PLC Cross-border Construction and Projects Handbook 2010/11: Q&A.

21.06.2010

Vitaly Mozharowski, Partner, Real Estate & Construction

1. The construction sector

Please briefly describe the main trends in the construction market in your jurisdiction? What have been the most significant deals?

The key event in the construction market was the reform of design, engineering and construction licensing, which came into effect in January 2010. The list of trades which must be licensed has been markedly shortened, and licences are now issued by self-regulated associations of:

Civil engineers.

  • Designers.
  • Construction companies.

Previously, these licences were issued by the state authorities.

For further detail on licensing, see Question 19.

The largest projects of 2009 were PPP deals (see Questions 29 to 31).

2. Transaction structures and finance

What transactional structures and corporate vehicles are most commonly used in construction projects in your jurisdiction?

In the industrial sector, transactional structures are generally very simple, if not primitive, for example:

  • Parent company loans. 
  • Capital injections.

In relation to commercial real property construction, the most common structures are:

  • Special purpose vehicles (SPVs).
  • Joint ventures (JVs).
  • Investment contracts.

3.  How are construction projects generally financed?

The most common financings are either:

  • A combination of debt and equity. 
  • Relatively simple secured loans.

4.  What forms of security and contractual protections do funders typically require to protect their investments?

Security

Funders most often use the following forms of security:

  • Mortgage over the construction facility and the underlying land (freehold or leasehold).
  • Pledge of shares in the company which owns the assets, or its parent company.
  • Pledge of bank accounts.
  • Pledge of goods, stock and equipment.
  • Parent company guarantee.
  • Bank guarantee.

Contractual
The most common contractual protections used by funders include:

  • Warranties.
  • Step-in rights.
  • Assignments of contractual rights.

Main parties

5. What are the main parties involved in a construction project in your jurisdiction? What are the most common procurement arrangements between them.

The key party to a construction project is the developer, that is, a company that holds a land and building permit.

The other key parties are:

  • Contractor. This is a licensed company that is generally employed by the developer, or, sometimes, by the technical supervisor (see below, Technical supervisor). It is responsible for:
    • safety and security on the construction site;
    • reporting to supervising authorities; and
    • the employment and co-ordination of subcontractors (see below, Subcontractors).
  • Technical supervisor. This is a licensed civil engineering company, employed by the developer to control the general contractor's performance and compliance with regulations, including permits. The technical supervisor is employed on the basis that a developer does not possess special construction-related knowledge and experience. However, in other cases the developer can perform the technical supervisor's role, as long as it has a relevant licence (see Question 19). 
  • Subcontractors. These are licensed construction companies employed by the contractor for specific works, for example, concrete works, roofs, electricity lines and so on.
  • Engineering company. This is a licensed company that assesses the suitability of the site for development, including its soil, infrastructure, and so on. It is generally employed by the developer, but sometimes by the technical supervisor (see above, Developer and Technical supervisor).
  • Designer. This is a licensed designer that elaborates design documents. It is generally employed by the developer, but sometimes by the technical supervisor (see above, Developer and Technical supervisor).

Standard forms of contracts

6. What standard forms of contracts are used for large construction projects in your jurisdiction? Which construction organisations typically produce them?

There is currently no standard construction contract form for Russia.

International Federation of Consulting Engineers (Fédération Internationale des Ingénieurs-Conseils) (FIDIC) contract forms are often used for large-scale construction projects, although they are not very well suited to local practice and regulation (see Question 38).

7.  Do construction contracts for international projects differ from the standard forms of contract set out in Question 6? If yes, please give brief details.
Generally, large-scale international projects involve the use of various international standard form contracts, in particular, FIDIC contracts.

8. Do contracts for engineering projects differ from the contracts set out in Questions 6 and 7? If yes, please give brief details.
There are no standard contract forms that are specific to engineering projects in Russia.

Contractual issues

9. What risks are typically allocated to the contractor? How are these risks (such as material price escalation and ground conditions) offset or managed?
The contractor is generally allocated the risk of:

  • Accidental destruction of, or accidental damage to, the facility, materials, equipment or assets. This risk ceases to exist after the developer takes the facility over from the contractor.
  • Material price escalation and foreign currency rate fluctuations.

10. How can liability be excluded? For example, can the contractor exclude liability for indirect or consequential loss, and loss of business or profits?

Contractually, a contractor can exclude or limit liability for losses caused to the developer, for example:

  • Indirect or consequential loss.
  • Loss of profit.
  • Loss of business.

