Deregulation of Wholly Foreign-owned Infrastructure Projects: Problems and Solutions

Today we can say that there is a set of largely complete laws, regulations and rules that govern the supervision and administration of domestically funded and constructed infrastructure projects. For wholly foreign-owned infrastructure projects, the current legal regime provides adequately for the initial preparation period and clear and thorough regulations exist regarding project feasibility study reports.

Problems in the Construction and Operational Phases of Wholly Foreign-owned Projects

In contrast to the solid regulations that govern the initial stages of projects, the current legal regime has insufficient regulation regarding the construction and operational phases of a wholly foreign-owned infrastructure project. Parties may find, for example, that there are no legal grounds to solve problems specific to a particular project. Necessary rules may be lacking or current regulations might be insufficient. Moreover, the regulations governing wholly foreign-owned projects are different and/or inconsistent with those governing domestically funded projects. Among the problems, our experience shows that the worst problems lie in the areas of project quality and project costs.

Inconsistent Standards for Project Construction and Quality Control

In contrast to the detail of the regulations that govern domestically funded projects, the current legal regime governing wholly foreign-owned projects relies on contractual stipulations among the contracting parties as the basis for enforcing project quality standards.

As such, in case of disputes regarding such standards, it is likely that there may be no explicit or solid legal grounds to determine which standards should be followed, or even what the relevant standards are.

Infrastructure projects involve a large investment, a lengthy construction phase, a relatively low but stable investment return and a long period of project operation. Separately, an infrastructure project is usually a constituent part of a more complicated and larger project. Using a power project as an example, since a power plant is a part of an entire power grid, problems with the safety and stability of the plant obviously will threaten the operation of the entire grid. As a result, there may be direct and/or consequential damages, the extent of which cannot be evaluated in advance. Thus, the quality of a particular infrastructure project not only relates to the project itself, but also affects the public interest. We believe that the project quality of any wholly foreign-owned infrastructure project in China must be regulated. The relevant parties to a project, as well as the competent government authorities, must be granted the right to be involved in the supervision and control of the project, especially with regard to quality issues.

The Uncertain Relationship between the Chinese Parties and Foreign Investors

A domestically funded project is regulated by explicit rules regarding supervision and control of project quality and how liabilities should be shared among various parties, i.e., the project planning authority, the investors, the constructors and the entity that supervises and controls project quality. However, for wholly foreign-owned projects, the current legal regime does not set forth explicit regulations on project construction, project inspection and acceptance, and project operation. The issues related to these areas are left to the parties involved in the project and are subject to the stipulations in various contracts or agreements.

Furthermore, since an infrastructure project involves many parties, during the initial phases of the project the Chinese parties usually entrust one party to act on their behalf to reach a package arrangement and to sign a memorandum of understanding or letter of intent with the foreign investors. Gradually, as the negotiations progress, different issues involved in the same project are addressed in various contracts or agreements that have the status of independent legal documents. Finally, the different Chinese parties sign the contracts or agreements in the name of each party. Unlike a BOT project where there is a concession agreement providing stipulations regarding the local government and foreign investors, in non-BOT infrastructure projects, there is no contract or agreement that stipulates the strategic requirements of the Chinese parties acting for the foreign investors and/or the undertakings of the foreign investors. Also, although the memorandum or letter of intent indeed provides for the strategic requirements that the Chinese parties have regarding the foreign investors and regarding the undertakings to be made by the foreign investors, these documents may very likely be unenforceable by law if such documents are not deemed as a contract or the parties do not intend such a preliminary document to be binding. Consequently, the most fundamental relationship in a wholly foreign-owned infrastructure project in China