Construction LawTrends in Construction Disputes in 2021

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Since 2016, the Government of Indonesia (“GOI”) has focused on developing infrastructure in the country. This is shown by, among others, the enactment of Presidential Regulation (“PR”) No. 3 of 2016 on Acceleration of National Strategic Projects (“PSN”) as amended several times, lastly by PR 109 of 2020 (“PR 3/2016”). Accordingly, there are (i) 12 (twelve) sectors containing 201 (two hundred and one) projects; and (ii) 10 (ten) programs.

The development of the PSN involves construction of relevant infrastructures over a certain long period of time so that disputes between the Contractor and Owner (“Parties”) may be unavoidable. Based on the Singapore International Arbitration Centre (“SIAC”) Annual Report 2019, there were 76 (seventy-six) claim applications related to the construction sector accumulating for 16% (sixteen percent) of the total claims. In the same year, 20% (twenty percent) of the total cases involving Indonesian parties in SIAC were about construction services. That figure had increased sharply from 2018 where claim applications from the construction sector only accumulated for 4% (four percent) of all cases.

It was also noted that because of disputes in the construction sector, there had been delays in some infrastructure projects, such as the waste-based power generation project in Surabaya that should have started operating in March 2021. Given the facts that many PSN developments and other types of projects are still ongoing, the following types of construction disputes are expected to arise in 2021:

1. Delay in the completion of work

The primary reason that possibly prevents the Contractor from being able to meet the completion date on time is the Covid-19 Pandemic. Since the World Health Organization declared Covid-19 a global pandemic on 11 March 2020, the GOI has issued several regulations to restrict the movement of goods and people within and to Indonesia, inter alia, by establishing Large-Scale Social Restrictions (“PSBB”).

Article 2 paragraph (1) and Article 4 paragraph (1) of Government Regulation No. 21 of 2020 on PSBB for the Acceleration of the Covid-19 Handling regulate that—upon approval from the Minister of Health—regional governments may establish PSBB in certain regencies/cities in the form of:
a. temporary closure of educational institutions and offices;
b. restriction on religious activities; and/or
c. restriction in public places or facilities.

Such closures and restrictions can in turn disrupt the delivery of materials used in construction services. As a result, the Contractor has to find alternative producers/suppliers, which could also lead to higher costs in procuring materials and additional works. Consequently, this may trigger a delay in reaching the completion date. This issue is still inevitable although several regions have issued regional regulations that allow temporary suspension of construction activities (e.g., DKI Jakarta), and there have been permissions to request changes in the specification of work (if the work has been determined to be temporarily suspended).

Such an exception is regulated under Regulation of the Governor of DKI Jakarta No. 33 of 2020 on Implementation of PSBB for Handling Covid-19 in DKI Jakarta, Decree of the Governor of DKI Jakarta No. 19 of 2021 on Enforcement, Term, and Restriction of PSBB for Outdoor Activities, and Instruction of The Minister of Public Works and Housing No. 02/IN/M/2020 on Protocol of Prevention of the Spread of Covid-19 in the Execution of Construction Services (“Instruction 02/2020”).

On the other hand, based on Article 54 of Law No. 2 of 2017 on Construction Services as amended by Law No. 11 of 2020 on Job Creation (“Law 11/2020”) (simultaneously referred to as “Law 2/2017”), the Contractor (and the Sub-Contractor) must complete the work that fulfills the requirements of the construction contract (“Contract”), namely the cost, quality, and time. Otherwise, the Contractor may be reluctant to pay for liquidated damages. In such a case, pursuant to the Contract provisions, the Contractor may request variations by means of an extension of time (“EOT”) and/or additional fees subject to the Owner’s approval. Then, disputes can possibly arise due to:
i. a whole rejection from the Owner since the procedures and requirements to request variations in the Contract are not fulfilled; or
ii. a partial rejection from the Owner e.g., different interpretation of:
• “cost” as to whether it is only a reimbursement or cost plus profit; and
• “additional works” as to whether the claimed works are qualified to be categorized as additional works eligible for EOT and adjustment of the Contract price.

The same problem as above can also occur between a Contractor and the Sub-Contractors.