Force majeure clauses also generally exclude liability for contractual breaches (see Question 12).

Construction contracts typically state that in addition to damage for losses, there will be a cumulative penalty for contractual breaches (for example, a payment delay). Sometimes, the contract will provide that this contractual penalty will be awarded instead of damages, or that the developer will decide, at its discretion, whether either or both a contractual penalty and damages will be awarded.

11. Do the parties usually agree a cap on liability? If yes, how is this usually fixed?
Generally, damages are not capped, and the party suffering damage is reimbursed for damages and lost profit.

However, contractually, compensation for damages can be capped, for example, at:

  • A specific cap. 
  • Only direct losses.

12. Are force majeure exclusions available and enforceable in your jurisdiction?
Force majeure clauses are available and enforceable in Russia. Force majeure events are generally drafted to be extraordinary circumstances beyond the parties' control, for example:

  • Natural disasters (earthquakes, floods and so on).
  • Public disasters (riots, nation-wide strikes and so on).
  • Prohibitions of a non-individual nature by legislative and executive bodies.

However, certain events will not be considered to be force majeure events, for example:

  • Missing goods, plant or materials.
  • Changes to the market price of goods, plants or materials.
  • Changes to labour costs.
  • Subcontractors' or suppliers' delays or omissions to act.

13. How are construction professionals usually appointed? How are their liabilities dealt with in the contract?

In the private sector, construction professionals are typically appointed through tenders. Liability issues and other key terms are subject to negotiation.

In the public sector, tenders are mandatory.
 
14. What are the usual methods of payment for construction work? Are there ways to secure payment or mitigate risks of non-payment?

It is common for contractors to request an advance payment before starting works on site. This advance is generally secured with a bank guarantee. Then, the developer typically withholds a notable portion of the contract price until after both:

  • The facility has been commissioned.
  • An operation permit has been obtained.

The main portion of the contract price is generally payable by instalment according to a contractual payments schedule, based on the achievement by the developer of key milestones that are specified in the contract.

Payment methods and payments schedules are negotiable and subject to contract.

15. What contractual provisions are typically negotiated to cover material delays to the project?

Generally, the parties negotiate a contractual penalty for delay, which is calculated as a percentage of the contract price accrued and payable by the contractor for each day of delay.
 
When it is obviously impossible to finish the construction by the deadline fixed in the contract due to the contractor's fault, the developer can, by law, unilaterally terminate the contract and claim damages. To avoid disputes, it is advisable for the contract to specify the mechanism for such termination, for example, prior written notice and delivery of receipt.

16. How are material variations to the works usually dealt with in the contract (for example, the effect on timing and cost)?
The contractor's assignment, and the cost and scope of the works are determined in:

  • The technical documentation (including design brief and the detailed design).
  • Bills of quantities which are appended to the construction contract.

The employer can by law unilaterally vary the technical documentation, provided that:

  • The cost of such variation does not exceed 10% of the agreed contract price specified in the bill of quantities.
  • The variation does not change the character of works.

All other variations are subject to further negotiations with and consideration by the contractor.

17. How do the parties typically manage their relationships with subcontractors?

Unless otherwise stipulated in the construction contract, the contractor can, without the developer's consent, use third parties to execute the works. The contractor remains responsible towards the developer for subcontractors' breaches of their obligations. The subcontractors are only liable towards the contractor, and cannot claim against the developer.

The parties can agree in the contract that the contractor will only appoint subcontractors with the developer's prior consent, which cannot be unreasonably withheld. The contract can provide for a list of pre-approved subcontractors. However, this does not affect the contractor's liability towards the developer.
 
18. What other main contractual provisions do the parties usually heavily negotiate?
The parties typically heavily negotiate the following other main contractual provisions:

  • Co-operation. Because the construction process involves the developer engaging many parties (the technical supervisor, technical consultants, designers, contractors and so on), it should explicitly specify how these parties will co-operate and co-ordinate.
  • Connection to utility supplies during construction. The developer and the contractor will negotiate who is responsible for temporary power, water and steam supply, and who will contract with the relevant source suppliers. Unless the contract states otherwise, the developer will procure the connection to utility supplies.
  • Warranty. A warranty will secure the contractor's performance of its obligations, and rectification of any breaches. This warranty can only be issued by a bank. It is highly advisable for the warranty's governing law to be the same as that of the contract. If foreign contractors offer non-Russian law guarantees, in practice this is not an effective enforcement tool for the developer.

