned route

TAV proposal calls for trains to run at speeds of up to 350 kph (217 mph) and the trip between São Paulo and Rio de Janeiro is expected to last 93 minutes. Seven mandatory stations are be built on the line:

- City of Rio de Janeiro downtown area;

- Rio de Janeiro International Airport;

- City of Aparecida, State of São Paulo;

- São Paulo/Guarulhos International Airport;

- City of São Paulo downtown area;

- Campinas/Viracopos International Airport; and

- City of Campinas downtown area.

The planned route will include 90.9 km tunnels and 103 km bridges and viaducts. An extension to Campinas, 70 kilometres from Sao Paulo was planned with the purpose of reaching the heartland of Brazil’s richest manufacturing and farming state.

The planned route is as follows:

The U.S. Supreme Court has been deciding cases regarding arbitration at (for them) a furious pace recently, and the latest decision (Rent-A-Center West, Inc. v. Jackson, 2010 WL 2471058 (June 21, 2010)) reconfirms the Court’s continued strong support for enforcing arbitration agreements as written, even where this deprives the courts of any significant role in determining threshold questions of arbitrability.

The Rent-A-Center decision is complex, and well illustrates the very fine distinctions being made in the U.S. law of arbitration, but which have the net effect of strengthening the arbitrators’ role at the expense of the courts. The underlying broader issue is whether it is for the arbitrators or the courts to decide questions going to whether there is in fact a valid contract and a valid agreement to arbitrate (so called “arbitrability” or “gateway” questions). Under the longstanding Prima Paint rule, a challenge to the validity of the entire contract (including, but not specifically directed at, the arbitration clause) is to be decided by the arbitrators. But a challenge specifically to the validity of the agreement to arbitrate, or as to whether that arbitration agreement covers a particular dispute, is normally for the courts to determine. This, however, can be altered by the parties if they “clearly and unmistakably” demonstrate their intent to delegate such gateway questions to the arbitrators.

In Rent-A-Center, a former employee (Jackson) sued his former employer (Rent-A-Center) for employment discrimination. Rent-A-Center sought dismissal in favor of arbitration, based on an arbitration agreement signed by Jackson at the outset of his employment. That agreement (which covered only arbitration; other employment terms were in other documents) not only specifically provided that discrimination claims were to be arbitrated, but contained a separate “delegation” sentence giving the arbitrator “exclusive authority to resolve any dispute relating to the . . . enforceability . . . of this Agreement.” Jackson countered by asserting that the agreement to arbitrate was unconscionable and thus unenforceable.

The Supreme Court resolved the dispute in favor of arbitration by, in effect, extending the Prima Paint rule. It held, by a 5-4 margin, that since Jackson’s challenge to the enforceability of the arbitration agreement went to the entire arbitration agreement, and not specifically to the “delegation” sentence, then it was up to the arbitrator to determine the unconscionability challenge to the enforceability of the arbitration agreement. It was not a matter for the court to decide. This extension of the Prima Paint concept thus appears to further narrow the situations where the court gets to determine “gateway” issues, at least if the arbitration agreement is worded so as to delegate gateway issues to the arbitrators.

The lesson for construction practitioners is thus that the particular wording of the arbitration clause, and how, if at all, it delegates the arbitrators to determine arbitrability issues, is more important than ever. The specific wording, if deemed “clear and unmistakable,” may indeed immunize the parties from any scrutiny by the court of all but the narrowest and specific of challenges to the clause’s enforceability.

Andrew D. Ness

For the past 10 years, the private initiative has invested more in the Brazilian railway system than the Federal, State or municipal governments altogether (public initiative). With the prospect of a World Cup (2014), Olympic Games (2016) and lots of investments in the energy sector, Federal and State governments are willing to play a more decisive role on this area.

According to a survey recently disclosed by the Ipea – Institute of Applied Economic Research (www.ipea.gov.br), while private capital injections have grown steadily during this period, State investments have faltered. In 1999, public initiative counted only R$ 20.9 million in railways while private initiative channeled R$ 232.8 million. Public initiative’s peak occurred in 2007 with R$ 352 million when, at the same year, private initiative have soared and exceeded R$ 1 billion in 2004. In 2008 private initiative came to R$ 4.3 billion (led in Brazil by mining company Vale, steel company CSN, and logistics company ALL) and State’s investments downsized to R$ 237 million.