2. Cost overruns

Another predictable dispute in the construction industry is a cost overrun. The details are as follows:
a. Industry closure
Since the Republic of China experienced the Covid-19 Pandemic in early 2020, imports of raw materials from China to Indonesia decreased by 31.43 % (thirty-one point forty-three percent). At the same time, many factories around the globe were closing their operations to comply with local regulations resulting in a shortage of equipment required so that the Contractor has to find another supplier/producer options with higher prices.

b. Additional costs related to Contractor’s employees
As explained in Point 1 above, restrictions on the movement of people are also related to mandatory protocols that must be implemented in the construction sector. Instruction 02/2020 regulates that as part of the Preventive Scheme of the Covid-19 Pandemic Protocol in the Construction Services Implementation (“Protocol”), the Protocol covers the Contractor’s additional obligation to provide additional health facilities, vaccines, vitamins, and additional nutrition for employees on-site (“Additional Health Facilities”). There are also some more costs when mobilization is required for employees/workers (“Employees”) such as costs for a swab and/or rapid tests.

In addition, Contractors as employers are not allowed to terminate the employment of the relevant Employees due to the Covid-19 Pandemic. Article 153 point (a) of Law 13 of 2003 on Employment as amended by Law 11/2020 (“Law 13/2013”) governs that employers are prohibited from terminating employment if the Employees are sick and absent from work for a maximum of 12 (twelve) months as evidenced by a statement letter from a doctor. In line with this provision, point (II) of Circular Letter of the Minister of Health of the Republic of Indonesia No. M/3/HK.04/III/2020 of 2020 regulates that employers are required to fully pay the wages of:
(i) Employees with the status of people under observation (ODP) who are absent for 14 (fourteen) days as evidenced by a statement letter from a doctor ;
(ii) Employees who are suspected of being infected by Covid-19 and are in a quarantine/isolation period;
(iii) Employees who are infected by Covid-19.

Employers can only adjust the wages of each Employee based on mutual agreement with a condition that the adjustment occurs because the Employers must comply with local regulations regarding restrictions in offices for:
• the prevention and handling of the Covid-19 Pandemic so that half or all of the Employees are absent; and
• the continuation of the employers’ business activity.

Please note that based on Article 154A points (c) and (d) of Law 13/2013, Employers can only terminate the employment of Employees if they are liquidated because of experiencing:
 a loss for 2 (two) consecutive years; or
 a force majeure event.

If a Contractor terminates Employees under the ground as stated in Article 154 (A) above and if a mutual agreement cannot be achieved, there are several procedures that must be carried out in stages i.e., delivery of written notification, bipartite discussions, and mechanism for resolving industrial relations disputes. Then, the Contractor must pay severance payment, and/or reward payment for the working term of the Employees, and substitution payment as regulated under Articles 151 and 156 paragraph (1) of Law 13/2013.

Points (a) and (b) above will increase the Contractor’s cost to complete the work. Similar to what has been explained in Point 1 above, the Contractor may request for variations, especially for additional costs. For point (a), the request for EOT may also possible. In this case, the Contractor is in a disadvantageous position.

Instruction 02/2020 declares explicitly that it is the Contractor’s obligation to provide Additional Health Facilities. Besides, under the design and, build; and engineering procurement and construction (“EPC”) contract scheme, the supply of materials for the completion of the works is under the Contractor’s scope of works. Apart from that, disputes can also arise between the Contractor and its Employees because of the existence of several requirements and procedures as regulated by laws, which may incur additional costs for the Contractor.

On the other hand, the Contractor may insist that such additional costs and works are not directly caused by the Contractor’s negligent act. Thus, the Contractor should be relieved from all costs and/or liability for losses incurred in connection with the project. The resolution of this kind of argumentation depends on the terms of the relevant Contracts.

3. Disagreement on the scope of force majeure

The first issue that may arise between the Parties to a Contract is whether or not the Covid-19 Pandemic must be classified as a force majeure event. Practically, this disagreement can possibly occur if the Parties, prior to the occurrence of the Covid-19 Pandemic, the Parties do not state in the Contract that any pandemic and/or epidemic are parts of a force majeure event. Article 1338 of the Indonesian Civil Code regulates that the Contract must bind the Parties and may only be revoked upon mutual agreement by the parties or by laws.

Contrary to the above, Presidential Decree No. 12 of 2020 on Stipulation of Non-Natural Disaster Covid-19 as a National Disaster (“Keppres12/2020”) issued on 13 April 2020 demonstrates that the Covid-19 Pandemic is a non-natural disaster but acknowledges it as a national disaster. In line with Keppres 12/2020, Instruction 02/2020 governs that if the Contract does not regulate the determination of force majeure events and temporary suspension of work due to the handling of the Covid-19 Pandemic, the Covid-19 Pandemic can be classified as a force majeure event if the criteria for identifying potential hazards on the site are met, as follows:

a. the construction activities are at high risk as the project site is in the center of Covid 19 – Pandemic’s red zone;
b. the construction activities involve employees who have been tested positive and/or they are in the status of Patients Under Observation (PDP); or
c. the head of the Minister of Public Works and the head of Civil Residents/body/instances/regional has issued regulations to temporarily suspend the construction activities due to a force majeure event.
(simultaneously referred to as “Identification Criteria”).

