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Managing construction risks in Asia-Pacific
India
Insight

Managing construction risks in Asia-Pacific: India

In recent years, the construction industry in India has emerged as an attractive destination for foreign investment. To support this heightened interest, the government of India has enacted an attractive foreign direct investment policy.

The construction industry in India consists primarily of two segments: real estate and urban development.5 The real estate segment covers areas such as residential premises, office premises, hotels and leisure parks.6 The urban development segment consists of infrastructure for water supply, sanitation, urban transport and healthcare.7

By 2025, the construction market in India is expected to emerge as the third-largest globally, with output expected to grow on average by 7.1 percent each year.8

India is a common law country, with its laws based historically on English law.

Contract Act,

1872

The Indian Contract Act codifies Indian contract law, and is rooted in English common law

 

Are there any restrictions on foreign investment?

In recent years, the construction industry in India has emerged as an attractive destination for foreign investment. For the construction sector, to support this heightened interest, the government of India has enacted an attractive foreign direct investment policy (FDI Policy) that provides a clear, predictable and secure framework. For context, all inward foreign investments into India must meet the eligibility criteria stated in the FDI Policy. Under the FDI Policy, foreign investments fall under two routes, namely, (1) automatic route (where prior government approval is not needed) and (2) approval route (where prior government approval is needed). The construction sector falls under the "automatic route."9

Thus, there are no restrictions on foreign investment in the construction sector.

However, in light of the COVID-19 pandemic, India has imposed certain foreign investment restrictions aimed at preventing "opportunistic takeovers or acquisitions of Indian companies" by investors situated in countries that share a land border with India.10 These restrictions extend to sectors otherwise covered under the "automatic route" such as the construction sector. Since these restrictions are responsive to the evolving situation created by the COVID-19 pandemic, they are subject to change from time to time.

Disputes under construction contracts can either be resolved through the dispute resolution mechanism agreed in the contract or through avenues available at law if no contractual mechanism exists

 

Is your contract enforceable under Indian law?

The Indian Contract Act, 1872 (Contract Act) codifies Indian contract law, which is rooted in English common law, with elements of civil law, equitable law and customary and religious laws.

The Contract Act defines a "contract" as "an agreement enforceable by law."11 Under the Contract Act, for a contract to be enforceable by law, it must meet these requirements: offer and acceptance; free consent; capacity to contract; lawful consideration; lawful object; and the contract must not have been expressly declared as void.12

Consequently, under Indian law, all contracts including construction contracts must meet these criteria to be enforceable. There is no separate regime governing construction contracts in India.13

There is no "Indian" standard-form construction contract. Instead, in the construction sector, contracting parties often prefer to use conditions such as the FIDIC form contracts for their project requirements. That said, for government contracts, often the ministry or department prescribes the underlying construction contract.14

Both bespoke construction contracts and forms such as FIDIC, NEC, etc., are enforceable under Indian law if they meet the requirements of the Contract Act.

a. Penalty or liquidated damages clauses

Under the Contract Act, there are two main remedies for breach of contract: damages and specific performance.

The non-breaching party can bring a claim for damages under either Section 73 (damages for breach) or Section 74 (liquidated damages) of the Contract Act.

Generally, Indian courts will enforce a liquidated damages clause if it is a genuine pre-estimate of losses resulting from a breach of contract. However, if an Indian court deems that the liquidated damages clause is actually a "penalty" clause, then it will not enforce it.

Indian courts acknowledge that different classes of contracts may exist, for which it is impossible to assess compensation for breach.15 In such cases, Indian courts defer to any liquidated damages provision contained in the contract.