Licensing requirements

19. What licences and other consents must contractors have to carry out construction work in your jurisdiction?

Before carrying out construction work, a contractor should ensure that the following are in place:

  • Construction licence. Licences for specific work types are issued by self-regulated associations (SROs) of construction companies accredited by the Federal Construction Supervision Authority. There are a hundreds of licensable types of construction works.
  • Design authorisation. The Regional State Expertise on Design issues a "positive statement" on a design, which confirm a design's compliance with laws and standards. 
  • Building permit. Local municipality mayors issue building permits.

Design, engineering and construction licensing was reformed in January 2010 (see Question 1).

Insurance

20. What types of construction-related insurance must be maintained by law? Are other non-compulsory types of insurance maintained under contract?

There is no statutory requirement to procure insurance under a construction contract. Therefore, legally, the parties are free to decide which risks they will insure.

However, to obtain a construction licence, a self-regulated association will require that a candidate has available and keeps in full force an insurance policy. The scope and terms of the insurance coverage will be determined by the relevant association.

The most commonly insured risks are those relating to:

  • Loss and damage to equipment, machinery, devices, construction materials and other property used in the course of construction works. This includes accidental loss.
  • Losses incurred by the staff of the contractor, developer and any other third party during the course of construction.
  • Destruction, damage to, or loss of the facility.
  • Existing buildings and facilities that are being rebuilt or are situated near the construction site.

Labour laws


21.  Are there any labour law requirements for hiring (domestic and foreign) construction employees.


National workers

If construction employees are being hired for work that is dangerous or implies a health risk, the employer:

  • Must arrange for the employee to have a preliminary medical examination when the contract is entered into.
  • Cannot employ persons under 18 for this work.  

In addition, construction employees must have documentation that demonstrates their qualification for the work that they will undertake.

There are no other special labour law requirements for hiring construction employees.

Foreign workers

Statutory immigration requirements for the employment of foreign employees apply.

In general, this means that foreign construction employees can only be employed if they have a work permit. However, foreign citizens can work in

Russia without a work permit provided that both:

  • They are employed by a foreign legal entity, that is, a production or selling company.
  • Their work involves providing:
    • installation services;
    • technical support services;
    • warranty services; or
    • follow-up servicing of technical equipment supplied to the Russian Federation.

 

22.  Which labour laws are relevant to construction projects? For example, minimum wage laws or restrictions on working hours.

There are no special labour laws for construction projects. However, Russian law guarantees additional minimum protection for employees undertaking work that is dangerous or implies a health risk, including:

  • A shorter working day.
  • Additional paid holiday.
  • Higher salaries.
  • Compensation for dangerous or unhealthy work.

Construction employees who undertake certain works stipulated by statutory rules have the right to an early pension.

23.  Does an employer have to pay statutory redundancy or other payments at the end of a construction project? Are all employees eligible?

If a construction employee works under a fixed-term employment contract, the employer does not have to pay him statutory allowances at the end of the project, other than mandatory payments, for example, his salary and pay for untaken holiday.

This is provided that there were legal grounds to have entered into a fixed-term contract. For example, a fixed-term contract is allowed if the employee will:

  • Perform at the most two months' work.
  • Work beyond the framework of the employer's ordinary activity.

If a construction employee works under an indefinite contract and the employer makes him redundant, the employee is entitled to receive statutory redundancy pay.


Health and safety laws

24.  What health and safety legislation applies to construction projects in your jurisdiction?

Health and safety legislation is set out in numerous laws and standards. The main health and safety legislation applicable to construction work is set out in:

  • The Labour Code.
  • SNiP 12-03-2001 (which sets out rules on safety of work).
  • Gosstroy Regulation No. 80 of 23 July 2001.
  • SanPiN 2.2.3.1384-03 (which sets out sanitary rules).
  • Order of the Ministry of Emergency Situations of Russia No.313 of 18 June 2003 (which sets out requirements on fire safety).

The main obligations of the employer under this legislation are:

  • The provision of employment conditions (including health and safety and a labour and rest regime) that correspond to labour law requirements.
  • Certified methods of individual and collective protection of employees.
  • The acquisition of certified special clothing, special footwear and other means of individual protection.
  • Safe working methods and technique trainings for employees.
  • The non-hiring of persons who are not sufficiently trained.
  • The organisation of mandatory (preliminary and periodic) medical examinations (see Question 21, National workers).
  • The certification of work places.

 

Environmental issues

25.  Please briefly set out local legislation regulating the effect of construction projects on the environment, in particular in the areas of:

  • Air.
  • Water.
  • Waste.
  • Environmental impact assessments.
  • Sustainable development.