Then, the relevant construction activities may be suspended temporarily due to a force majeure event based on:
i. a report and recommendation from the local National Task Force for Covid – 19 Pandemic (Satgas Pencegahan Covid-19) to the Commitment Maker Authority (Pejabat Pembuat Komitmen);
ii. an agreement between the National Task Force for Covid – 19 Pandemic (Satgas Pencegahan Covid – 19) and the Commitment Maker Authority (Pejabat Pembuat Komitmen) approving the fulfillment of the Identification Criteria;
iii. approval of temporary suspension of the Authorised Budget User (Kuasa Pengguna Anggaran); and
iv. a stipulation of temporary termination made by the Commitment Maker Authority (“Temporary SuspensionStipulation”).

Consequently, after the Commitment Maker Authority issues the Temporary SuspensionStipulation, the construction activities must be suspended, and the Parties must be released from their respective obligations, subject to the Contract provisions.

Although the Covid-19 Pandemic can be determined as a force majeure event by law based on a case-to-case basis, this still cannot cease other issues related to the effects of the Covid 19-Pandemic as a force majeure event. Article 47 point (j) and its elucidation for Law 2/2017 stipulate that force majeure is a mandatory clause in the Contract which contains events that occur beyond the will and control of the Parties that cause loss to the Parties. Furthermore, there are two types of force majeure event, namely:
• absolute force majeure, in which the Parties can not execute their respective rights and obligations entirely, and

• relative force majeure, in which the Parties are still able to execute their respective rights and obligations.

Instruction 02/2020 does not define the classification of the temporary termination of work as either an absolute or relative force majeure event. It can be argued that since the term is “temporary suspension” and there is a specified period of the temporary suspensionin the Temporary Suspension Stipulation, the Owner may express that the Contractor must use its best endeavors to reduce delays and conduct remedy to the works. Also, the project must still continue upon the end of the period of the stipulated Temporary Suspension. As for any additional costs, the Owner can use a lump-sum basis as an argument for not changing the price nor imposing the additional costs to the Contractor.

Conversely, the Contractor as a Party who has a tendency to claim a force majeure event can choose:
 to claim a force majeure event to be eligible for additional costs and EOT; also to rebute that the unexpected costs must be borne by the Owner because the delay happens due to changes in laws and/or regulations; or
 to not continue the project if the unexpected costs are too excessive, including the Additional Health Facilities that it must bear under Instruction 02/2020.

In general, there is no specific scope of force majeure events under Indonesian laws. Similar to the FIDIC 2017 Conditions of Contract, Article 1244 and 1245 of the Indonesian Civil Code simply states that force majeure events are events which:
o are unexpected by the impacted Party;
o cannot be accounted for the impacted Party’s liability;
o occur without the bad faith from the impacted Party;
o do not constitute a deliberate act of the impacted Party; and/or
o may cause a forbidden act if the relevant obligations are implemented.

The impacted Party must provide evidence that it has experienced the above requirements of a force majeure event. Then, the Party can be released from the obligation to pay losses, fees, and interests.

It must be understood that when the Contractor claims a force majeure event by using Instruction 02/2020 as its foundation, the Owner may also claim the same. In practice, this means that the Owner will also be relieved from paying the Contractor. An issue then may arise when the Owner is unable to pay the Contractor for the part of the works that have been completed.

However, the basis for suspending or resuming work due to the Covid-19 Pandemic may depend on the relevant force majeure provisions under the Contract such as notification requirements, deadlines for releasing each Party’s obligation, and the effects of each prolonged and non-prolonged force majeure events on the work.

4. Bankruptcy

Due to the Covid-19 Pandemic, both the Owner and the Contractor may experience financial issues. On the side of the Contractor, if the project is a turn-key contract or an EPC contract, the Contractor may not be able to finance the project in advance because of the price for supplying the materials and for the labor-related costs increases. On the other hand, there are higher requirements from banks to apply for loan, withdrawal, and/or financial closing =

One example of a construction company that was under the status of bankruptcy was a joint operation named CNQC – Mitra (“Joint Operation”). It consisted of Qingjian International (South Pacific) Group Development Co. Pte. Ltd (a Chinese construction company) and PT Mitra Pemuda Tbk (an Indonesian construction company). The Joint Operation aimed to construct a building in Indonesia owned by PT Logos Indonesia Bekasi One. The declaration of bankruptcy was made through Decree of the Central Jakarta District Court No: 161/Pdt.SUS-PKPU/2020/PN. Niaga.Jkt.Pst on 11 November 2020 .