Nevertheless, where a non-breaching party is in a position to prove its actual loss, it should do so. Simply invoking the liquidated damages clause in the underlying contract will not entitle the non-breaching party to liquidated damages unless it actually proves its loss.16

In case of liquidated damages, Indian courts will only award reasonable compensation "not exceeding the amount so stated." This gives the courts discretion to consider what amount of damages is reasonable and whether to award the full amount stated as liquidated damages in the contract.

b. Exclusion and limitation of liability clauses

Exclusion or limitation of liability clauses are valid under Indian law. Parties to a construction contract are free, for example, to exclude liability for indirect and consequential losses.17 A limitation of liability clause could also cap the liability of the contractor, usually agreed as a percentage of the contract price.

Most construction contracts, however, carve out from exclusion or limitation of liability clauses fraud, willful misconduct, recklessness or gross negligence. Establishing any of these exceptions generally requires the non-breaching party to discharge a high burden of proof.

Indian courts construe limitation or exclusion of liability clauses strictly and they are unlikely to go beyond the terms of the contract.18 Usually, Indian courts will enforce a limitation of liability clause, unless doing so defeats the purpose of the contract or is against the public interest or public policy.19 Where an exclusion of liability clause is inconsistent with the main purpose of the contract, Indian courts will not apply the clause to the extent of any inconsistency.20

c. Conditional payment clauses

The Contract Act recognizes the validity of pay-when-paid clauses. Such clauses provide that the payment to subcontractors may be subject to payment by the owner to the main contractor if so agreed by the parties under the subcontract. The subcontractor will have to bear the risk of the owner's non-payment.21 That said, pay-when-paid clauses are not a common industry practice.22

7.1%

The output of the construction market in India is expected to grow by 7.1% each year by 2025

 

How does a contractor secure adequate cash flow in India?

From a legal standpoint, a contractor can secure adequate cash flow in several ways under the Contract Act:

  • First, a contractor may suspend performance of its obligations under a construction contract on grounds provided for in the contract. Grounds for suspension may include non-payment for work performed, non-fulfillment of conditions upon which the performance is contingent, force majeure, etc.23
  • Second, the contractor may place liens on the property, as Indian law recognizes the contractual right to lien of a party to a contract24

Apart from these general contractual mechanisms, there are no statutes protecting unpaid contractors per se in case of interruption or cancellation of major projects.25

US$
454.8
billion

Demand for construction in India in 2015 – 2020

 

When does a right to terminate arise from a breach of contract under Indian law?

Under Indian law, the Contract Act entitles a party to terminate a contract under these circumstances:

  • Section 39 of the Contract Act entitles a party to terminate a contract if the other party refuses to perform its promise in its entirety. However, if the party entitled to terminate the contract allows the breach and acquiesces to the contract continuing despite the breach, then this ground for termination no longer remains available
  • Section 53 of the Contract Act entitles a party to terminate a contract for breach if, in case of reciprocal promises, one party prevents the other party from performing its part of the contract. In such a case, the party prevented from performing its obligations has the option of terminating the contract
  • Section 55 of the Contract Act entitles a party to terminate a contract if "time is of the essence" and the other party fails to perform its obligations within the stipulated time. In such a case, the non-breaching party has the option of terminating the contract

The termination of a contract obliges parties to restore any benefits that they have received under the contract. The parties may additionally claim damages and compensation that are foreseeable and arising from the breach of contract, as provided under Sections 73, 74 and 75 of the Contract Act.

When a breach of contract arises, a party may exercise its right to terminate under the contractual provisions or under the Contract Act.

The parties may prescribe certain circumstances that allow either party to terminate the contract. Examples include completion of work beyond a certain time limit, force majeure, liquidation or bankruptcy, abandonment of work, and failure to carry out remedial work, and failure to secure relevant local licenses or permissions.

India’s ongoing efforts to modernize its arbitration landscape have led to the establishment of new arbitration institutions

 

When might the parties' obligations be amended, or performance excused due to unforeseen circumstances?

The Contract Act permits the amendment of contractual obligations, or excuses performance in two scenarios: occurrence of a force majeure event; or occurrence of an event that renders performance impossible (also called frustration of contract).