As public investments have not changed significantly during the last decade, railway works and network expansion have primarily counted on the funds raised by private concessionaires. The overwhelming presence of highway transportation has caused the railway system to account for only 30% of total transports in volume terms in 2008, as compared to more than 50% in other countries. This is one of the Brazilian infrastructure bottlenecks that impair long-term investments, since it is difficult to make country’s agricultural output flow smoothly.

The Brazilian railway network comprises 12 railways for cargo transportation stretching along circa 28 thousand km. Between 1999 and 2008, the cargo volume carried soared 79.6%, with emphasis on iron ore, pit coal, soybean, corn, sugar, and others. These products are primarily carried through the Vitória-Minas and Carajás railways, and by MRS Logística (controlled by Vale and CSN). For the sake of comparison, thanks to hefty public investments, China can already count on a railway network that stretches along 86 thousand km, and is planning to expand it to 125 thousand km in the next few years.

Ipea estimates that 141 new infrastructure railroad projects would be required to improve efficiency and competitiveness in this industry. Such priority works comprise, among others, the Transnordestina network linking the Brazilian ports of Pecém (CE) and Suape (PE); the North-South railway extension up to the Brazilian port of Rio Grande (RS); and the additional route along this same network to the interior region of São Paulo. Current Brazilian network could be expanded to at least 40 thousand km by 2020. At least R$ 40 billion (around US$ 22 billion) would have to be invested in these projects in the next 10 years.

Basic notes on some of the major projects to come:

1) North-South Railway (EF 151)

1st Parcel – 50% of the winning Auction bid, at the time of financial settlement, upon the signature of the Sub concession Contract and the delivery of the railroad section defined as: Palmas (TO) – Anápolis (GO), scheduled for December 2010.

2nd Parcel – 25% of the winning Auction bid, upon the delivery of the railroad section defined as: the Ouro Verde de Goias (GO) – Rio Verde (GO), scheduled for July 2011.

3rd installment – 25% of the winning Auction bid, upon the delivery of the railroad section defined as: Rio Verde (GO) – Estrela D’Oeste (SP), scheduled for December 2011.

2) West-East Integration Railway (EF 334)

1st Parcel – 40% of the winning Auction bid of financial settlement, upon the signature of the Sub concession Contract and the delivery of the railroad section defined as: Ilhéus (BA) – Caetité (BA), scheduled for July of 2012.

2nd Parcel – 30% of the winning Auction bid, upon the delivery of the railroad section defined as: Caetité (BA) – Correntina / Barriers (BA), scheduled for December 2012.

3rd Parcel – 30% of the winning Auction bid, upon the delivery of the railroad section defined as: Figueirópolis (TO) – Correntina / Barreiras (BA), scheduled for July 2013

Procurement conditions for participation in the railroad projects:

• Acquisition of the Bidding Documents (www.valec.gov.br)
• The participation of individual Brazilian and Foreign Companies is permitted
• The participation of consortiums between Brazilian and / or Foreign Companies in one Consortium is also permitted
• The presentation of a commitment to form a consortium indicating the participation of each member of the consortium and the leader
• The members of the Consortium will reply jointly and individually for all the actions taken with joint responsibility
• The Consortium can not alter its composition without the prior consent of VALEC (VALEC – Engenharia, Construções e Ferrovias S.A., a public company supervised by the ANTT – National Transport Agency and which has the concession for the North South Railway and the West-East Integration Railway)
• Competence in Public Administration
• Unconditional Acceptance of the Conditions in the Procurement Documents

With reason, non-Americans tend to be wide-eyed at the extent to which U.S courts require affirmative disclosure of potentially relevant documents and facts – and at the cost these discovery procedures routinely entail. One change just announced, however, represents a bit of retrenchment that will make handling construction disputes in U.S. Federal courts a bit less challenging. Specifically, a party will no longer need to disclose all communications with its retained expert witnesses, along with the experts’ draft reports, per a rule change scheduled to take effect on December 1, 2010.