Environmental protection legislation is based on the presumption of the potential environmental danger of any anticipated construction activity.

Therefore, the design documentation for each construction project is examined by the state and requires an environmental impact assessment (EIA) in relation the following issues before it can be implemented:

  • Air protection measures.
  • Recycled water supply measures (for industrial facilities).
  • Measures for the protection and rational use of soil, including:
    • measures for collecting, using, decontaminating, transporting and placing hazardous waste; and
    • subsoil protection measures (for industrial facilities).
  • A programme to monitor any change in the ecosystem during, among others, construction and operation of the facility.

An EIA is mandatory and requires the local community to be informed of any anticipated construction activity. The local community's comments are included in the EIA.

26.  Are buildings required to comply with carbon emissions or climate change targets?

There is not yet any requirement to comply with carbon emissions or climate change targets, for example, the Kyoto Protocol, under Russian environmental legislation.


Corrupt practices


27.  Are there any rules prohibiting corrupt business practices and bribery (particularly affecting construction projects)? Please set out any civil and criminal penalties that apply.

Local and foreign companies are liable under administrative law for bribery.

Individuals can be criminally prosecuted for bribery and incitement to bribery. The punishment can be:

  • A fine. 
  • Correctional work. 
  • Arrest.
  • Imprisonment.

The imposition of an administrative penalty on a company does not exclude criminal prosecution of an individual, and vice versa.

Insolvency

28.  What rights do the client and funder typically require on the contractor's insolvency?

From a purely legal point of view, insolvency is not a legal ground for contract termination (until the contractor is actually liquidated). However, in practice it is quite common for the contract to specify that insolvency is an acceptable termination ground which gives a right to employ a new contractor.

 

PPPs/projects

29.  Are public private partnerships (PPPs) common in construction projects in your jurisdiction? If yes, which sectors commonly use PPPs?

PPPs are a new concept in Russia. The first PPP projects in Russia have been launched in the last two years, and related to the transport and municipal infrastructure sectors. They included:

  • Rebuilding Pulkovo Airport in St Petersburg.
  • Concessions relating to motorways between Moscow, Minsk and St Petersburg.

30.  What legislation applies to PPPs in your jurisdiction?

The following legislation applies to PPPs in Russia:

  • Federal Law No. 115 dd. of 21 July 2005 on Concession Agreements (as amended).
  • Federal Law No. 94 dd. of 21 July 2005 on the Supply of Goods, Works and Services for State and Municipal Needs (as amended).
  • Various regional laws to encourage PPP projects.

31.  Please briefly outline the typical procurement/tender process in a PPP transaction.

PPP projects generally awarded through a tendering process. The key stages to a tender are:

  • The public authority makes a public announcement of the tender in the mass media, no less than 30 days before the deadline for filing applications for the pre-selection stage.
  • Potential bidders pay tender deposits and file applications for the pre-selection stage.
  • The tender commission selects the bidders based on formal criteria (at least two bidders must be selected).
  • The public authority makes a public announcement of the qualifications required to select from these pre-selected bidders, no less than 60 days before the deadline for filing bidders' applications for the qualification stage.
  • Pre-selected bidders file applications for the qualification stage.
  • The qualification tender takes place.
  • The winner is announced in the mass media.
  • The concession agreement is executed.

 

Construction dispute resolution

32.  What are the most common dispute resolution methods used in your jurisdiction?

The most commonly used dispute resolution method in Russia is litigation. Arbitration is also used, although less often than litigation (see Question 33).

33.  What are the most common alternative dispute resolution (ADR) methods used? (Consider, if relevant, adjudication, dispute review boards and expert determination.)

Arbitration is the most common ADR means used for the settlement of construction disputes. This method has become increasingly popular during recent years, but is still used less frequently than litigation (see Question 32).

Other ADR methods, for example, adjudication, are occasionally used.

34.  Which courts usually deal with construction disputes in your jurisdiction? Are there any specific construction courts or tribunals?

Most construction disputes fall under the jurisdiction of commercial state courts ("arbitrazh" courts), which are competent to adjudicate on disputes between legal entities arising out of commercial activity. There are no specialised courts for construction disputes in Russia.

35.  Which organisations are usually used to arbitrate construction disputes in your jurisdiction (please include their website address)?