Force majeure applies only if agreed. If the contract contains a force majeure clause, then amendment of obligations or exemption from performance will depend on the language and scope of the force majeure clause.

Force majeure typically occurs when:

  • An event beyond the control of the contracting parties occurs
  • It prevents the affected party from meeting contractual obligations and
  • The event is unforeseeable and its impact cannot be mitigated

Generally, a force majeure clause will include specifically events such as floods, sabotage, earthquake, strikes, riots, epidemics, etc. They sometimes exclude circumstances from their coverage, such as fluctuations in foreign exchange rates, increases in costs of machinery, equipment, materials, spare parts, etc.26

In the case of construction projects, contracts usually contain detailed risk allocation provisions outlining who bears the risk of unforeseen circumstances such as force majeure or impossibility of performance.

Section 56 of the Contract Act deals with "impossibility of performance" or frustration. Frustration occurs when it becomes physically or commercially impossible to perform the contract; performance becomes unlawful; or contractual performance becomes radically different from what the parties had contemplated when entering into the contract.

To invoke Section 56 of the Contract Act, the frustration event:

  • Must occur after the contract has been signed
  • Could not have been foreseen by the parties
  • Cannot be in the control of any party and
  • Cannot have occurred due to any fault of the parties themselves

Fulfilling all these conditions will exempt a party from performance. Section 56 does not apply when performance merely becomes inconvenient, economically infeasible, burdensome or onerous.27 Further, if the party undertaking performance knew, or, with reasonable diligence could have known that performance was or would be impossible or unlawful and if the other party did not know this (or could not reasonably have known this), then the party that has undertaken such performance must compensate the other party for any loss sustained due to such non-performance.

 

How can disputes under construction contracts be resolved?

Disputes under construction contracts can either be resolved through the dispute resolution mechanism agreed in the contract or through avenues available at law if no contractual mechanism exists.

India does not have any specialized courts or tribunals that deal with construction disputes. Nonetheless, the Commercial Courts Act 2015 empowers commercial courts in India to adjudicate disputes arising out of construction contracts.

Below is a brief overview of each available mechanism:

  • Dispute boards: In construction disputes, it is quite common for parties to refer their disagreement for adjudication to a dispute board first. However, the decision of the dispute board is generally not binding on the parties. Consequently, subject to any contractual requirements, often, dispute board decisions are referred to arbitration
  • Conciliation: The Arbitration and Conciliation Act 1996 (as amended in 2015 and 2019) provides a framework for settling disputes through conciliation. Conciliation is a non-binding procedure in which a neutral conciliator assists the parties in reaching an amicable settlement of their dispute in an independent and impartial manner.28 The conciliator may make proposals for settlement or formulate the terms of a possible settlement. Section 30 also empowers a sole arbitrator or arbitral tribunal to encourage parties to conciliate and clarifies that doing so is compatible with the parties' arbitration agreement. If a settlement is reached, it can be recorded in the form of an arbitral award and is enforceable in court
  • Mediation: Mediation in India is divided into two categories: judicial mediation and private mediation.29 The mediator facilitates the settlement process, while the parties are free to decide according to their convenience and terms. In August 2019, India signed the Singapore Mediation Convention, which aims to facilitate the enforcement of a mediated settlement agreement in foreign jurisdictions30
  • Litigation: The hierarchy of courts in India is broadly divided into: local or district courts; regional High Courts; and the Supreme Court of India. Foreign investors may be reluctant to agree to this choice, due to the possibility of having to engage with an unfamiliar judicial process. They also often have concerns about the independence, impartiality and efficiency of the Indian courts
  • Arbitration: The Arbitration and Conciliation Act 1996 (as amended in 2015 and 2019) contains the framework for arbitration in India. The act is modeled on the 1985 UNCITRAL Model Law and the UNCITRAL Arbitration Rules 1976. Arbitration is a popular choice of dispute resolution for construction contracts, particularly international contracts. The Arbitration Act covers both domestic arbitration (involving all Indian parties) and international commercial arbitration (involving at least one foreign party). If the "legal seat" of the arbitration is in India, then Indian courts will have supervisory jurisdiction over matters such as the appointment of arbitrators, interim relief and set-aside proceedings. Even though India's arbitration landscape has evolved as arbitration-friendly, foreign investors may still prefer to choose institutional arbitration under the auspices of the LCIA, SIAC, ICC or the like and their specialized arbitration rules, which offer consistency, transparency and predictability.