Under current Rule 26 of the Federal Rules of Civil Procedure, all communications between legal counsel and a testifying expert who has been specifically retained to provide expert testimony, as well as drafts of that expert’s report, are subject to discovery by the opposing party. It is routine, not surprisingly, for the opposing party to request these documents. This then leads
lawyers and their testifying experts to go to great lengths to communicate in a manner that does not create a discoverable record, often at considerable expense and loss of efficiency. For example, substantive discussions about complicated and highly technical issues are limited to oral conversations, and the expert takes no contemporaneous notes. E-mails are similarly confined to purely administrative matters. Drafts of the expert’s report are not prepared. Sometimes, a duplicative “consulting” expert who will not testify has to be hired to provide assistance on issues where, if the testifying expert gets involved, the associated communications would all have to be produced. All this makes the process of retaining experts more costly and less efficient, and puts parties who cannot afford duplicate experts at a disadvantage.

This is all about to change, as the U.S. Supreme Court has recently approved amendments to Rule 26 that significantly alter current practice. (Congress can alter or block the amended rules, but this is not expected).

Under new Rules 26(b)(4)(B) and (C), most communications between the attorney and a testifying expert, as well as drafts of that expert’s report, will be covered by the work-product privilege and will no longer be subject to broad discovery rights. This will permit the attorney and the expert to communicate more freely about substantive issues, without the fear of those communications being obtained by the opposing party. The new rule has three exceptions, however: 1) the expert’s compensation; 2) the facts or data provided by the attorney and that the expert considered; and 3) the assumptions that the attorney provided and that the expert relied on; must all still be disclosed.

Another change relates to expert witnesses who are not required to provide a written report stating their opinions, because they are not retained or specially employed to provide expert testimony. Such “non-retained” experts are often used in construction disputes because project personnel are often subject matter experts, and therefore are permitted to testify as “hybrid” witnesses who provide factual testimony about events on the project, plus opinion or expert testimony in their specific area of expertise. While these experts do not need to provide a report, the rule changes include a new requirement to disclose the subject matter on which the witness is expected to testify as an expert, and to provide a summary of the facts and opinions that the witness is expected to offer. Draft versions of these disclosures, however, will be protected to the same extent as draft reports by “retained” experts. The revised portions of the Rules of Civil Procedure that will become effective December 1, 2010 can be found at:

http://www.supremecourt.gov/orders/ordersofthecourt.aspx

Todd Wagnon
Andrew Ness

On Monday, April 19, 2010, a federal judge in the Eastern District of Virginia handed down “the longest-ever prison sentence” for a Foreign Corrupt Practices Act (FCPA) violation. Charles Jumet was sentenced to 87 months in prison for conspiring to violate the FCPA and for making false statements to federal agents. Jumet, a vice president of Ports Engineering Consultants Corp. (PECC), pled guilty to paying over $200,000 in bribes to high-ranking Panamanian government officials between 1997 and 2003 in exchange for maritime contracts to maintain lighthouses and buoys along Panama’s waterways. (PECC’s president, John Warwick, also has pled guilty to the same conduct and is scheduled to be sentenced on May 14). In addition to the long prison term (over 7 years) Jumet was also sentenced to three years of supervised release and fined $15,000.

Neil MacBride, the U.S. Attorney leading the prosecution team, noted, “Bribery isn’t just a cost of doing business overseas. Today’s sentence makes clear that this is a serious crime that the U.S. government is intent on enforcing.” This statement succinctly illustrate the US DOJ’s commitment to prosecute individuals who violate the FCPA.

Assistant Attorney General Lanny Breuer has made no secret that the “prosecution of individuals is a cornerstone of [the DOJ’s FCPA] enforcement strategy.” “Put simply,” Breuer said in a November speech, “the prospect of significant prison sentences for individuals should make clear to every corporate executive, every board member, and every sales agent that we will seek to hold you personally accountable for FCPA violations.” Thus, the FCPA poses a hazard not just for corporate reputations and profits but also for the individual executive. Companies can be fined, but only individuals can be put in prison, and DOJ well knows that the prospect of a stretch in the Federal pen can have considerably greater deterrent effect than the possibility of your employer having to pay a fine. Look for more such announcements in the months and years to come, as FCPA enforcement efforts continue to escalate.