Just like the Contractor, the Owner may face a financial problem to pay the Contractor. Particularly, in the real estate sector, there have been substantial drops in property sales while there are still regular expenses (such as interest loans and operational fees) that must be paid by the Owner as a developer. The financial problem that is experienced by the Owner as explained above occurs in DKI Jakarta.

The Contract usually regulates that bankruptcy of either Party will result in termination of the Contract. In this case, a dispute is likely to arise when the Owner experiences bankruptcy and can not pay parts or all of the completed works, especially when the relevant Contract regulates that the Owner must pay the works that have fulfilled the specification, regardless of termination of the Contract. On the other hand, pursuant to article 55 of Law No. 37 of 2004 on Bankruptcy and Postponement of Debt Payment (“Law 37/2004”), creditors who have security rights over the relevant properties (“Separatist Creditors”) are prioritized to obtain proceeds from the sale of the debtor’s (the Owner’s) property.

In addition to disputes that may arise between the Contractor and the Owner, the disputes may also arise between the Owner and third parties, namely the buyers, especially in the construction of apartments. Pursuant to article 37 of Law 37/2004, if— at the time of the declaration of bankruptcy (“Decree”) of the debtor (the Owner)—the Owner has not delivered the relevant object as agreed in the agreements with a certain period of time, the relevant agreement is terminated by laws as of the declaration of the Decree. Then, the buyer is acknowledged as the concurrent creditor who can claim compensation for the losses. However, the buyers may only get the portion of the sale of the Owner’s property after the Separatist Creditors and the preferred creditors sequently. One example of the bankruptcy case between the Owner and the buyers is case No: 5/Pdt.Sus-Pailit/2020/PN Niaga Jkt.Pst between PT Sentul City Tbk (the Owner) and the Respective buyers. .

Conclusion

The four construction disputes predicted to occur in 2021 as described above are primarily as the results of the Covid-19 Pandemic that creates multiplier effects. Compared to the Owner, the Contractor is in an inopportune position particularly because delays in work will occur naturally while regulatory changes can possibly take place quite a long time afterward. Hence, the negotiation strategy to continue the project and to minimize losses for both Parties must remain in compliance with the Contract.

Below are the risk mitigations and recommendations that the Parties may take to reduce any risk associated with the four predicted disputes:

1. The Parties should review the entire Contract

Regarding events that will make the Contractor eligible for the EOT and/or additional costs, the Contractor must know the relevant procedures and requirements to claim for an EOT and/or additional costs. In this event, the Contractor may insist that the Owner provide additional costs and/or time because delays occur due to changes in laws and regulations.

With regards to the scope of force majeure events, the Contractor can request an amendment to the Contract. The Contractor can propose to include pandemic and/or epidemic as a force majeure event. If this step is impossible to take, the Contractor may argue that the Protocol is covered under “the acts of the GOI and/or public authority”, or rely on the catch-all clause, inter alia, “…. without limitation but subject to the provision under the Contract” because usually the Contract only regulates natural disaster as a force majeure event.

Moreover, the Contractors should also request an amendment to the specification of equipment and materials. This is necessary to avoid further difficulties in finding substitute producers and/or suppliers.

Lastly, the Contractor can also bring up outstanding payment issues that have not been paid by the Owner. The Contractor can also request a change in the date and stages of each milestone under the schedule so that the payment can be made earlier even in smaller amounts. This is to prevent bankruptcy claims to the Owner that may occur afterward in which the Contractor may not be the priority creditors.

2. The Owner should open discussions and/or negotiations with the relevant third parties as
there can potentially be a dispute between:
a the Contractor and its employees and/or labors; and
b the Contractor and the buyers

Similar to the explanation in Point (1) above, the Owner should be the initiator of the discussion regarding the possibility of reduction and/or postponement of salary payments, or postponement of the delivery of goods. This step is necessary because it shows the good faith of the Owner to carry out its obligations regardless of unforeseen circumstances.

 


ADCO Law earns the trust to represent clients from multinational companies to emerging entities across a wide range of industries to achieve their business objectives in Indonesia.

By combining commercial sensibilities and legal expertise, ADCO as a Law Firm Jakarta assists the clients to structure, organize and implement their business ventures and investments, including structuring, financing, and securing investments as well as establishing new foreign companies in Indonesia. Should you have more queries regarding this matter, please do not hesitate to contact us.

Dendi Adisuryo

Managing Partner
dendi.adisuryo@adcolaw.com

Aisyah Redita
Legal Counsel
aisyah.redita@adcolaw.com

+6221-52903034
info@adcolaw.com

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