That said, India's ongoing efforts to modernize its arbitration framework have led to a number of arbitration institutions being established in India. These include:

  • The Delhi International Arbitration Center, New Delhi
  • The Indian Council of Arbitration, New Delhi (which also offers specialized Dispute Board services)
  • The Mumbai Center for International Arbitration, Mumbai

 

1 World Bank, https://data.worldbank.org/indicator/SP.POP.TOTL?locations=IN.
2 World Bank, https://data.worldbank.org/indicator/NY.GDP.MKTP.CD?locations=IN.
3 Press Information Bureau, Ministry of Finance, Government of India https://pib.gov.in/newsite/PrintRelease.aspx?relid=186413.
4 https://www.investindia.gov.in/sector/construction. See also https://www.giiresearch.com/report/time270376-construction-india-key-trends-opportunities.html, which reports that India's construction industry regained growth momentum in 2018, with output expanding by 8.8% in real terms, an increase from 1.9% in 2017. This was driven by positive developments in economic conditions, improvement in investor confidence and investments in transport infrastructure, energy and housing projects. In 2018-2019, the government increased its expenditure towards infrastructure development by 20.9%, going from INR4.9 (trillion) (US$ 75.9 billion) in the Financial Year 2017-2018 to INR6.0 trillion (US$89.2 billion) in Financial Year 2018-2019. The industry is expected to rise from a value of US$505.7 billion in 2018 to US$690.9 billion in 2023.
5 See https://www.investindia.gov.in/sector/construction (Snapshot: Building a sustainable future).
6 See https://www.investindia.gov.in/sector/construction (Snapshot: Building a sustainable future).
7 See https://www.investindia.gov.in/sector/construction (Snapshot: Building a sustainable future).
8 See https://www.investindia.gov.in/sector/construction (Snapshot: Building a sustainable future).
9 Among others, 100% FDI is permitted in construction (development) projects such as: (1) development of townships; (2) residential/commercial premises; (3) roads or bridges; (4) hotels, resorts; (5) educational institutions; (6) recreational facilities; and (7) city and regional level infrastructure (see India's FDI Policy for 2020, available at https://static.investindia.gov.in/2020-04/FDI%20Policy%202019%20revised_19%20April%202020.pdf).
10 According to the restrictions, any investing entity (1) that belongs to/ is incorporated in a country sharing a land border with India; or (2) that is beneficially owned by a citizen of or a person situated in a country sharing a land border with India must obtain approval (from the Government of India) prior to making its investment. These restrictions came into effect on 22 April 2020. The following transactions will require government approval: (a) direct acquisitions; (b) indirect acquisitions; and (c) transfer of existing foreign investments that resulting in beneficial ownership by a foreign investor from a country that shares a land border with India. (see Department of Economic Affairs Notification No. S.O. 1278 (E) dated April 22, 2020, available at http://egazette.nic.in/WriteReadData/2020/219107.pdf.).
11 Indian Contract Act, 1872, s. 2(h).
12 Indian Contract Act, 1872, s.10.
13 Sumeet Kachwaha and Dharmendra Rautray, 'India: Construction and Engineering Law 2019', The IGLG to: Construction & Engineering Laws and Regulations, July 2019, question 1.7, available at: https://iclg.com/practice-areas/construction-and-engineering-law-laws-and-regulations/india/.