The following organisations are used to arbitrate construction disputes in Russia:

• The International Commercial Arbitration Court at the Chamber of Commerce and Industry of the Russian Federation (www.tpprf-mkac.ru/indexeng.php).
• The Arbitration Institute of the Stockholm Chamber of Commerce (SCC) (sccinstitute.se/?id=23696).
• A few domestic arbitration institutions.
Construction tax

36.  What are the main tax issues arising on construction projects in your jurisdiction? For example: 

  • Value added tax (VAT)?
  • Stamp duty/transfer tax (or equivalent)?


Recovery of input VAT

Construction typically generates massive amounts of input VAT that is subject to recovery. At the same time, there is often lack of output VAT on sales to consume this input VAT. Although this excessive input VAT is technically recoverable, the Russian tax authorities are generally reluctant to refund any excess in cash immediately. As a result, timely refund of input VAT on construction often requires court litigation. This can have a major impact the timing of the cash flows of the project.

Double tax treaty exemptions for construction

Many double tax treaties signed by Russia provide exemptions under which a construction site will not be deemed a permanent establishment within a certain period (typically 12 to 18 months). This avoids the imposition of profits tax. However, the rules are not sufficiently detailed, and are subject to interpretation by the Russian authorities, which sometimes argue that a particular type of operations is not eligible for the exemption. Therefore, great care should be taken to ensure that all conditions of the exemption are complied with.

Interest deductibility restrictions

The deductibility of interest expenses is capped in Russia at 15% per annum for foreign currency loans. Therefore, if a foreign currency loan is tranched and the interest on any of these tranches exceeds 15% (for example, if payment-in-kind loans are used), loan tranches should be blended together in an SPV.

Russia also has thin capitalisation rules that, as a general rule, restrict deductibility of interest on loans from foreign direct or indirect owners (or Russian entities affiliated with or providing guarantees to these owners), if the loan exceeds three times the borrower's net assets, calculated according to Russian accounting rules.

Russian tax law currently contains a loophole exempting loans from thin capitalisation rules if they are provided by foreign "sister companies" (that is, companies that are not in the borrower's direct ownership chain). However, this loophole could be closed at any time.

Infrastructure transferred to local government

Russian tax law does not explicitly allow parties to deduct infrastructure costs that they transfer to local authorities or infrastructure entities as part of property development. Although it has been a market practice for property development companies to expense these items, the tax authorities continue to challenge their deductibility.

Restricted deductibility of leasehold improvements

Current rules on the deductibility of leasehold improvements often do not allow the lessee to reliably claim deduction for the cost of these improvements over the course of the lease. This often forces the parties to devise special solutions (incorporating the cost in the rent) to achieve this deductibility.

37.  Are any methods commonly used to mitigate tax liability on construction projects? Are there any tax incentives to carry out construction regeneration projects?

The most common ways of mitigating tax liabilities are as follows:

  • For construction not aimed at re-sale, it may be beneficial to perform the construction within the operating company rather than in a separate legal entity, to speed up the input VAT recovery.
  • Using internal debt (through special purpose finance vehicles) aimed at generating additional tax-deductible interest expenses. This avoids Russian withholding tax on cash repatriation, and restrictions on the distribution of dividends.
  • For real estate development projects, it is common to arrange for the project to be owned by a foreign company located in a jurisdiction with which Russia has double tax treaty (for example, Cyprus), to avoid capital gains on the subsequent re-sale of the Russian property company.

Cross-border issues

38.  Please outline any special considerations for foreign contractors operating in your jurisdiction. For example:

  • Special licensing or other requirements for foreign contractors.
  • Legal or practical considerations that may restrict foreign contractors.

There are no special requirements for foreign entities with respect to licensing or other requirements.

However, foreign contractors should:

  • Be aware that in practice, Russian civil law is often used for construction projects. Standardised contract forms (for example, FIDIC contracts) will need to be adapted to fit Russian civil law requirements (see Question 6).
  • Ensure that foreign and national workers have been correctly hired (see Question 21).
  • Consider whether certain documentation will be enforceable if it is not governed by Russian law (see Question 18).
  • Familiarise themselves with Russian public law procedures and regulation that affect construction, for example, relating to:
    • health and safety regulations and compliance (see Question 24);
    • environmental protection (see Question 25);
    • accounting law provisions; and
    • documentation preparation.

Reform

39.  Are there any proposals to reform construction law in your jurisdiction?

There are legislative initiatives in Russia to simplify the regulation and permitting of construction, to render the statutory requirements more liberal. However, these reforms are not expected to become law until two or three years' time.

In addition, Russian regions and municipalities are currently elaborating zoning and planning rules. This town planning reform is expected to take another one to three years.

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