Fiona Philip
Andrew Ness

When forced to litigate in the U.S., many businesses – especially multinational ones – prefer to be in federal rather than state court. The U.S. Supreme Court just made it a bit easier to fulfill that desire.

Most construction disputes are contract cases not involving federal law, so a federal court will only have jurisdiction if the suit involves more than $75,000 and is between citizens of different U.S. states. The key question is usually: where is a corporation a “citizen” for the purpose of determining whether such “diversity of citizenship” exists?

By statute, a corporation is a citizen of both the state (1) where it is incorporated, and (2) where it maintains its “principal place of business.” While the state of incorporation is obvious, for nearly 60 years, federal courts have struggled to define a corporation’s principal place of business. Last month, the United States Supreme Court reconciled divergent tests and clarified this at last. In Hertz Corp. v. Friend, No. 08-1107, slip op. (Feb. 23, 2010), the Court held that a corporation’s principal place of business is just one place, its headquarters. By limiting corporations to one static principal place of business, Hertz increases the number of states where a corporation is not a citizen, meaning it increases the likelihood of getting access to the federal courts in a particular case.

For 60 years, the Circuit Courts of Appeal have been split over where a corporation had its principal place of business. Some circuits held it was the state containing the corporation’s “nerve center.” Others held it was any state where the corporation conducted significant activities. Thus, in the Ninth Circuit a corporation had a principal place of business wherever the corporation conducted “significantly larger” or “substantially predominant” operations. Under such fluid standards, corporations with a presence in all 50 states might be considered a citizen of most or even all 50 states, effectively precluding access to federal courts. What’s worse, the fluidity of the tests made it impossible to predict the outcome from one case to the next.

In Hertz v. Friend, Hertz was sued by California residents in state court. Hertz removed to federal court, asserting it was not a California citizen. The lower court concluded Hertz’s principal place of business was California under the Ninth Circuit test, Hertz was a California citizen, and thus there was no jurisdiction in federal court. The Ninth Circuit agreed.

The Supreme Court reversed, concluding that a corporation’s principal place of business is best interpreted as “the place where a corporation’s officers direct, control, and coordinate the corporation’s activities.” The Court noted in most cases, this should be the state containing the corporate headquarters, “provided that the headquarters is the actual center of direction, control, and coordination.” Id. Hertz’s headquarters is in New Jersey, so it was not a citizen of California and the federal court thus had jurisdiction.

With this relatively simple test for determining principal place of business, Hertz reduces the likelihood that a corporation will be deemed a citizen of more than two states, and makes predictable what those states are. So corporations should have relatively predictable access to federal courts in the remaining 48 states.

Michael McNamara
Andrew Ness

The U.S. has been a staunch supporter of arbitration since 1925, when the U.S. Arbitration Act became law. The Arbitration Act makes arbitration agreements binding and simple to enforce, without significant exception. Rather suddenly, a substantial backlash against mandatory arbitration has appeared on the scene. One of the clearest indicators is the proposed Arbitration Fairness Act (H.R. 1020) that was introduced in the House of Representatives in February of 2009, and is still very much in play. While the anger is not directed at construction dispute arbitration, the concern is that commercial arbitration will end up being limited in important ways, as well as mandatory arbitration schemes where the use of arbitration is seen as one-sided and unfair.

The proposed AFA would limit the scope of the Arbitration Act to exclude from its coverage: a) disputes between an employer and employee arising out of their employment relationship; b) consumer disputes between an individual and the seller or provider of real or personal property, services, money, or credit for personal, family, or household purposes; and c) disputes between a franchisor and a franchisee.
More significantly, the AFA would take away in all arbitrations the arbitrators’ authority to determine the validity and enforceability of arbitration agreements. This is a hallmark of U.S. arbitration law that has been generally successful in keeping courts from interfering in the interpretation and enforcement of arbitration agreements. It would be a major departure from current federal policy and several decisions of the United States Supreme Court.