14 Probal Rose, Laxmi Joshi and Ramesh K Vaidyanathan, Getting The Deal Through, 'Construction: India', August 2018, question 8.
15 Maula Bux v. Union of India, 1969 (2) SCC 554; Oil & Natural Gas Corporation Limited v. Saw Pipes Limited, (2003) 5 SCC 705.
16 Fateh Chand v Balkishan Das, 1964 SCR (1) 515; MBL Infrastructure Ltd v. Ircon International Limited, 2016 SCC Online Cal 7747; and Ultratech Cement Limited v. Sunfield Resources Pty. Ltd, (2016) SCC Online Bom10023.
17 Binsy Susan, Adarsh Ramakrishnan and Amogh Srivastava, GAR Know how, 'Construction Arbitration: India', question 30, available at: https://globalarbitrationreview.com/jurisdiction/1006155/india.
18 Binsy Susan, Adarsh Ramakrishnan and Amogh Srivastava, GAR Know how, 'Construction Arbitration: India', question 31, available at: https://globalarbitrationreview.com/jurisdiction/1006155/india.
19 Lily White v Manuswami, AIR 1966 Mad 13.
20 Soham Lal Passi v P. Sesh Reddy and Ors, 1996 SCC (5) 21, New India Assurance Co Ltd v Savitri Parag and Ors, 2002 ACJ 1781, B.V Nagarahu v M/s Oriental Insurance Co Ltd, (1996) 4 SCC 647.
21 Probal Rose, Laxmi Joshi and Ramesh K Vaidyanathan, Getting The Deal Through, Construction: India, August 2018, question 21.
22 Binsy Susan, Adarsh Ramakrishnan and Amogh Srivastava, GAR Know how, 'Construction Arbitration: India', question 33, available at: https://globalarbitrationreview.com/jurisdiction/1006155/india.
23 Sumeet Kachwaha and Dharmendra Rautray, 'India: Construction and Engineering Law 2019', The IGLG to: Construction & Engineering Laws and Regulations, July 2019, question 3.9, available at: https://iclg.com/practice-areas/construction-and-engineering-law-laws-and-regulations/india/; Binsy Susan, Adarsh Ramakrishnan and Amogh Srivastava, GAR Know how, 'Construction Arbitration: India', question 16, available at: https://globalarbitrationreview.com/jurisdiction/1006155/india.
24 Probal Rose, Laxmi Joshi and Ramesh K Vaidyanathan, Getting The Deal Through, Construction: India, August 2018, question 20.
25 Probal Rose, Laxmi Joshi and Ramesh K Vaidyanathan, Getting The Deal Through, Construction: India, August 2018, question 23.
26 Binsy Susan, Adarsh Ramakrishnan and Amogh Srivastava, GAR Know how, 'Construction Arbitration: India', question 9, available at: https://globalarbitrationreview.com/jurisdiction/1006155/india.
27 For example, in Energy Watchdog and Others v Central Electricity Regulatory Commission, (2017) 14 SCC 80, the Supreme Court held that an unexpected rise in the price of the commodity would not absolve the party to a contract from performing its part.
28 The Arbitration and Conciliation Act 1996, section 67(1).
29 Section 89 of the Code of Civil Procedure 1908 sets out that where it appears that there exist elements of a settlement, which may be acceptable to the parties, the Court shall formulate the terms of settlement and refer it to the parties for their observations. Following this, the Court may refer the settlement for mediation. Where a dispute has been referred to mediation, the Court shall effect a compromise between the parties.
30 Irish Ng, Kluwer Arbitration Blog, The Singapore Mediation Convention: What does it mean for the Future of Dispute Resolution, 31 August 2019 available at: http://arbitrationblog.kluwerarbitration.com/2019/08/31/the-singapore-mediation-convention-what-does-it-mean-for-arbitration-and-the-future-of-dispute-resolution/?doing_wp_cron=1589776330.7040979862213134765625.

 

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