Supporters of the proposed change believe that mandatory arbitration is being used in ways unfair to parties of unequal bargaining power who routinely fail to read the “fine print” mandating arbitration in many consumer transactions, such as when opening a bank account or obtaining a credit card. Among other objections, opponents fear that adding such restrictions would have the unintended consequence of reducing the effectiveness of arbitration as a cost effective remedy for commercial disputes. In reality, the pending legislation is likely to undergo significant revisions in both House and Senate committees before any final votes are taken.

While the construction industry is not specifically targeted by the AFA, concerns have arisen that subcontractors and suppliers, for example, may attempt to claim unequal bargaining power when confronted with standard arbitration clauses contained in many form subcontracts. As a result, those concerned about cost effective and efficient dispute resolution in the construction industry, both within the U.S. and internationally, are following the AFA’s progress through Congress closely.
Laura Kamas
Andrew Ness

Non-U.S. companies frequently ask whether they are eligible to compete for U.S. Government construction and renovation projects, whether within the U.S. or on U.S.-owned facilities abroad. The answer is a simple “yes” in the great majority of cases, unless the project requires access to secure or classified information. Much of the work on U.S. Embassies, for example, requires such access (and some is restricted to only U.S. firms). To work on a secure/classified project, the contractor must possess an Industrial Facility Clearance (FCL), issued in accordance with the National Industrial Security Program Operating Manual (NISPOM). So let’s consider the requirements for that.

To be eligible for an FCL, a company must: (1) need access to the classified information; (2) be organized under the laws of the United States; (3) have a reputation for integrity and lawful conduct; and (4) “not be under foreign ownership, control, or influence (FOCI) to such a degree that the granting of the FCL would be inconsistent with the national interest.” NISPOM ¶ 2-102. Factors considered here include the amount of foreign ownership, the type and sensitivity of information that will be accessed, and the company’s record of compliance with U.S. laws and regulations. NISPOM ¶ 2-301.

Translated, this means that the contractor needs to be a U.S. corporation, but that corporation can be foreign-owned or controlled (that is, a U.S. subsidiary), so long as it complies with the FOCI mitigation rules.

The FOCI mitigation rules are security measures to mitigate the extent of foreign control. One of the most commonly used measures is a Special Security Agreement (SSA). NISPOM ¶ 2-303(c). An SSA allows the foreign owner to maintain inside directors on the Board of the U.S. subsidiary/contractor, while excluding them from all decisions affecting the firm’s classified work. A Government Security Committee of independent, outside directors, approved by the U.S. government, oversees and ensures the proper handling of classified materials. What this means as a practical matter is that the foreign parent can have no influence or control over any decisions relating to the secure/classified project. For example, during the bidding phase the costs of the potential project can be discussed generally with the foreign parent, but the parent cannot be told of the security issues or the potential costs to comply with the security issues. Similarly, during performance, the parent can be told in general terms how the project is going, but cannot be told about a specific issue such as a blast-proof security wall that is causing a project delay.

Another mitigation method sometimes used is the establishment of a Proxy Agreement (PA) or Voting Trust Agreement (VTA). NISPOM ¶ 2-303(b). Under a PA or VTA, the voting rights regarding the foreign-owned stock of the U.S. subsidiary are vested in cleared U.S. citizens approved by the U.S. government. These Proxy Holders or Trustees become the directors of the corporation, to act independently from the foreign parent. Although the Proxy Holders must obtain approval from the foreign parent for major decisions, such as the sale of corporate assets or a corporate merger, the Proxy Holders or Trustees otherwise retain complete control, but the foreign parent still gets the financial benefit of its subsidiary’s operations.

Approval of FOCI mitigation measures is at the discretion of the government agency letting the contract, so there is no sure-fire guarantee of success. But by working with the government and being willing to implement those FOCI mitigation measures the government suggests, it usually is possible to obtain an FCL and compete for secure/classified U.S. Government projects.

Barbara Werther
Andrew Ness